8 minute read 28 Jun 2018
Stock exchange market display screen

How global trade is changing as new tariffs are enacted

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.

8 minute read 28 Jun 2018

Businesses must prepare for a potential loss of clients in a world marked by uncertainty and greater competition among governments.

US President Donald Trump expects that the Tax Cuts and Jobs Act (TCJA) will boost businesses’ bottom line and encourage greater investment at home. But some wonder how introducing new tariffs on targeted imports and renegotiating the long-standing free trade agreement with Canada and Mexico will affect those goals.

Since he assumed the presidency in January 2017, Trump has acted on his campaign pledge to pursue “America First” trade and economic policies. This approach could upend the global movement towards open trade in recent decades.

As Chatham House stated in its November 2017 research paper, Trade Policy Under President Trump: Implications for the US and the World, “without the US as its champion, the global trade agenda risks faltering.” The challenge for businesses going forward will be to adapt to this evolving global trade landscape as governments balance pro-growth and protectionist trade and tax policies.

“Companies today are experiencing unprecedented levels of political and economic change worldwide,” says Jon Shames, EY Geostrategic Business Group Leader. “More than ever before, organizations need to understand the business implications of these changes, including evolving tax and tariff policies, and integrate this into their decision-making at the highest levels.”

More than ever before, organizations need to understand the business implications of these changes, including evolving tax and tariff policies, and integrate this into their decision-making at the highest levels.
Jonathan Shames
EY Global Geostrategic Business Group Leader

The risk of business disruption includes the potential loss of clients. Even if increased tariffs and duties apply for just a short period of time, a business could end up losing a large number of customers who have already found new suppliers and vendors. It will not be easy to woo back these clients.

Carrots and sticks

The aim of the new US tax law is straightforward: make US businesses more competitive and strengthen economic growth.

“Now is the perfect time to bring your business, your jobs, and your investments to the United States of America,” Trump told the World Economic Forum in Davos in January 2018.

The IMF said in its January 2018 World Economic Outlook that by lowering its corporate income tax rate to 21%, the US would enjoy a higher rate of growth until at least 2020 as the country benefits from rising inward investment flows, and as businesses put their capital to work in the US rather than in, say, Canada or Mexico.

In the US, the new law will increase the size of the overall economy, measured as gross domestic product, according to an analysis by the Washington-based EY Quantitative Economics and Statistics (QUEST) group. The biggest effect will be in the first five years, after which there will be only a very small boost in growth as the tax cuts largely expire, QUEST found.

Along with incentives for US investment such as the lower tax rate and shift to a quasi-territorial system, the TCJA also includes “sticks” to discourage investment elsewhere in the world, including a base erosion and anti-abuse tax (BEAT).

The stick is that you may get whacked with a tariff if you invest somewhere else.
Edward Alden
The Bernard L. Schwartz senior fellow at the Council on Foreign Relations (CFR)

“This is an explicit goal of the Trump administration,” says Edward Alden, the Bernard L. Schwartz senior fellow at the Council on Foreign Relations (CFR), and an expert on US economic competitiveness. The carrot is lower taxes. “The stick is that you may get whacked with a tariff if you invest somewhere else.”

Some businesses are making strategic investments in the US. In January 2018, Samsung Electronics Co Ltd said its new US washing machine plant started production. LG Electronics has unveiled plans to open a new washing machine factory in the US in the final quarter of 2018. In April 2018, SunPower Corp. announced plans to buy US solar panel producer SolarWorld Americas in a bid to offset the impact of Trump’s import tariffs.

The question is what happens from here. The TCJA could spur other jurisdictions to lower their corporate income tax rates to match the US’s top rate of 21%. But while tax competition is nothing new, countries today must balance the need to attract economic activity by reducing corporate income tax rates or offering incentives with the need to maximize tax collections through transparency and digitalization initiatives.

Rising frictions

Along with changing the US tax system, Trump views reforms to the international trade system, including the recently announced tariffs, as part of his “America First” plan.

And his actions have pleased many domestic steel and aluminum producers and labor groups, who support the tariffs. Since these tariffs were enacted, several steel and aluminum companies announced that they will reopen idled facilities. Supporters have downplayed the likelihood that higher steel and aluminum prices resulting from the tariffs will have a negative impact on the US economy, noting that these products often are a small portion of the overall content of manufactured goods.

