What Does Corporate Tax Reform and Paying for the Wall Have to Do with Each Other?

Maybe something, maybe nothing.

There is a lot of confusion about how the Trump Administration will make Mexico “pay for the wall”. It is unclear to me that the individuals within the Administration, including the President, have any more clarity than we do.

Here are my main observations:

  1. If corporate tax reform takes the form of the House’s blueprint for Destination Based Cash Flow Tax (DBCFT) with border adjustment, and is the basis for the view that Mexico will pay for the wall, then it is not “Mexico” that pays, but — depending on what happens to the dollar, and the extent of exchange rate pass through — US consumers, producers in all countries we trade with, and shareholders in US firms will pay.

  2. If the idea is to place an explicit tariff on Mexican goods imported into the US, separate from whatever happens in the arena of corporate tax reform, then it’s possible that Mexican producers will pay, although it’s possible that US consumers will also pay in part.

  3. If the idea is to place a tax on remittances from the US to Mexico (an idea mooted during the campaign), then indeed Mexicans may pay, but Mexican Americans who wish to remit funds to Mexico might also pay. To the extent the Trump Administration views such individuals as not real Americans, but “Mexicans”, then Mexico in aggregate would pay. (I have no idea what level of tax would be required, but here are some thoughts on the implications for financial openness.)

An Elaboration on the DBCFT Impact

The DBCFT acts like a Value Added Tax (VAT), except that wage expenditures are also exempted from taxation, as pointed out by Krugman. The most simple public finance approach to evaluating the DBCFT relative to a no-tax situation is to assume the non-deductibility of imports results in an increase in demand for exports (due to the fact that exports are not taxed) that in turn increases the demand for dollars, so that in the end import prices and export prices are unchanged (see here). Hence, the DBCFT is neutral with respect to imports and exports. Shareholders bear the burden of the tax. In principle, ignoring aspects of tax shifting, etc., if total revenues are the same, then the burden falls in the same way on shareholders as in the currently existing tax system.

This public finance interpretation seems at variance with the commonplace view that the new tax system is in effect a tariff on imports. It may very well act like a tariff, if the dollar does not adjust. If it adjusts halfway (as in this example), then import prices will rise. Then the burden falls at least in part on US consumers.

Of course, if corporate tax revenues are less than under the current tax system, then in a way, it’s not possible for the new tax system to “pay” for the wall, estimated around $12-$15 billion by Senate Majority Leader Mitch McConnell.

I think in the short term, it is likely that the proposed tax reform will yield more revenue (particularly because right now the US runs a trade deficit with the rest of the world). However, there is no guarantee, running over a longer horizon.

In any case, it’s not very clear that “the Mexicans” are going to be paying for the wall through this route…

That’s my view; Tim Taylor has a good discussion here. See also Bill Gale’s Brookings piece.

By the way, as Joel Trachtman notes, the DBFCT is unlikely to be WTO compliant.

9 thoughts on “What Does Corporate Tax Reform and Paying for the Wall Have to Do with Each Other?

  1. 2slugbaits

    If the DBFCT is not WTO compliant, then Mexico will have a free hand in pirated copyright and patent infringements.

    I wonder just how effective a ban on remittances is likely to be in a world in which drones are ubiquitous and getting more sophisticated.

    1. efc

      “then Mexico will have a free hand in pirated copyright and patent infringements.”

      That would be awesome. Cheaper stuff for everyone and the gop corporate types would be so furious. Hey, you lie with dogs…

  2. Lord

    I have heard it would take a rate of 30% to be revenue neutral, more sizable than the 20% proposed. i am not sure even imports can make up that large a reduction.

  3. dwb

    Yeah, everyone chasing squirrels. “I am going to make XXX pay for this” more often means payback in the sense of “Retribution or revenge.” People are chasing squirrels here (or wild geese if you prefer that cliche). If Mexico “pays for the wall” in the sense of some perceived loss (which may only mean a loss of status or correction of the trade deficit ), Trump will largely be seen as successful.

