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The Mexican Border Tax: Will It Backfire?

Summary:
Less than a week after taking office, President Donald Trump is threatening a trade war with Mexico, one of the United States’ top trading partners, citing its refusal to pay a billion to billion bill to construct a wall on the border. Following the cancellation of a visit to the United States by President Enrique Peña Nieto of Mexico, White House Press Secretary Sean Spicer discussed plans to impose a 20 percent tax on US imports from Mexico as a first step toward imposing a border adjustment tax on all imports, as contemplated by legislation in Congress sponsored by House Republican leaders. (By evening, the White House was backing slightly off the plan, saying it was only an option.) There is little doubt that such a tax would yield significant revenue. In 2015, US merchandise

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Less than a week after taking office, President Donald Trump is threatening a trade war with Mexico, one of the United States’ top trading partners, citing its refusal to pay a $10 billion to $20 billion bill to construct a wall on the border. Following the cancellation of a visit to the United States by President Enrique Peña Nieto of Mexico, White House Press Secretary Sean Spicer discussed plans to impose a 20 percent tax on US imports from Mexico as a first step toward imposing a border adjustment tax on all imports, as contemplated by legislation in Congress sponsored by House Republican leaders. (By evening, the White House was backing slightly off the plan, saying it was only an option.)

There is little doubt that such a tax would yield significant revenue. In 2015, US merchandise imports from Mexico totaled about $300 billion, so the tax could yield $60 billion if applied to all Mexican products.  

But a number of problems arise from Trump’s plan. For example, the tax would provoke retaliation by Mexico and other trading partners, like China, if Congress applies the tax to all US trade.

But first Congress would have to approve this tax, whether applied across the board to all US imports or to Mexican imports alone. Lawmakers are likely to look at how it would affect their constituents, and the picture might not look pretty to them. For example, it is unclear who would actually “pay” the tax. That would depend on whether the tax comes out of the profits of Mexican exporters, or whether it raises the cost of Mexican products (from avocados to tequila) purchased by US consumers, or increases production costs of automobiles and other goods made by US producers who may or may not be able to pass the added cost on to their customers in the form of higher prices. Suffice it to say, some or most of the cost is likely to come out of the pockets of US taxpayers!

Imposition of such a sizeable border tax would constitute the beginning and ending salvos of a renegotiation of the North American Free Trade Agreement (NAFTA). The disruption to production and trade would be so large that it would precipitate the collapse of the NAFTA. The proposed tax would be more than three times higher than US duties applied against Mexican goods before NAFTA was negotiated in the early 1990s. The tax would violate US obligations under the NAFTA and the World Trade Organization and trigger immediate Mexican countermeasures against US exports.

 All this because Mexico runs a $60 billion surplus in merchandise trade with the United States (or $50 billion if you count goods and services)?

Auto companies will be the most directly affected. Production has been integrated across the Canadian and Mexican borders for decades. A 20 percent border tax could disrupt production lines. It almost certainly will adversely impact their bottom lines. Think of what happened on September 12, 2001, when the borders seized up. Within weeks, major US factories were on the verge of shutdowns because of inadequate supplies. A 20 percent border tax would do something similar, because some goods would become too expensive to buy and alternatives would not be readily available and/or price competitive.

Final note: The wall will take 5-10 years to build; during that time, and assuming no growth in bilateral trade, two-way US-Mexico trade normally would total between $3 trillion to $6 trillion. If trade is reduced by only 10 percent, a very conservative estimate given the size of the proposed border taxes, the cumulative reduction in trade would be $300 billion to $600 billion. And the US trade deficit may or may not change. Why is Trump putting so much at risk for so little?

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