Why U.S. Tax Reform Threatens Mexico's Financial Future

While tweets and speeches may continue to cause consternation in Mexico and Canada, the existential threat to NAFTA seems to have passed.

President Donald Trump is now talking about giving “renegotiation a good, strong shot” rather than rescinding the free trade agreement entirely. On the docket will be intellectual property, labor rights, e-commerce, rules of origin and the environment – issues Canada and Mexico are happy to upgrade, the outlines already defined within the ill-fated Trans-Pacific Partnership. More contentious issues could include “Buy American” clauses, border customs processes, sanitary measures, and import licenses, as well as specific grievances around the Canadian dairy and soft lumber industries, and regarding Mexican sugar imports. The process will undoubtedly be drawn out; the negotiations won’t begin in earnest until three months after the White House informs a still-waiting Congress.

But for Mexico, there is another huge challenge to its economic future: U.S. tax reform.

The most obvious and widely noticed threat is a border adjustment tax (BAT). As laid out in Speaker Paul Ryan’s tax reform “blueprint,” it would charge a 20 percent levy on all goods and services brought into the United States, and exempt U.S.-made exports from being taxed at all. Its proponents claim the dollar would appreciate the 25 percent necessary to call it an economic wash; others believe Mexico and other exporting nations would suffer. This pseudo-value added tax (VAT) is looking less and less likely, as it is opposed by Wal-Mart, Target and nearly every other major retailer, as well as by oil companies, car makers and others that depend on products from elsewhere to run their factories and businesses here. Even if it passes, it will face legal challenges in the World Trade Organization (WTO) for its non-VAT qualities, in particular allowing companies to deduct wages when calculating their BAT tax burden.

A corporate tax cut is more likely to succeed, and could be as damaging for Mexico. Republicans across the board have long favored a reduction, and with the U.S.' current 35 percent tax rate ranking highest among OECD nations, they have an argument for it. Ryan talks of lowering the corporate rate to 20 percent, bringing the United States in line with the United Kingdom and Luxemburg. Trump’s more drastic 15 percent proposal would put the United States in the bottom 20 percent of chargers, beating out Germany and closing in on the “corporate tax haven” of Ireland.

If the U.S. rate plummets, Mexico will be forced to follow suit.

View full text of article, originally published in Americas Quarterly.