    It is true that when you set out on a journey of revenge, you need to dig two graves, i.e. be prepared for repercussions. But it is not enough to suggest that there may be repercussions. Most people know this. In the minds of Trump supporters, we are already unfairly paying for it now. It’s is about burden shifting: from the unemployed, to someone else. If the burden shifts to “producers in all countries we trade with, and shareholders in US” I doubt people will get too worked up about that. In fact, they may see this as a bonus win-win-win. Make everyone (else) pay for the wall!

    Yes, people are willing to shift the burden from the unemployed to consumers, possibly in the form of higher import prices.

    People really need to take a sabbatical from the moral outrage (mainly, it is not persuasive and it’s not working). Nobody cares if Mexico pays for it, in the literal legalistic sense. The real root problem here is that economists (and the Fed) for too long have been peevishly focused on inflation, not full employment. No, we are not at full employment (people have dropped out of the labor force). No, the burden of trade shocks is not evenly distributed across the US. Wages are stagnant, and the fruits of productivity appear to be accruing mostly to some highly paid technology elites in San Fransisco and Seattle, not middle America. It is not a coincidence that middle America hates the left coast and PhDs. The message you should be receiving loud and clear is that people are willing to tolerate higher import prices in exchange for higher employment and higher domestic labor demand (and not “high skilled” demand, either, it must be diverse demand across the skill stack – not everyone is wired to write R code, Python, or java).

    As for whether this tax plan actually ameliorates the problem, I have not been persuaded either way. If Mankiw is right ()http://gregmankiw.blogspot.com/2017/01/a-three-point-tax-reform.html), its certainly worth a try.

  4. Steven Kopits

    Here are two recent articles of mine related to the topic, on CNBC:

    Forget Mexico—Here’s who should pay for the wall

    Op-Ed: How Trump can end illegal immigration right now—without a border wall

    The reaction to these two articles has been genuinely impressive. A good number of people actively looked up my email address to send me comments, almost all supportive, but looking for greater detail.

    Indeed, this morning a Hungarian radio station asked for an interview based on these articles. (All my recommendations are essentially derived from my experiences in Hungary, I might add.)

    I think there is a genuine hunger out there for a good technical approach to illegal immigration. A lot of Americans are not mean or anti-Mexican, but they want control over illegal immigration. They are also aware that we have to make trade-offs and that there are risks. Very importantly, however, I think people are willing to sign up, but they want to know what they are being asked to do and what they should expect — or not.

    I have proposed a solution which treats economic immigration as a business, rather than as a moral crusade. As a business, it is to be run professionally and profitably, with a focus on convenience, speed and certainty to insure compliance.

    The proposed program achieves many, but not all, of the objectives of conservative, middle class Americans. The feedback I am receiving suggests Americans are willing to take a business-like approach which neither permits unfettered immigration nor seals the borders hermetically.

    If you want to comment, pro or contra, here’s my email address: steven.kopits@prienga.com

    1. efc

      “(All my recommendations are essentially derived from my experiences in Hungary, I might add)”

      Christ. You admit that? You know we all know what the Hungarian government is right now? That you admit you got your ideas from your experience with a fascist government says a lot.

      1. Steven Kopits

        I lived in Hungary from 1990 to 2005. The current authoritarian incarnation of the Orban regime took power in 2010.

  5. Marc

    They should have nothing to do with each other. One is economic corporate income tax policy (or really a blend of tax & trade policy) and the other is a jingoistic Protect America position by someone who perceives that he has the political capital to get away with it. A wall doesn’t even fall under immigration policy or infrastructure policy. If a BAT/DBCFT happens – and it shouldn’t ( see http://www.border-adjustment.com ) – the funds should be in lieu of current corporate income tax revenue. Corporate income tax revenue receipts should not be dedicated to any particular infrastructure plan or to any other specific spending program.

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