US President Donald Trump emphasized an “America first” approach to trade policy, and China might be hit by trade protectionism. We have provided an analysis of tariffs in report “Impacts of trade protectionism on US and Chinese economies” published on January 9. In this report, we explore two other major policy options – border adjustment taxes and non-tariff barriers – for trade protection.

While the need for trade reforms has been a Republican consensus, the President and House have different plans for trade taxation. Trump proposed a tariff of 10% on all imports and punitive tariffs of 45% and 35% on imports from China and Mexico; and he pledged to lower corporate income tax from 35% to 15% and to levy a reduced tax rate on multinationals’ repatriated funds. A tax overhaul plan proposed by House Republicans in June 2016 advocated a border adjustment tax (BAT) to enhance US competitiveness.

Under the BAT, imports will be taxed at the US corporate income tax rate, while exports exempt from any US taxation. Besides cutting the tax rate from 35% to 20%, the House plan seeks to move to a destination-basis tax system, with tax jurisdiction following the location of consumption rather than that of production. The BAT arrangement is akin to how the VAT is levied – imports are subject to the VAT while exports are exempt from the VAT (or given a tax rebate). The introduction of the BAT may have the following impacts:

Facilitating US trade rebalancing: The BAT is equivalent to a 20% import tariff and a 7~14% export subsidy (assuming a 20~40% gross margin for exports).

Pushing US inflation up significantly: A 20% rise in import prices may raise CPI inflation by >3ppt, while an increase in external demand would also push up the US inflation.

Affecting sectors differently: The BAT will hit import- dependent sectors (e.g., retail, and refinery), while benefiting exporting sectors (e.g., aircraft, and agricultural products).

Putting appreciation pressures on the US dollar: The combination of a 20% import tariff and a ~10% export subsidy is equivalent to a one-off US dollar devaluation by ~15%.

Compared with the House plan, Trump’s tariff proposal would actually look less aggressive and more straightforward. The 10% tariff is well below the 20% BAT on imports. And exports will be subject to a reduced corporate income tax, rather than being exempt from taxation under the BAT. