The Border-Adjusted Tax: War!

President-elect Trump has made several references to and has called out a number of US companies using threats of, “paying a tax at the border if you want to sell your goods in the United States”.  This is certainly a new take on the fallacious, centuries old, theory that prosperity can be achieved through forcing the residents of your own country to pay higher prices on the goods they purchase.  The border tax, as conceived, is simply another way to protect local government, in this case the US federal government and state governments, and inefficient and high-cost industries and labor from more agile foreign competitors, governments, industries and labor.

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If I want to travel from point A to point B, I can walk, run, ride a bicycle or drive.  If you are an inefficient business or industry, laborer or government, that wants to profit at the expense of your fellow citizens, you can institute a tariff, prohibit or severely limit the importation of competing products, directly subsidize specific businesses or industries or institute a border-adjusted tax.  A border-adjusted tax is most like a tariff, and like any tax, it will ultimately go to benefit the government that levies the tax or the protected business or industry, at the expense of every other American.  It is not true that foreign governments or their citizens will be the only ones to pay the tax and, thus, be damaged.  The tax will be born and paid for by the jurisdiction that levies the tax, period.  The only question in this case is; who in the United States will pay the tax?

I am not going to review the mechanics of the tax, only its consequences.  The important thing to understand is that the tax is designed to raise the cost of imports relative to domestically produced goods.  There are two scenarios under which this border-adjusted tax can play out.  Most likely, to one degree or another, both will play a part upon implementation.

Scenario 1:  Even including the additional border tax, certain domestic, US, businesses, will still not be able to compete with foreign producers.  Say, China or Mexico can produce a product for $100, a tax increases the cost to $120 in the US, but the lowest possible cost of production in the US is still $150.  The foreign producers maintain their market share and their labor force loses no jobs.  Domestically, in the US, after the tax, consumers will pay 120% more for the same imported products.  This additional cost will decrease the number of products US consumers can purchase and, all else equal, will lead to additional overall unemployment in the private sector.  The federal government will pocket the proceeds and unless they hire more government employees, lower taxes or hand out specific subsidies to the private sector (offsetting the higher cost of the imported products and the tax completely) the net job loss in the US will be higher.  Exactly where in the economy those jobs would be lost is unknown.  It would depend on pre and post-tax distribution of spending, cost structures of existing business and industries, tax legislation and potential distribution of subsidies.  At best, there will simply be a rearrangement of income and wealth in the US.

Let us consider a practical example.  Assume prior to the border-adjusted tax, California imports vehicles from Mexico each year totaling $10 million.  California sends Mexico $10 million and Mexico sends California 400 vehicles at $25,000 each.  This is done on a strictly voluntary basis and both producers and consumers are satisfied with the result.  If they were not, they would not engage in the transactions that make up the whole.  Post a border-tax that adds 20% to the cost, those exact same $25,000 vehicles now cost US consumers $30,000.  Both foreign and US-based producers would be compelled, and even obliged, to add the cost of the tax to the selling price.  Under this scenario, despite the rise in cost to US consumers, there would be no percentage loss in market share (though there may be a decline in number of units sold) as no US producer is still able to compete.

If Californians still desire the 400 vehicles, they will have $2 million less to save or spend elsewhere in the economy.  That $2 million is sitting in the Treasury of the United States government.  In the unlikely event that Washington, DC, would send $2 million in relief payments to California, it is certain that jobs will be lost in California.  The industry we call federal government, and Washington, DC, in general, would flourish due to an increase in sales “revenues to help the people”.

Alternatively, and due to the higher cost, Californians might limit their vehicle purchases to the original $10 million.  They purchase not 400, but 333 of the higher-cost products being imported (a 16.75% decline in business), causing unemployment and financial hardship in the auto dealership sector of the economy.  Their other purchases remain the same.  California now has 67 fewer vehicles, and their employment situation is destabilized.  Washington, DC, as reward for a job well done, purchases and distributes those $2 million (67 x $30,000) worth of vehicles to well-deserving lobbyists and politicians.  Of course, Washington, DC, might not purchase any new vehicles, limiting Mexico to the sale of fewer, 333, vehicles, instead of 400.  In sum total, Washington, DC, collects less tax, but more than they were collecting prior to the tax, and remains the windfall beneficiary of the loss felt in California and Mexico.

