US tax cuts to Trump ‘reshoring’

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DAN STEINBOCK

President Trump has begun to reset the White House trade policies. The latest twist is a tax plan seeking to ‘reshore’ US companies. Will it work?

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DURING his two terms, President Obama touted the Trans-Pacific Partnership (TPP). On his inauguration day, President Trump announced US withdrawal from the TPP and promised to renegotiate Nafta, while using deficit targeting to re-evaluate America’s “unfair free-trade agreements.”

Recently, the Trump administration released new plans to use tax changes to boost “reshoring”; that is, to transfer business activities that have been moved overseas back to the US. In Asia, some observers have expressed serious concern about the White House’s plans. They fear that a low US corporate rate could make US firms leave Asia and lead to tit-for-tat tax cuts in other countries, while encouraging emerging economies’ manufacturers to invest more in the US and less at home.

How valid is that concern?

The tax cut plans    

In the US, there is a great demand for tax reforms. The individual income tax system is broken, and while US corporate tax rates are high internationally, US companies have parked more than $1 trillion worth of cash abroad.

CORPORATE TAX RATES IN G20 ECONOMIES, 2016

In 2016, US corporate tax rates were around 30 to 35 percent in major advanced economies (France, Japan, Germany), except for the UK (19 percent). At 39 percent, the current US rate is the highest among all G20 economies, including India and Brazil (35-34 percent) as well as China and Russia (25-20 percent). (See table.)
The Trump plan would almost halve US corporate rates to just 15 percent. Such a dramatic cut would put America ahead even of Singapore (17 percent) and Hong Kong (16.5 percent).

However, the Trump plan would also face immense hurdles. The tax proposal is not a broad reform package and the administration may ultimately opt for tax cuts, which are easier to implement than a full tax rewrite. Also, there is an execution challenge. While Trump’s advisers expect the tax plan to pay for itself with economic growth, even Republicans believe such cuts cannot pass through Congress without offsets.

But let’s assume that the plan is doable and could be executed. Then, the question is, would it work abroad – particularly in emerging Asia?

The hurdles abroad    

The short answer is that the Trump tax plan faces major obstacles. First of all, despite much political posturing, there has been no major outflux of foreign firms from China and Asia, as of yet. As long as advanced economies remain amid secular stagnation and emerging economies offer growth that is 3 to 4 times faster than in the US or Europe, time will work for emerging economies.

Second, since the 1970s, America has been burdened by trade deficits. While Washington has sought to ‘bilateralize’ its deficit problem first with Japan and more recently with China, the issue is regional by nature. Moreover, as costs are rising in China, emerging Asia will take the mantle over time but US trade deficits will prevail.

Third, relocation is more attractive to companies that rely on low-cost production. After Guangdong opted to scale out low-margin and highly polluting textile factories around 2007, the latter soon surfaced in Bangladesh (corporate tax rate today 25 percent) and Sri Lanka (15 percent), Indonesia and Myanmar (25 percent), among others. At Guangdong, this was not seen as a loss, but as an opportunity to move toward higher value-added, in line with the rebalancing of China’s economy. China is no longer as exposed to the vagaries of export-led growth as it was prior to the global crisis.

Conversely, companies that rely on revenues from advanced technology seek to retain their role in global R&D hubs to stay close to the cutting edge of global innovation – as evidenced by US companies in Japan in the 1980s, South Korea and Taiwan in the 1990s and China today.

Fifth, even when relocation offers some benefits, US and other multinationals may prove reluctant to move their core operations, due to strategic considerations. While many US companies may have been initially attracted by cheap production costs, today an increasing number of these companies rely on rising middle classes for their profitability – particularly in Asia’s large emerging economies.

Contradictory pressures at home

Furthermore, the tax cut plans must also cope with Washington’s contradictory policy objectives. Trump would like America to invest far more in infrastructure modernization and is thus promoting expansionary policies.
However, the Fed is pushing monetary tightening, which will raise interest rates and strengthen the dollar – which, in turn, would make Trump’s expansion more costly.

While Trump’s reshoring goals are understandable, the plans face huge hurdles internationally and centrifugal pressures in Washington. In short, the news about the impending US reshoring is far too premature.

Dan Steinbock is the founder of the Difference Group and has served as the research director at the India, China, and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more information, see http://www.differencegroup.net/ For contact: info@differencegroup.net

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