Under Trump’s plan, Mexico won’t pay for wall

Last week, Donald Trump signed an executive order directing construction of the border wall between the United States and Mexico, one of his signature campaign promises. After President Trump restated his claim that Mexico would pay for the wall, President Enrique Peña Nieto of Mexico promptly canceled a planned meeting with Trump for the following week. The next day, White House press secretary Sean Spicer announced a plan that the wall would be funded through placing a 20 percent import tax on all imports from Mexico.

What exactly is an import tax and who pays it?

An import tax is a tax levied by the federal government on foreign goods shipped to the United States for sale in the United States. The tax is typically collected at customs upon entry. The importer pays the tax and passes some of that cost on to consumers by raising the sales price of the good.

If Trump follows through with his import tax plan, American consumers would likely pay more for goods imported from Mexico, although it is difficult to estimate the precise amount. The chief executive of Toyota estimated that the cost of a Toyota Camry, which is made in the United States but with 25 percent of its parts imported from Mexico, would increase by $1,000. As Mexico is our third-largest trading partner, this tax would significantly affect our economy, and certain sectors in particular. Mexico’s top exports to the United States are vehicles and parts used in the assembly of Americanmade cars in U.S. factories, as well as electronics, crude oil and vegetables. In each affected sector, producers would have to decide how much of the tax to pass on to consumers and how much to absorb themselves.

What is a border adjustment tax?

Another idea, proposed by House Republicans, would take the form of a border adjustment tax. This proposal would reform the corporate tax code to allow companies to deduct export sales from their tax bill, while removing the provision in the current code that allows firms to deduct importing costs. Trump has denounced this plan as “too complicated,” and it is unclear how the swapping of an export sales tax for what is essentially an import tax would affect government tax revenue, the value of the dollar and trade volumes.

Because most exporters are also importers, this tax will primarily affect the biggest, most productive U.S. firms. Evidence suggests that policies designed to limit imports also negatively affect export performance, an outcome that would threaten U.S. jobs.

What are the likely political and economic outcomes of a 20 percent tax on Mexican imports?

Standard economic theory suggests that this tax would hurt consumers and society as a whole by making the cost of goods more expensive and limiting the variety of foreign goods that are available to the public. The likely winners from trade protection are domestic firms that produce the goods that compete with Mexican imports and people working for those firms.

Yet most leading U.S. firms are deeply integrated into global supply chains and import a substantial amount of their production inputs - automobile parts, aircraft parts, electronic equipment, machinery - before exporting the final product. Some industries, such as the auto industry, import most of their component parts from Mexico. The transnational nature of modern production systems is a reason recent political science research has found that leading firms lobby not for protection, but for trade liberalization.

How is Mexico likely to respond?

Mexico is likely to retaliate against an import tax by levying a similar tariff on U.S. exports to Mexico. This hurts U.S. exporters by making our goods less competitive than goods produced elsewhere. U.S. automakers, for example, would be doubly hurt: Not only would they pay the 20 percent import tax on parts from Mexico, but they would also have to pay the retaliatory tax levied by the Mexican government when finished cars are exported to Mexico. U.S. consumers would also feel the effects of both tariffs when purchasing goods imported from Mexico that were manufactured with Americanmade inputs. The complexity of North American supply chains means that a trade war between the United States and Mexico would result in higher prices on both sides of the border.

Because trade policy is made reciprocally, smaller firms that are not globally integrated are less likely to support trade liberalization than the larger firms with global supply chains. My research shows that this intraindustry cleavage is changing the lobbying landscape in the United States, as industry associations are increasingly hamstrung by the competing trade preferences of their member firms, and individual firms are becoming more politically active.

Is this tariff legal under World Trade Organization trade rules?

Another possible outcome is that Mexico takes the United States to court at the World Trade Organization, as Trump’s proposed tariff likely runs afoul of WTO trade rules. This would initiate a costly and protracted legal battle, funded by U.S. taxpayers, but which the United States would probably lose. If the United States did lose such a case, the WTO would allow Mexico to impose “trade remedies,” retaliatory measures that would punish U.S. exporters to Mexico.

These measures would likely affect a range of U.S. industries and could lead to layoffs in the United States. Mexico could target industries that would be especially politically painful for the United States. A trade war between the United States and Mexico would benefit firms from other major trade partners, such as China, Japan, South Korea and the European Union as U.S. and Mexican products become more expensive and less competitive in each other’s markets.

What is the history of trade protection?

A large body of research suggests that trade protection slows economic growth by making goods more expensive, reducing consumption and reducing firm competitiveness, which makes it difficult for firms to expand and hire more workers. It makes economic downturns even worse, as during the period after World War I, when global trade ground to a halt, raising tensions between nations and arguably creating the perfect conditions for a Second World War. Trade protection may make war more likely, as countries are less likely to fight wars with their trading partners.

Through an import tax, Trump may be able to raise the revenue to build his promised wall. But it wouldn’t be Mexico who would pay for it: The costs would fall heavily on U.S. consumers, U.S. firms and U.S. workers.