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A U.S. border tax won’t fix trade deficit, but it could clobber Canada

President-elect Donald Trump speaks during a news conference in the lobby of Trump Tower in New York, Wednesday, Jan. 11, 2017, in New York.

Evan Vucci/AP Photo

The good news is that Donald Trump didn't mention Canada once during his rambling and combative news conference this week.

Mexico, yes. China, too.

But just because Canada isn't the main target of the U.S. president-elect's wrath as he prepares to move into the White House doesn't mean there won't be heavy collateral damage here.

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Mr. Trump's vow to repatriate U.S. jobs and slap a "big border tax" on companies that shift work offshore is sending shudders through Canada's business community – particularly the auto sector.

Trump spokesman Sean Spicer confirmed Friday that Canada would not be immune if a company move harms U.S. workers.

No other country is more exposed to U.S. trade than Canada. And no country – with the possible exception of Mexico – would suffer more if Mr. Trump and the U.S. Congress go ahead with this misguided and likely illegal border-tax scheme.

Just exactly what the United States will do is unclear at this point. Mr. Trump appears to be talking about selectively punishing U.S. companies that move production out of the country (heads up, General Motors, Apple and others).

Republicans in the House of Representatives are proposing something much broader: the creation of a "border-adjusted" corporate tax regime that would tax all imports – while exempting exports. Under the Republican plan, the U.S. tax rate would be cut to 20 per cent from 35 per cent. U.S. companies would pay no tax on revenues they generate from exports but would face the full 20-per-cent levy on all imports.

It is a seductive idea in a country that currently has one of the highest corporate tax rates in the world. The current system gives U.S.-based multinationals a perverse incentive to lower their tax bills by shifting profits and operations offshore.

But this idea isn't being sold to Americans as a way to create a more rational tax system. Instead, the rhetoric is all about boosting the economy, wiping out the chronic U.S. trade deficit and bringing manufacturing jobs back to the Rust Belt.

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"The word is now out that when you want to move your plant to Mexico or some other place and you want to fire all of your workers from Michigan and Ohio and all these places that I won, [it's] not going to happen that way any more," Mr. Trump told reporters. "There will be a major border tax on these companies that are leaving and getting away with murder."

The notion that taxing imports will supercharge the U.S. economy is pure fantasy. It won't significantly reduce the trade deficit or spur GDP growth, largely because a tax would push up the value of the U.S. dollar and conversely depress other currencies, including the Canadian dollar. Americans would buy fewer imported goods, reducing the supply of U.S. dollars. In turn, a border-adjusted tax would subsidize exports, increasing demand for cheaper U.S. goods and the dollars needed to buy them.

So it ends up a wash. And the burden will fall heavily on U.S. consumers and service-sector workers.

The proposed tax would also likely run afoul of the World Trade Organization, which has ruled previously that tax exemptions on exports are illegal unless they are structured as value-added consumption taxes (like Canada's GST or Europe's VAT). Canada, Europe and much of the rest of the world would challenge it, triggering a potentially destructive trade war.

But just because a U.S. border tax is nonsensical and probably illegal doesn't mean Congress and the Trump administration won't give it a whirl anyway.

The U.S. has been down this road before. In 1971, President Richard Nixon imposed a 10-per-cent surcharge on most imports and introduced export tax breaks – a response to a persistent current account deficit. The U.S. opted to exempt raw materials, including crude oil, and cars from Canada, but the levy was still highly damaging.

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A new border tax would be unambiguously bad for Canada. National Bank of Canada says in a research note that a 10-per-cent tax would send non-oil exports plunging 11 per cent. Economists Dan Ciuriak and Jingliang Xiao similarly argue in an upcoming C.D. Howe Institute study that Canada would take a "significant hit" from such a tariff, wreaking havoc on cross-border supply chains in industries such as autos.

And forget about getting even. Mr. Ciuriak and Mr. Xiao conclude that tariff retaliation would only magnify the damage to Canada's economy while inflicting only modest pain on the U.S.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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