But some automakers have warned that the tariffs could lead to higher prices. Ford Motor Co said in a March statement that “despite the fact that Ford buys the vast majority of its steel and aluminum for US production in the US, this action could result in an increase in domestic commodity prices – harming the competitiveness of American manufacturers,” according to a Reuters report.

Canada, Mexico and the US have been renegotiating their North American Free Trade Agreement (NAFTA), which entered into force on January 1, 1994. Trump has called it the “worst trade deal,” saying it has hurt US workers and companies. Mexico and Canada have approached the negotiations as an opportunity to deepen economic integration in North America.

The three countries have completed seven rounds of discussions, with nine chapters (including competition, telecommunications and regulatory practices) and six annexes (such as technology, chemical and pharmaceutical) concluded. There are contentious issues that still need to be resolved, however, including rules of origin for the auto sector, market access for agriculture and a sunset clause.

In June 2018, President Trump said he could imagine negotiating separate deals with Canada and Mexico. Canada and Mexico are still pushing for a trilateral agreement.

At the beginning of 2018, the US began renegotiating its free trade agreement with South Korea (KORUS FTA) as Trump complained about the rising trade deficit with that country. In March 2018, the two countries announced they had reached an “agreement in principle”.

Trump also announced plans to exit the new Trans-Pacific Partnership (TPP) trade agreement in January 2017. Japanese Prime Minister Shinzo Abe used that maneuver to take on the role of champion for the deal. The remaining 11 countries, including Canada and Mexico, signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) in March 2018. The following month, Trump said he would reconsider joining if it were “substantially better” than previously, according to a Reuters report.

Elsewhere, the UK, which has been part of the EU (previously the European Economic Community) since 1973, is preparing to depart. The UK is hoping to keep the benefits of the single market and customs union during a transitional period from March 29, 2019 to December 31, 2020. Brexit will likely complicate taxes and tariffs, alter the movement of goods and require additional documents for both UK-based and non UK-based businesses.

While businesses may hope for the best, they should plan for additional uncertainty and market volatility ahead. Overall, the appetite for new free-trade agreements has declined since the 2008 financial crisis, according to an EY analysis of International Monetary Fund (IMF) data.

While there was a proliferation of free trade agreements focused on trade in goods and reducing trade barriers, the second-generation of free trade agreements targeting the protection of intellectual property (IP) and trade in services have slowed, according to Adrian Ball, EY Asia-Pacific Leader for Indirect Tax.

“The world of trade has been flipped on its head,” says Ball.

So how are shifting global trade and tax policies affecting economic growth? In April 2018, the World Trade Organization (WTO) forecast merchandise trade volume growth of 4.4% in 2018 compared with 4.7% in 2017. The WTO went on to warn growth will drop to 4% in 2019 amid signs that “escalating trade tensions may already be affecting business confidence and investment decisions, which could compromise the current outlook.”

“A cycle of retaliation is the last thing the world economy needs,” WTO Director-General Roberto Azevêdo said in the April 2018 WTO report. “I urge governments to show restraint and settle their differences through dialogue and serious engagement."

The most likely outcome, experts say, is a future in which nations compete with each another for investment (a situation that should normally benefit bigger and richer nations), while agreeing to sovereign-to-sovereign trade deals. Taxes are likely to continue to fall, with trade disputes resolved on an ad-hoc basis rather than via the WTO, and tariffs, which have been falling for years, once again at the top of the list of risks that companies have to monitor.

“The question is not how much liberalization moves forward but how far it retreats,” says Alden. “A big backslide on free trade would be a problem for everyone.”

For his part, Trump has said he is playing the long game. “I’m not saying there won’t be a little pain,” he said in an interview with WABC Radio in New York on April 6. “But we’re going to have a much stronger country when we’re finished.”

Summary

Firms need to be ready to adapt their strategies as developments unfold, and seek professional advice about changes to countries’ policies on tariffs and duties. New trade tariffs and duties and the slowdown of goods at borders could seriously disrupt businesses’ global supply chains going forward. Businesses should focus on developing a trade strategy and planning techniques for mitigating additional costs and navigating new barriers.

About this article

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.