So far, Canadian manufacturers have escaped U.S. president-elect Donald Trump's Twitter tirades, but Canada may not be able to dodge the new U.S. government's protectionist measures.
Lurking in a Republican blueprint to overhaul the U.S. tax code is a policy that has the potential to hurt Canada's economy: a border adjustment tax.
The measure was crafted by the most powerful congressional lawmaker, House Speaker Paul Ryan, and is part of the Republican Party's plan to revamp tax policy and entice businesses to operate in the United States.
The Republican blueprint provides very few details on how the border tax would work. This is what we know so far.
What is a border adjustment tax?
The border adjustment tax is designed to boost domestic production and U.S. exports. It is also aimed at stopping so-called corporate tax inversions, in which U.S. companies move their headquarters to another country with a lower corporate tax rate to reduce their taxes.
The border adjustment tax would effectively tax imports to the United States at the corporate tax rate, and exempt from taxation the profits made when companies export from the country.
If the U.S. corporate tax rate is slashed from the current 35 per cent to 20 per cent – as the Republican blueprint proposes – that means a 20-per-cent tax would be slapped on imports to the United States.
For example, a car that was assembled in Canada and then imported to the United States would be taxed at 20 per cent. Meanwhile, the U.S. engine exported to Canada would not be taxed.
"Under current law, if you import something, that is deductible like any other business expense," said Hendrik Brakel, senior director of tax policy with the Canadian Chamber of Commerce.
"Under a border tax, you can no longer deduct the cost of imports. It effectively ends up being a 20-per-cent tariff," he said.
Impact on Canada?
A border adjustment tax would penalize all exporters to the United States. But the impact on the country's closest trading partners, Canada and Mexico, would be the most severe.
About 75 per cent of Canadian exports go to the United States, accounting for about a fifth of Canada's economic output, according to Toronto-Dominion Bank research.
A tax on Canadian exports to the United States would make Canadian products more expensive. It would force U.S. businesses to look elsewhere for cheaper products and slow trade with Canada's largest trading partner.
"On its face, this proposal is devastating," said Daniel Schwanen, vice-president of research with the C.D. Howe Institute think tank. "This could really hurt trade and millions of workers in Canada," he said.
According to the Canadian Manufacturers & Exporters (CME) group, it would be a logistical nightmare because manufacturing parts are difficult to track and finished products contain varying amounts of Canadian content.
For example, car parts move across the Canada-U.S. border multiple times before a vehicle is ready to be sold to a customer.
"How would they tax a vehicle?" said Mathew Wilson, senior vice-president of CME, which represents 90,000 manufacturers across Canada. "The majority of cars going into the U.S. have more U.S. content than Canadian content."
According to Mr. Wilson, there isn't a system in place to trace products to their country of origin. The 1965 Auto Pact between the United States and Canada, as well as the North American free-trade agreement, allow most manufacturing parts to move freely between countries without being taxed.
"Would you tax the full value, or do you only tax the amount that came from Canada?" Mr. Wilson said. "How do you even figure out the amount that came from Canada. There is no regulation or law that asks for how much comes from Canada. All you have to track is how much comes from the NAFTA partners."
The tax proposal wouldn't necessarily give U.S. exporters a lasting advantage, though. Economists believe the tax would cause the U.S. dollar to rise sharply – making U.S. exports more expensive and other countries' goods, including Canada's, cheaper to import.
Countries most exposed to a border-adjustment tax
A measure from TD Securities ranks Mexico and Canada as the most exposed
|Country||Exports to the US (% of total)||Exports (% of GDP)||Exports to the US (% of GDP)||Total Impact Score|
Source: TD Securities, Bloomberg
Note: Ordered by Total Impact Score, a sum of the previous three columns
Odds of becoming law?
For the first time since 2006, Republicans will control the White House, the House of Representatives and the Senate.
In theory, that means Republicans should have an easier time passing laws. But there are roadblocks. Republicans only have a slim 52-48 majority in the Senate and it is unknown what kind of support there is for a border adjustment tax.
Republicans and Mr. Trump agree on cutting the corporate and individual tax rate, but there are sharp disagreements over Mr. Trump's protectionist policies.
Retailers, tech companies and other importers would likely oppose the tax and lean heavily on lawmakers to scrap the measure.
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