What America's proposed border tax means for your business

Posted by: Kaitlyn Mason on February 27, 2017

Although President Trump's proposed border tax has a long way to go before it becomes official policy, it may have serious implications for Canada’s economy. Here our Economic Policy Analyst, Franco Terrazzano, explains the proposed tax, and why it matters to you.

The new Trump administration has been anything but dull, especially with respect to foreign policy. From a Canadian business perspective, one of their most controversial announcements so far has been their consideration of a border adjustment tax.

But what exactly is this new, proposed tax?

Along with providing the necessary funds to build The Wall between the United States and Mexico, the border tax is a part of a scheme to reform America’s corporate tax structure and aid in reducing their $500 billion trade deficit.

The American corporate tax rate is 35% - one of the highest in the world. The current rate is applied on all profits made by American companies, regardless of where the profits are earned. As a result, multi-national companies with locations around the world may take the opportunity to claim their profits in a different jurisdiction with a lower corporate tax rate.

Under the proposed system, the corporate tax rate will drop from 35% of 20% and will be applied only on goods and services sold within the United States.

The border tax makes good on Trump’s campaign promises by discouraging firms from setting up shop abroad, then selling back into America. This tax scheme also relieves pressure felt by American firms who face international competition. With the border adjustment, imported goods and production inputs become relatively more expensive, and exports less expensive.

But what does this mean for Canadian businesses that sell their goods in the U.S.?

Unfortunately for Canadian businesses, this is anything but good news. Under the border tax, all Canadian goods manufactured in Canada and sold in the United States will be taxed at 20%. This policy change will increase the cost of bringing Canadian goods into the U.S. market.

Advocates of the border tax argue that the new tax structure will likely result in no net effect on foreign (Canadian) producers. This argument is based on the idea that the border tax will increase the value of the US dollar by as much as 25%, making imports cheaper and offsetting the tax.

These advocates suggest that the tax on imports will restrict the supply of dollars worldwide as Americans buy less goods from abroad. Similarly, cheaper American exports would increase the demand for U.S. dollars, as foreigners would want more USD to buy more U.S. goods. Their theory suggests that increasing demand and reducing supply will appreciate the USD to fully offset the effects of the border tax.

Unfortunately for Canadian exporters, the USD is unlikely to appreciate to the exact level that fully offsets the tax.

The first issue is that to restrict the supply of U.S. dollars worldwide, Americans must buy less goods from abroad. Thus, the amount of foreign goods sold to American consumers must be reduced – at least initially.

The second issue with the appreciation argument is that there are many different factors that contribute to a currency’s value. In fact, exchange rates depend on many macroeconomic variables, not just the demand and supply of traded goods.

Finally, the appreciation argument loses steam if Canadian businesses price their exports in USDs (which many do). If this is the case, a stronger USD may not mitigate the border adjustment tax.

Canadian exporters, and our national economy, will likely feel negative impacts from the border adjustment. The National Bank of Canada has estimated that a 10% border tax would be enough to cause Canada’s total goods sold to the U.S. to fall by 9%.

The border adjustment tax is still a proposal and has a long way to go before it becomes official policy. Nevertheless, as an organization that promotes fair economic competition, the Calgary Chamber will continue to advocate against policies that unduly put our business community at a disadvantage.

Franco Terrazzano is an Economic Policy Analyst at the Calgary Chamber.