One more possibility exists.  To ensure sales remain at 400, and to combat and deter any future competition from producers in the US, the government of Mexico, producers operating in Mexico, Mexican labor, land and capital owners could, conceivably, agree to lower their costs collectively, everyone takes a hit, in order to maintain sales of 400 units to California (this, incidentally, in whole or in part, could and would happen automatically due to floating exchange rates).  Investing in more efficient methods of production would accomplish the same end, but would draw capital from other areas of the Mexican economy.  Either way, yes, Mexico suffers and Washington, DC benefits.  California is no better off.  Industry in Mexico is entrenched further and Michigan and Ohio still have no new jobs, which is what this is all about in the first place.  Further, Mexico has less money to spend on goods that are being imported from the United States, depressing exports and adding to unemployment in any number of states, areas and regions of the United States.

Scenario 2:  The border tax is sufficiently high such that certain US industries and businesses are now able to successfully compete with foreign producers.  Say, China or Mexico can produce a product for $100, a tax increases the cost to $120 in the US, and the lowest possible cost of production in the US is $110.  Not only will domestic industry gain 100% of the market share under this scenario, producers will be able to add just under an additional $10 to the price of the product and still maintain exclusive rights to markets impacted in this way by the new border-adjusted tax.  Unemployment of labor and capital resources will ensue in foreign countries.  Domestically, the US federal government will collect no additional taxes.  The tax, instead, will be collected in the form of higher prices paid by US consumers to certain businesses and labor in industries so privileged under the new tax legislation.  Using our example above, the benefit would accrue to labor and capital in Michigan and Ohio.  As consumers will have less money to spend in other industries, any employment gained in the industry and states that has benefited will be offset in full by unemployment in industries states that are now at a disadvantage.  The outcomes described under this scenario would be fleeting, immediate, and short-term impacts only.

Longer-term, and assuming the impacted foreign government did not interfere with capital and labor markets, this loss of business will reduce the cost of capital and labor such that the cost of production will decline to a point where foreign capital and labor will once again be able to compete with, and perhaps even out-compete, Michigan and Ohio capital and labor.  Eventually, a higher tax or even an outright ban of imports, will be required to protect the now higher-cost producers.  As always happens under these types of protectionist schemes, there is simply a transfer of wealth from one segment of the population to another and certainly no additional wealth will accrue to the nation as a whole.  But, it is far worse than that.

Unintended Consequences

Already, as we can see, by attempting, in a misguided way, to financially benefit a certain group of Americans, we must harm another group of Americans, not to mention our foreign allies and economic partners, in the process.  And, that any move to alter market forces will tend to be offset, or counter-balanced, by yet other economic forces such that, in the end, there is no net financial or economic benefit to the nation.  But, perhaps, some might say it is worth it if we can damage or punish the 1% or those “foreigners”; the Mexicans, the Chinese and the Californians!

What of the CEO’s and executive management teams of large global companies that are so vilified?  Those that are exporting jobs?  How about the “capitalists”?  Are they impacted in any way?  In the short run, they are, and perhaps dramatically so.  This is due to the adjustment and movement of capital and resources required by any change, let alone an unanticipated border tax, that greatly alters the global investment landscape.  If the border-adjusted tax is high enough, US capital invested in any foreign country, plants, equipment, etc., that cannot be moved or altered to accommodate some other production for local economies, will be subject to a complete write-down in value and/or abandonment.  A US border-adjusted tax, or like-kind tariff, could, quite literally, lead to the same type of capital destruction and abandonment that occurred following Fidel Castro’s government over-throw and subsequent nationalization of all foreign and domestically owned property in Cuba.  Millions, even billions, of US investments might be lost.  Powerful CEO s and other executives that lead large companies and the most wealthy capitalists, in the long-run, however, will survive, recover and even prosper.

