The imposition of a border adjustment tax (BAT) by the United States would hit Canadian exporters hard, according to a C.D. Howe Institute report. In Aftershocks: Quantifying the Economic Impacts of a US Border Adjustment Tax, authors Dan Ciuriak and Jingliang Xiao find a BAT would be trade-distorting and economically damaging to the United States and its trading partners.
The BAT is part of a proposed tax package in the US Congress that involves the repeal of the US corporate income tax, which is currently levied at 35% of taxable profits, and its replacement with a so-called destination-based cash-flow tax (DBCFT) levied at 20% for incorporated businesses and 25% for unincorporated businesses. Like a Value-added Tax, the BAT would incorporate border adjustments: It would tax imports and exempt exports.
They find an initial strong import-reducing and export-expanding effect from the BAT would drive up the value of the US dollar in international currency markets and thereby undermine the newfound competitiveness of US export-oriented businesses while eroding the protection afforded by the BAT to US import-competing businesses. In the end, it could be a wash on net exports, while addressing issues unrelated to trade but rather to international gaming of the US tax system by its own multinational corporations. However, when a stylized version of a BAT is evaluated in a quantitative economic model that takes into account firm-level business decisions in response to the new set of incentives, the authors conclude that the BAT is not neutral at the aggregate level, has pervasive sectoral impacts, and overall negative impacts on the United States and its trading partners.
Canada would not fare well. "The import component of a BAT would impact heavily on US firms’ decisions on sourcing from Canada. Canada absorbs a good portion of the tariff while still feeling a significant shift in US firms switch to domestic inputs. Overall, we find that the BAT would reduce Canada’s real GDP by almost 1 percentage point and Canadian prices by about 2 percentage points," say the authors.
Canada’s exports to the United States are heavily weighted to intermediate inputs, including raw materials, basic fabricated materials, and manufactured inputs such as auto parts that go into value chains sponsored by US multinationals. The authors find Canada’s worst-hit industries in terms of reduced exports would include: autos, fossil fuels, and machinery and equipment.
Dan Ciuriak is Fellow-in-Residence with the C.D. Howe Institute (Toronto), Senior Fellow with the Centre for International Governance Innovation (Waterloo), Associate with BKP Development Research & Consulting GmbH (Munich), and Director and Principal, Ciuriak Consulting Inc. (Ottawa).
Jingliang Xiao is a Research Associate with Ciuriak Consulting and responsible for policy modelling.