The International Security Dimension of Border Adjustment Taxes

By Danny Lam

Border Adjustment Taxes (BAT) is a controversial issue that thus far, have been primarily viewed as a means to reform the US corporate tax system, simultaneously achieving the goal of raising revenues while improving the competitiveness of US businesses worldwide.

There is a much more important case and argument for BATs: It is perhaps the ideal mechanism to achieve a range of key foreign policy goals of the US, from dealing with the PRC to petulant allies.

Domestic tax reform via BAT is a chance to address one of the major failings of the present international system: compartmentalization of security and trade issues have created a situation whereby the PRC regime, the world’s largest trader and greatest beneficiary of “free riding” on the international system, is now actively undermining international order maintained and paid for by US allies upon which global free trade rests.

Proposals for BAT raises many questions including whether it is legal under WTO.    The WTO was never meant to be a deal with trade between near enemies like the PRC, Russia, Iran, North Korea and the US and allies.

There are, at least two ways to address the issue without renegotiating WTO.

Article XXI Security Exceptions:

“(b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests”

(c) to prevent any contracting party from taking any action in pursuance of its obligations under the United Nations Charter for the maintenance of international peace and security”

These clauses offer multiple “escape hatches” such as unilaterally declaring the PRC’s military aid to the North Korean nuclear and missile programs, the PRC’s military buildup, etc. an existential threat to the US and allies, or to invoke the inherent right of self-defense in the UN Charter.

The other alternative is to craft a WTO compliant Border Adjustment Tax which can in theory be done under Article XX(b). “(i) be necessary, (ii) to protect human, animal, or plant life or health, and (iii) satisfy the requirement of the chapeau of Article XX to the effect that it not be applied as arbitrary or unjustifiable discrimination or a disguised restriction on trade.”   In any case, to do so will likely involve years of legal disputes that risk an adverse conclusion.

The easiest way to implement a border adjustment tax is to simultaneously invoke Article XXI (Security Exception) and Article XX(b) so as to provide a difficult to defeat regime. Combining this with bilateral agreements with key trading partners to waive their rights (if any) to seek redress under WTO should make it unlikely that the US will have to risk WTO adjudication. Ultimately, the goal will be to renegotiate the WTO treaty to foreclose the option.

Once the legal strategy is formulated, the question then becomes what and how should such a BAT charge be structured and what it should aim to achieve.

A BAT need to create an adjustable middle ground between the “on and off” of sanctions that is presently the only policy instruments short of war to compel regimes like Russia, North Korea, and Iran to change their behavior.  By being a tax or charge, it gets away from the issue of enforcement of sanctions, and convert it into a revenue opportunity for the US and allies.

BAT Impact on Enemies or near Enemy “Peer Competitors”

Sanctions, when international consensus allowed it, have rarely been all encompassing or suffocating in the post War era. There have always been exceptions for food, medicines, and allowing exports to pay for them.

What to do about nations like the PRC, who dominate international trade and are peer competitors to the US and allies and actively arming for a war with the US?

By levying a BAT of, e.g., 30% without exception or exemptions on all imports (direct or indirect) from regimes like China, Russia, Iran, it would not “kill” trade per se, but over time, encourage customers to do what businesses do best, to seek more economic alternatives.

For example, it was not possible for EU states to sanction Russia’s gas and oil exports after Crimea and the Ukraine were invade because there is no substitute for them in the short run.  A EU BAT will enable essential trade to continue, but strongly motivate customers to find alternatives and switch — greatly enhancing the impact of sanctions over time.   Contrast this with the present exemption from sanction for Russian gas exports to EU, where customers are taking their time seeking alternatives. With a 30% BAT on Russian gas imported to EU, they will act to find cheaper alternatives.

In all likelihood, China or Russia will retaliate with similar levies, but if the OECD nations are to stand together with a NATO for trade, much of what China source from the west for domestic consumption (rather than re-export) have few non OECD suppliers and no substitutes.

The customarily retaliatory tactics used by the Beijing regime like playing off Airbus against Boeing, abruptly funneling tourists away from one country to others, slashing key imports (e.g. salmon from Norway), etc. can be blunted if OECD nations had a collective defense in trade like NATO Article 5.   Likewise, retaliation at individual foreign firms like Qualcomm would be less effective if OECD nations fielded a collective defense and stood behind any member nation’s targeted by PRC.

As for export processing industries like Foxconn that heavily utilize off shore manufacturing facilities based in China, such a tax will weigh heavily on them in the short run — and yes, encourage industry to move away from China.   Which is not a bad stratagem.

BATs will in due course, allow individual areas of PRC (provinces or cities) to be narrowly target for sanctions or concessions in return for curbing abhorrent behavior like facilitating the export of synthetic narcotics.   The key is to not enshrine the administration of BATs and concessions in a process that require legislative action but allow for rapid action by the executive branch — much like temporary anti-dumping tariffs.

What about US retailers and consumers?

BATs levied by the US on PRC’s consumer goods will raise prices.

But a lot less than whatever the BAT rate shall be.

It is only the landed cost of an item (CIF) that is subject to the BAT, which is typically only one quarter of the retail value of the product. If the BAT is uniformly applied, there are very few retailers that do not have the means to pass along the very modest increase in retail prices that a BAT will cost.

Neutrals and Allies

Much of the world (though relative little of the trading volume between the US) is with neutrals or allies (e.g. sub-Saharan Africa or Latin American or India) that only minimally contribute to international security. Assessing a standard BAT at a significantly lower rate than enemies or near enemies will give them the same benefits that “free trade” gave when world tariff rates now average 2.88% (2012).

If a BAT is set at 30% for enemies (not sanctioned) or near enemies, then a BAT of 20% for Neutrals and allies would be more than enough to make it expensive to be an enemy.

What’s more, for allies of the US that have collective responsibilities for the defense of the international system, the revenues collected from the BAT can be in part used to induce them to do the right thing.

Countries like Germany and most of EU that is dragging their feet on defense can be induced to do so with funds derived from the BAT.

Germany, for example, exported $121b to the US in 2014.   A BAT of 20%, net of demand effects, will raise about $24 billion.   Turning to Germany’s present defense budget of EUR 37 billion in 2017, that conveniently brings Germany’s defense expenditures to just about 2% GDP immediately. The NATO target that Germany refused to meet until 2024.

Conceivably with the BAT, the US can offer Germany $5 billion of credits for acquisition of US defense equipment or assistance in restructuring the horrifically inefficient European defense industry.

As Germany begin to meet their defense obligations — and not just in a financial sense of 2% GDP — but in actual capabilities tied to war plans, the US can negotiate with Germany a reduction in the BAT.

Let’s revisit the BAT issue from the National Security perspective.

It could become the most valuable and efficacious of policy instruments for the US.


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