RISKS UNDER TRUMP’S POTENTIAL TAX PROPOSALS

Donald Trump was catapulted to the US presidency on a crusade to “Make America Great Again,” and since his inauguration has attempted to deliver on that pledge. He has already issued Executive Orders to fulfill controversial campaign promises, including a withdrawal from the Trans-Pacific Partnership, the dismantling of Obamacare, and a Muslim travel ban.

He has softened his stance on some fronts.

He agreed to honor the “One China” policy, subduing concerns of him further straining America’s glacial relations with China. He welcomed Japanese President Shinzo Abe to the White House, signaling that the US will work to remain an important player in Asia. Positive developments notwithstanding, Trump is known for his rash remarks, making it difficult to gauge his commitments.

Trump has been consistent one front: trade. He has sustained his protectionist views, focused on bringing back jobs and corporate activities to his country. Although China and Mexico have been the regular targets of Trump’s economic provocations, the Philippines may find itself caught up in his political whims. The Trump team’s tax proposals, if enacted, could have serious effects on this country.

President Duterte’s “pivot to Asia” might have been prescient. However, the US is still the most dominant nation in the world; policy shifts in the US will have repercussions in the global economy, especially for emerging markets.

BORDER TAX ADJUSTMENT

Washington is currently debating an overhaul of the tax system. Under the main proposal in the House of Representatives, the corporate tax rate will be lowered from 35% to 20%.

To compensate for the foregone revenue, the Republicans have proposed a “border tax adjustment,” which US tax analysts say would effectively subsidize exports and tax imports.

By increasing the tax burden on importers, the proposal is expected to narrow the trade deficit and generate $ 1 trillion over a decade. Ultimately, its goal is to encourage domestic investment and discourage companies from moving jobs and their headquarters outside the US.

With the US as the Philippines’ third largest trading partner, a border tax adjustment on goods can adversely affect our exporters. Merchandise exports to the US totaled $ 4.27 billion in the first half of 2016, making up 16% of Philippine exports. The US is also one of the top destinations for electronic products, with a 17% ($ 1.84 billion) of our electronics exports headed there.

Theoretically, a border adjustment will eventually result in a stronger dollar, offsetting the tax increase as imports become cheaper. However, the dollar may have to rise by 15% to 25% to neutralize the effect of the tax on trade. A stronger dollar would make it harder to service dollar-denominated debt. On the upside, although over 60% of the Philippines’ external debt stock is denominated in US dollars, the bulk of our debt is in medium to long-term accounts, spreading out the exposure to foreign exchange fluctuations.

TAXING REMITTANCES

During the campaign trail, Trump vowed to build a wall along the Mexico-US border.

More recently, he suggested that Mexico would shoulder the cost of the border wall by blocking transfers and remittances. The details surrounding the wall are still nebulous, but a tax on remittances is a serious possibility. While only Mexico has been singled out in Trump’s rhetoric, a policy could be applied more generally.

If so, the Philippines, which counts remittances as its highest source of foreign revenues, faces a significant risk. Bulk of overseas Filipinos’ remittance inflows in the country originates from the US, totaling $8.06 billion for the first 11 months of 2016. Although the share of remittances from the US has declined by over 30 percentage points since 2000, at the present level they still comprise a third of total inflows.

The impact of remittances to both the economy and the country’s social fabric are well documented. Around 95% of households with at least one OFW receive remittances. The Bangko Sentral ng Pilipinas’ latest Consumer Expectations Survey ( CES) reveals that households receiving remittances primarily spend it on food and other household needs, education, and debt payments. Given the country’s underdeveloped financial system, particularly in more remote areas, remittances have been instrumental in smoothing out household consumption.

A tax on remittances would only raise the cost of sending money and reduce the incentive for overseas Filipinos to remit funds through a formal medium.

The International Monetary Fund (IMF) reports that remittances are underreported by at least 50%, as a substantial amount of transfers are coursed through informal networks. A decline in overall transfers as a result of higher costs, would have serious implications in the country’s consumption- driven economy. Moreover, remittances that are not coursed through a regulated financial system only make it more difficult for governments to track and arrest money laundering, terrorist financing, and other illegal activities.

It will take some time before these tax proposals reach their final form. While our economy continues to move in a positive trajectory, global risks are growing amidst an increasingly protectionist environment. We cannot just rest on our laurels.

With the US as the Philippines’ third largest trading partner, a border tax adjustment on goods can adversely affect our exporters.