Beyond this, and to close out our analysis of the proposed border-adjusted tax, what is the potential outcome of what amounts to economic war?  with Mexico?  with China?  or, for that matter, with California?  The Founding Fathers (FF) of the United States, specifically those that drafted, approved and ultimately ratified, The Constitution of the United States, were, in my estimation, short-sighted, egregiously and terminally, in fully accounting for the impact of the protectionism and economy-wide interference preserved in the Constitution.  The FF were well aware of the impact of mercantile policies, of highly regulating domestic commerce and privileging and protecting certain producers at the expense of other producers, but they took only limited action against preventing it.  Yes, they prohibited tariffs and other border restrictions between the states in the newly formed union.  They did not, however, forego their federal “right” to regulate commerce between, and ultimately as decided by the Supreme court within, the states.  They also preserved their “right” to regulate trade with foreign nations, governments and business interests alike.  So, while the Constitution famously created a trade-free zone and separated church and state, it failed in separating commerce and state, the economy and state and foreign trade and state.  (It also failed in separating money and state, but that’s a topic for another time.)

It is difficult to underestimate the cost of war, of lives and capital, that this error of omission may have caused through the course of history in the United States.  Sighting only two examples, however, the Civil War and World War II (WW II), we can begin to see the potential toll it has taken.  It is, of course, impossible to know for sure, but one would have to seriously question the degree of animosity between the North and South had it not been for federally legislated foreign tariffs beneficial to the North, and detrimental to the South.  If we must question this, we must then question whether the South would have ever seceded and whether there would have ever been serious disagreements on trade, let alone acts of war.  And, perhaps the United states would have been drawn in to WW II anyways, but it is unclear whether the war would have required fighting two enemies, on two fronts, simultaneously, without the Roosevelt administration, in cooperation with Congress, turning back decades of favorable trade agreements with Japan leading up to Pearl Harbor. (See How U.S. Economic Warfare Provoked Japan’s Attack on Pearl Harbor)

All in all, if you examine the inevitable hostilities fostered through a philosophy of antagonistic domestic or foreign trade policies, protectionism, or economic nationalism, it is but a direct precursor to war.

Economic Nationalism is a Philosophy of War

Few people in history have been able to express themselves, and the true nature of an issue, more eloquently and succinctly than Ludwig von Mises (1881 – 1973).  He was a true hero to freedom-minded men and women, and was, indeed, ahead of his time.  A time, in the 20th century, when intellectual thought was stuck in the early and mid-nineteenth century Utopian fantasy of socialism, and it’s offspring of nationalism, fascism and communism.  Mises always stood strong against the charlatans and snake oil salesmen of socialism.  In true fundamentalist fashion, his socialist opponents ridiculed and maligned private property and free-market principles, theories and philosophies.  And, as one socialist “theory” or fantasy after another fell to the ground, and the last vestiges of the state ownership equals prosperity lie crumbled around them, their sophistry grew more absurd, condescending and nasty.    The evidence had been mounting for decades but Mises, unfortunately, did not live long enough to witness the complete collapse and total failure of the socialist philosophy that coincided with the dismantling of the USSR.  One thing is for sure, though, he was right.  He was right about everything!

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Despite complete failure, the stubborn and backward-minded among us continue to long for the elusive promises of their 19th century demagogic heroes, forcing all of us to deal with the consequences today.  The march against Mises and the philosophies he supported never did die.  In a time of outright declarations of socialism, nationalism, fascism and communism, and the advocating of nationalist policies such as, “Fair Trade, Not Free Trade!”, it would be important to review an important piece of writing by Ludwig von Mises.  He recognized that, far from being beneficial, trade protectionism as part of a nationalist agenda, is not only a very harmful economic policy to follow, it is also a philosophy of war.

Economic Nationalism Is a Philosophy of War


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