US tax cuts could raise trade deficit: experts

The pending tax-cut legislation in the US Congress could boost the economy, but it also could increase the US trade deficit with China and other countries, according to some economists.

One goal of the tax cuts, in addition to simplifying the tax brackets for individuals, is to spur growth in the US economy and boost American companies by cutting the corporate income tax rate from 35 to 20 percent.

The House of Representatives (on Nov 16) and the Senate (on Dec 2) have passed their own tax bills and will work out a final version, which will go to US President Donald Trump to sign into law.

The tax cuts could increase the US trade deficit by at least $1 trillion over 10 years “and possibly much more”, by raising the US government budget deficit by the same amount, according to William Overholt, a senior fellow at Harvard’s Asia Center and former director of the RAND Corporation’s Center for Asia Pacific Policy.

“Much of the US trade deficit is with China, so unless something else like a trade war happens to affect the Sino-US deficit, this deficit will increase quite dramatically,” he said. “Interest groups in the US will blame this on China, but any serious economist will acknowledge that it results from the new tax system.”

The US trade deficit with China for 2017 through October stood at close to $309 billion, according to US Commerce Department data. China calculates the data differently and reports a significantly lower deficit between the two countries.

“On balance, the Republican tax plan will boost US economic activity and strengthen the value of the dollar, worsening the US trade deficit,” said Sung Won Sohn, professor of economics at California State University, Channel Islands. “As for China, the (higher) US income effect will mean more imports from China.”

On the investment side, “to the extent that the dollar appreciates, investments in the US will become more expensive (for overseas investors)”, said Sohn, however, “with stronger economic growth, the US will be a more attractive destination for Chinese investors”.

Cornell University economist Steven Kyle also said that the tax cuts would strengthen the US dollar, which in turn would make it even more attractive for the US to import rather than export.

Although, Kyle said, “I don’t see the changes in trade being a massive change from what we were likely to see anyway, more of a strengthening of existing trends.”

The trade deficit will increase because of the stimulation to the US economy, which can increase personal consumption, resulting in more imports from China, according to Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics.

If the US corporate income tax rate of 20 percent goes into effect, it will be below the 25 percent rate in China, which also may encourage Chinese investment into the US, Hufbauer said.

US corporations, however, by taking advantage of various deductions, paid an effective marginal tax rate of 18.6 percent in 2012, according to The Washington Post, which cited a Congressional Budget Office report.

In February, China amended its corporate income tax law for the first time in 10 years; the corporate income tax rate, however, remained unchanged

Overtime, there likely will be more Chinese businesses in the US, attracted by lower corporate tax rates, which will spur more competition in US industries, according to Wendy Liu, head of China equity research at Nomura Securities.

“Rising competition may help shake up some sleepy and complacent businesses in the US,” Liu said.

However, the debt levels of US and Chinese corporations may play a role in how willing each country is to hoard or invest, according to Liu.

Earlier this year, the Chinese government enacted stricter rules on capital outflows, slowing the pace of Chinese dealmaking in the US. Still, the value of Chinese foreign direct investment in the US stood at $136.5 billion through the third quarter, according to the Rhodium Group, which tracks such investments.

Overholt said that tax cuts are one of the “smaller forces” affecting Chinese investment in the US and vice versa.

The main reason China invests in the US is to acquire technology and distribution channels, while the objective of US investment in China is to access China’s vast domestic market and burgeoning middle class. None of those situations will be affected by the tax changes, Overholt said.

Hufbauer said no profits made in China will be significantly taxed going forward, except those subject to a new 20 percent excise tax in the House version of the bill. He said thatwould negatively impact the income earned by overseas affiliates of US firms.

“This is not a small change, but a huge change and may affect some Chinese firms related to US firms,” Hufbauer said. “The excise tax provision may increase the tax burden on inputs shipped from China to related US firms. Other things affect cost besides corporate income taxes, but at the margin, the US will be a more favorable location.”

Both House and Senate bills also contain provisions to persuade American companies not to move profits from the US to tax havens such as Switzerland.

The measures seek to “tax income that is very high relative to the amount of foreign subsidiary assets generating the income”, Hufbauer said.

These often are assets related to intellectual property, which account for most of the profit margin on a product.

Hufbauer gave Apple’s iPhone as an example: Though the materials to make it may cost only $40, it can sell for $1,000.

“The US is trying to tax that high-return income in countries like Switzerland, companies’ favorite places to locate IP, because they don’t tax at high rates and have strong IP protection laws,” Hufbauer said.