US tax cut overall may restructure global industry

By Zhang Monan Source:Global Times Published: 2018/9/25 22:13:39

Illustration: Luo Xuan/GT

While tariffs and a trade war could be seen as US President Donald Trump's extreme means of putting pressure on the world to fulfill his promise of "making America great again," this begs a bigger question. Will his tax cut - the largest overhaul of the US tax code in three decades - generate a "siphon effect," drawing industry and capital to the US and restructuring the global allocation of economic resources?

Under the "America First" policy, the tax reform is the core measure of the Trump administration's aim to strengthen the US' leading role in the world. For a long time, high tax rates and a complicated tax system have been major constraints to the competitiveness of US companies and the domestic business environment.

Thus, while pursuing other policies involving trade protection and immigration restriction, the US intends to enhance its comparative advantages in international competition through large tax cuts, a territorial tax system and a one-time deemed-repatriation tax, to bring manufacturing and capital back to the US.

In the short term, such measures are expected to boost US economic growth and employment. In the medium and long term, they could help the US regain competitiveness by controlling the global industrial chain and international division of labor.

Undoubtedly, favorable tax treatment for multinationals can lure capital back to the US. But that's not the only goal of Trump's tax overhaul. The reform of the tax system and industry protection policies may have a more profound meaning.

According to the 2016 Global Manufacturing Competitiveness Index compiled by Deloitte, China remained the most competitive manufacturing nation in 2016. Deloitte cited advantages such as research and development (R&D) expenditures, huge consumer demand, a strong raw material supply and competitive infrastructure.

Nevertheless, the US tax reform is very likely to reshape the industrial chain's distribution among the US, Germany and Japan, instead of affecting China significantly.

Moreover, other countries may also be motivated to cut taxes. At present, the UK's corporate tax rate is 19 percent, which is scheduled to be lowered to 17 percent by 2020. France, Japan, and India have also made or implemented tax reduction plans, indicating the intensifying competition in terms of manufacturing costs, global trade and taxation.

The measures Trump has taken since he became president indicate an obvious rise of economic nationalism. In terms of results, the tax overhaul is aimed at prompting the return of manufacturing and capital, and it's similar to such moves as protecting domestic manufacturing by curbing imports, adopting unilateral trade sanctions, breaking multilateral international rules and renegotiating trade agreements.

Many of the detailed provisions in the US tax bill violate the principles of the multilateral free trade system, posing major challenges to the international economic and trade system and the global tax governance framework. For instance, one provision imposes a 20 percent tax on companies' payments to overseas affiliates.

The tax overhaul also includes a new provision, the foreign-derived intangible income (FDII) deduction, which allows US companies to get a tax deduction for exports of intellectual property or services to other countries. The EU contends that the new provision constitutes a prohibited subsidy under the WTO's Agreement on Subsidies and Countervailing Measures.

In the meantime, a patent box is adopted in the taxation of FDII, which sets a special tax rate of 13.1 percent on income attributable to intellectual property obtained in foreign countries, which will obviously enhance the competitiveness of US high-tech companies.

For a long time, US-based companies like Apple, Google and Qualcomm stashed most of their profits abroad after gaining huge benefits from publicly funded research. The new tax arrangement is intended to encourage US companies to retain intellectual property rights (IPR) in the US.

The trade row between China and the US is making the situation even more complicated, especially after the US slapped tariffs on $200 billion of Chinese imports. Looking at the global industrial chain for high-technology manufacturing, the US remains the center for design and R&D, with the actual manufacturing in China, Mexico and South America. Differences in terms of labor costs and resources have greatly contributed to the current structure of the global industrial chain, which could be expected to stabilize and get stronger due to each country's comparative advantages.

In the short term, the traditional manufacturing sector won't react to the dividends of the US tax reform by reshaping the industrial chain, due to high replacement costs.

As for US high-technology multinationals, a more viable approach under the new tax code is to shift profits within their industrial chain and retain more profits in the US.

Given the relatively low costs of replacing links in the technology-intensive industrial chain, the US tax cut and the trade war are likely to prompt advanced manufacturers to flow back to the US and to readjust their global layouts involving IPR, R&D and production.

The author is a research fellow at the China Center for International Economic Exchanges.


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