A bright side to the border tax

The first weeks of President Trump’s administration have been eventful, to say the least. And on economic policy, many of the recent moves affect Canada directly. Approving the Keystone XL pipeline, for example, is a valuable boost to our economy, but cancelling the Trans-Pacific Partnership is not.

And in the coming months, some ambitious proposals are on the agenda, from corporate tax reform — which features an ominous sounding “border adjustment tax” — to re-negotiating NAFTA. Though it’s hard to know how things will play out, and some concern is warranted, much of the public discussion misunderstands the nature of the proposed changes or neglects potential benefits for Canada. There’s reason for much more optimism.

Let’s start with the border adjustment tax. With $400 billion in exports from Canada to the U.S. last year — equivalent to 20 per cent of our economy — any proposal featuring the words “border” and “tax” creates understandable apprehension. But while it may sound like a protectionist tariff, it isn’t.

A key part of Republican House Speaker Paul Ryan’s corporate tax reform plan includes levying taxes based on where a good is sold, not where it is produced. Imports to the U.S. would be included in the new corporate tax base while exports would not be. This should sound familiar. Here in Canada, we charge GST on imports, but not on exports. It’s not protectionism because all goods purchased in Canada are subject to the GST, whether they’re imported or not. This will also be true under Ryan’s proposal. There are other complications, to be sure, but economists have long known such border adjustments are nothing like tariffs and are not necessarily trade distorting.

Even so, Canada may still be affected. In his FP Comment column recently, economist Jack M. Mintz noted one downside for Canada in the Republican tax proposal: the reform would improve U.S. tax competitiveness, potentially drawing investment dollars away from Canada. It’s an important point, but there are also some potential upsides for Canada.

First, comprehensive corporate tax reform could measurably increase U.S. investment and productivity. Analysis of a similar tax reform proposal in 2005 by then president George W. Bush’s Treasury Department suggests potential long-run gains in the U.S. national income of between 1.4 to 4.8 per cent (depending on the method used). With a stronger U.S. economy comes larger export opportunities for Canadian producers and cheaper imports for Canadian consumers. It’s tough to quantify precisely the gains to Canada, but with the help of a modern workhorse trade model, I roughly estimate a productivity increase that boosts long-run U.S. national income by three per cent could add nearly $2 billion to Canada’s economy.

Second, U.S. savings may rise. One critical aspect of the Ryan plan makes capital investment immediately and fully deductible from a corporation’s tax liability. This effectively makes the tax on new investment zero, increasing the incentive to save and invest. The same Treasury analysis mentioned earlier estimates the U.S. capital stock could grow by between five and 20 per cent (again, depending on the method used), funded primarily from increased domestic saving. So while Canada’s tax competitiveness relative to the U.S. might fall, there is more investment to go around.

This intuition carries over to more than just tax reform. Consider the new administration’s goal of lowering regulatory burdens on business. Estimates vary, but a recent survey by the Congressional Research Service finds that regulations could be costing the U.S. economy from as little as US$70-100 billion per year to as much as US$2 trillion. As with tax reform, trade linkages mean any boost to the U.S. economy benefits Canada too. Instead of being a threat, improved competitiveness south of the border is a potential opportunity north of it.

Finally, mutually beneficial opportunities even exist within that largest of elephants in the room: renegotiating NAFTA. Trade benefits both parties. What politicians might call a “concession” is often nothing of the sort. Consider dairy, one of Canada’s most heavily protected sectors. If the U.S. can successfully force Canada’s hand in finally liberalizing our supply-management system, consumers here could gain nearly $3.5 billion from the resulting lower prices, according to recent estimates from the OECD. Incidentally, Wisconsin is not only a source of valuable Electoral College points for Trump and the home of House Speaker Paul Ryan, but also one of the largest and most productive dairy producers in the country.

Whether Republicans in Congress and President Trump in the White House can successfully reform the tax code, ease regulations, and improve (rather than scrap) trade arrangements remains to be seen. But there’s reason for optimism. Global trade and investment are not zero-sum games. What’s good for the U.S. economy is often good for Canada’s.