GOP Tax Bill Threatens Global Economy

If the Republican tax bill wasn’t already offensive enough in its attempt to transfer billions of dollars of wealth from low and middle income earners to the most wealthy among us with the least need, it is also turning into yet another foreign policy disaster for the Trump administration.

According to the Wall Street Journal, the finance ministers of the five largest European economies are protesting that the tax bill violates WTO rules and contains what are arguable protectionist measures that violate double taxation treaties the US is a party to. In a letter to Treasury Secretary Steve Mnuchin, the finance ministers write that the tax bill “could contravene the U.S.’s double-taxation treaties and may risk having a major distortive impact on international trade…It is important that the U.S. government’s rights over domestic tax policy be exercised in a way that adheres with international obligations to which it has signed up.”

The Journal notes that “Two provisions in particular have prompted pushback from foreign executives, overseas trade bodies and politicians. One, contained in the House version, proposes a 20% excise tax on U.S.-based affiliates of foreign firms. Another provision, in the Senate version, attempts to shore up ‘base erosion’ — or the decrease in a country’s tax base when firms shift profits to jurisdictions with lower taxes.”

According to the Europeans, the 20% excise tax would discriminate against foreign companies doing business in the US, thereby violating WTO rules and the double taxation treaties. The “base erosion” provision would make cross-border transactions between subsidiaries of the same firm subject to a 10% tax, potentially severely restricting the finance and insurance industry. Finally, an item in the Senate version that provides preferential treatment for some types of foreign incomes could be construed as an subsidy that is currently banned by international trade rules.

Now, much of the foreign impact of the tax bill is doing exactly what Trump promised during the campaign, namely providing incentives for businesses to relocate to the US. Its provisions specifically hurt large foreign exporters to the US such as China, Japan, and Germany, again part of the declared Trump agenda. But the bill will also be a windfall for passive foreign investors in US businesses due to the lower corporate tax rate. Some estimates have put this benefit at around $700 billion. Perversely, at the same time, it will actually punish foreign companies that invest in new plants and facilities inside the US, especially those with integrated international supply chains such as automakers, due to the very provisions the EU ministers object to.

We can see these perverse effects already when we look at what Broadcom, the Singapore-based semiconductor giant, is doing. Broadcom is re-domesticating itself back to the US in a move touted as a big win for American workers by the Trump administration. The reality is a little bit different. The sole purpose of Broadcom’s relocation was to mount a takeover of its US-based competitor Qualcomm. Admittedly, the primary driver of this move was regulatory but there is no doubt that the tax proposals also provided an incentive for Broadcom.

The problem, of course, is that Broadcom’s takeover of Qualcomm will actually end up reducing US employment due to the overlapping jobs in both companies. The Times estimates that prior Broadcom mergers indicate that the over 5,000 US jobs could be lost when the two firms become one. And, in fact, under the current tax plan, there would be an actual incentive for foreign companies to simply relocate the corporate headquarters to the US, buy up US companies, and then actually cut US jobs, exactly the opposite of what the bill was intended to do. More importantly, the bill’s violation of trade and tax rules and treaties could begin the unwinding of those international agreements and a protectionist race to the bottom across the industrialized world. This would almost be a replication of the disastrous Smoot-Hawley tariffs in the wake of the Great Depression that dampened global trade and extended the depression years longer than necessary. Such an unraveling would raise the cost of goods around the world and probably provoke another global recession.

As I’ve said many times before, the problem with globalization is that, in any individual country, it will create winners and losers. The job of each country’s government is to make sure that the gains to the winners are redistributed somewhat to the losers in order to help them transition to the new economy, rather than let all the benefits accrue to the handful of winners. Here in the US and in most of the rest of the world, governments have failed miserably at that requirement. But the answer is not to institute protectionist policies that will end up hurting everyone in the end.

Originally published at tidalsoundings.blogspot.com on December 12, 2017.

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