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The difficulty in understanding tariffs versus value-added taxes and a border tax issue

The border fence
The existing fence on the Texas-Mexico border. Imposing tariffs on Mexican goods to build a wall could hurt U.S. consumers, according to a recent study.
Consumption tax versus production tax and ramifications for imposing tariffs on Mexico goods.

Last week President Trump once again talked about the "very real" potential of the implementation of a tariff or border tax on Mexican imports as a way to neutralize the cost of a border wall, the focus of his immigration reform for the U.S.-Mexico border.

While farmers and other rural voters strongly supported Trump in his presidential bid, agricultural producers have been expressing concerns and even doubt recently on his trade policies and his plans for renegotiation of the North American Free Trade Agreement.

Dr. Katherine R Baylis, Associate Professor of Agricultural and Consumer Economics at the University of Illinois-Urbana, with help from Jonathan W. Coppess, a Clinical Assistant Professor at UI-Urbana, recently addressed the implementation of such a border tax and its economic implications in a comprehensive article, "Tax Reform and Trade Policy," that appeared in the academic journal "Farmdoc Daily," published by the UI-Urbana Agricultural and Consumer Economics Department.

As it turns out, understanding the difference between a tariff and an added-value tax, or border tax, are difficult to comprehend, and then complicated by the question of consumption-based taxes versus production tax systems, and what it all means to U.S. agricultural producers.


According to Baylis, a tariff on Mexican imports would effectively be subsidized, or covered, by the elevated cost of such products and reflected in the retail price of the imported goods at checkout stands across the United States. In other words, a tariff on imports would ultimately be paid for by U.S. consumers who would absorb the increased cost of goods streaming across the Mexican border.

To make it simple, Baylis states "According to basic economic theory, a standard tariff is a tax applied to imported products and is therefore generally expected to increase their cost. Accordingly, much of the burden of a tariff would fall on U.S. consumers."

That part may be simple to understand, but it gets complicated in a hurry.


She explained that a border tax adjustment, by comparison, is "a re-calibration of a domestic tax" in trade policy circles. As such, it cannot be applied to a single country, and like a tariff, it would run counter to U.S. trade commitments, such as the North American Free Trade Agreement (NAFTA), and would likely generate trade retaliation, in this case, from Mexico.

Such retaliation could be devastating to U.S. agricultural producers. Mexico is one of the top three trading partners with the United States. Exported goods to Mexico totaled slightly more than $267 billion in 2015, and have been growing since then. Imported good from Mexico totaled about $316 billion in 2015, so the trade deficit to the U.S. was an estimated $49 billion that same year.

But of most concern to the U.S. ag industry, agricultural exports to Mexico in 2015 totaled about $133 billion, and represented a trade surplus for the U.S. of over $21 billion. A trade retaliation by Mexico over a new border tax adjustment or tariff imposed by the Trump administration could greatly affect not only the trade surplus realized by the U.S., but could also significantly affect U.S. farmer and livestock producer income as Mexico looks to other countries for agriculture imports.

But now comes the hard part to understand.

Baylis' article says every nation fundamentally faces the question of whether to tax consumption or production in order to generate government income. But the issue of consumption versus production can be difficult to understand. To better comprehend the difference, she explains it this way:

"If we tax consumption, we tax everything that we consume, whether it is produced here or abroad. Sales taxes and value-added taxes are generally consumption taxes," she explained.

By contrast, while sales taxes are assessed on the sale price of a good, value-added taxes only tax the difference between the sales price less the cost of material inputs for that good. For example, she points to a livestock producer who raises cattle for market. If the producer is feeding his own cattle, "a sales tax would be on the sales price of the cattle, while a value-added tax would be on the sale price of the cattle, less the cost of the calves and the purchased cost of the feed."

Further complicating the issue, "either a production or consumption tax can be designed to be progressive, and have higher rates for wealthier individuals or corporations, or be regressive, where poorer people pay a larger fraction of their income or consumption to the tax."

"A typical argument in favor of a consumption tax is that any tax can create disincentives and we might be more worried about creating a disincentive to produce than a disincentive to consume. Note that many other countries such as the EU, Japan and Mexico use a consumption tax base," Baylis says.

She further explains that the first difference is that in a production (or income) tax, savings are taxed before those dollars go into the bank. On the other hand, a consumption tax applies to those dollars when they are spent. The second difference is how non-resident people or firms are treated. A production tax will tax all U.S. production regardless of where it is consumed, while a consumption tax applies to consumption by all U.S. residents, be they firms or people. The third difference is how imports and exports are taxed.

Now you should be getting the picture, trade taxes are very complicated.


The U.S. corporate taxing system comes into play here, and that's when the tax code can become truly difficult to grasp. But, as Baylis points out, most of the problem comes from the U.S. taxing system and its difference from taxing systems like those practiced in the EU, Mexico and Japan.

Finally, to leave us even more perplexed over the issue, trade between the nations of the world get complicated by World Trade Organization trade rules and regulations. Ultimately, all trading partners that are members of WTO must conform to those trade policies, so to completely understand the difficulty and the impact on a border tax system, it becomes necessary to understand not only complicated tax codes, but national and international trade rules.

Agriculture groups across the U.S. have expressed concern that the Trump administration may not be fully aware of the complexities of tariffs, border taxes and other and deeper issues involved in trade negotiations and how they might affect U.S. producers, and the concern is rising over a possible head-long dive into implementing changes, like a border tax, that could result in a trade war and serious disruption in U.S. agriculture exports headed south across the border. And that, it seems, could be devastating to U.S. agricultural interests.

For a much deeper and comprehensive look into the issue, read Baylis' article, "Tax Reform and Trade Policy" ( from the University of Illinois-Urbana.

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