With these questions in mind, I reached out to my colleague at the NYU School of Law, Professor Mitchell Kane, an expert in international tax law. What follows is a lightly edited version of our conversation.
Joshua Tucker (JT): Trump’s proposal seems like it would be an effective deterrent to moving production offshore. So why are people concerned with it?
Mitchell Kane (MK): Imprisoning CEOs who moved jobs offshore would also be an effective deterrent. Absent evidence of some corruption (as might be reached by the Foreign Corrupt Practice Act), we would reject such a proposal out of hand. So the question is not whether we can imagine laws that would have the effect of keeping production in the United States. The question is whether we are willing to accept the trade-offs.
JT: What are the trade-offs in this case? Isn’t an import tariff just a fair leveling of the playing field since countries like Mexico impose a VAT (value-added tax) rebate at the border?
MK: The problem is that there are two outcomes we like: more rather than fewer U.S. manufacturing jobs and lower rather than higher prices on manufactured goods that we consume here. We need to accept that so long as labor costs are higher in the United States than in other countries, these two objectives will have to be traded off one another.
If we write rules to channel companies into higher cost structures, this will ultimately show up in consumer prices. That’s true regardless of whether Mexico rebates its VAT upon export of goods. When companies move production offshore it lowers their cost structure. Those cost savings will be passed along to consumers back in the United States eventually.
Not immediately, of course, or there’d be no incentive to offshore. But eventually American consumers are the beneficiaries of reduced costs. One way of viewing an import tariff is as an instrument that takes cost savings away from consumers and transfers them to the government.
JT: That would explain why many Republicans are hostile to the proposal. But how would this actually transfer funds to the government? It seems like the whole point is to get companies not to move. So if they don’t move the government wouldn’t actually be collecting any revenue from the tariff, right?
MK: There are two possibilities.
Suppose the tariff is set at an amount that is lower than the labor cost savings from moving offshore. For example, say the tariff captures half of the cost savings. In that case it could still be profitable to move offshore. The cost savings that are collected through the tariff are in a sense taken off the table. They cannot be passed along to the consumer because from the company’s standpoint they are no longer savings. They are costs paid to the government.
The second possibility is that the tariff is set so high that it fully absorbs any potential savings from reduced labor costs. Then there’d be no reason to move. But it would also become increasingly difficult for U.S. companies to compete with foreign companies that could use lower cost inputs and sell into the United States.
To complicate matters, we may not know which possibility we are facing. The problem is a dynamic one. The amount of tariff a company can absorb and still see profit will decrease over time as cost savings are passed forward to consumers.
Also, Trump has talked about an import tariff at a single rate. This will affect different sectors differently based on labor intensity in the sector.
JT: Isn’t the answer to the foreign competitors problem to impose a tariff on those companies as well?
MK: That did not seem to be the original Trump proposal captured in the tweet sequence above, but it has been suggested by a number of Republicans, including Newt Gingrich. Once the tariff is extended to apply to foreign firms, however, this would almost certainly lead to countervailing measures such as trade penalties imposed on U.S. exporters.
JT: It sounds like a preferable option might be to reform the corporate tax system as suggested by House Majority Leader Kevin McCarthy in his response to the Trump tariff proposal when he said he did not believe in starting a trade war. Would that prevent companies from leaving the U.S.?
MK: McCarthy clearly favors the “Better Way” tax reform blueprint put forward by House Republicans over the Trump tariff idea. Among other things, the House Republicans want to lower the U.S. corporate tax rate from 35 percent to 20 percent and adopt a “destination basis” principle that would tax imports but exempt exports in the spirit of a border-adjusted VAT.
There are many problems with our international tax system, which is sorely in need of reform. A reduction in the explicit statutory rate is almost certainly a good idea compared to the current system in which companies often plan aggressively to reduce their effective rates in any event.
But the idea that the proposals advanced by House Republicans would preserve U.S. jobs makes no sense. Their basic premise is that at least for goods sold into the United States, companies should be taxed the same whether they have domestic or foreign production.
The problem, of course, is that the underlying economics favor foreign production. If the tax system is neutral, companies will move the jobs overseas. Even worse, for products destined for foreign consumers the proposals under the Better Way blueprint will actually favor foreign production by exempting profits from U.S. tax altogether.
I come back to the basic tension. If you like markets and the cost savings they bring, the jobs have to go. If you want to keep the jobs, you have to give up some of the benefits of the market. House Republicans seem to believe that reform of the tax system will allow them to preserve the benefits of markets and to preserve jobs. They are wrong.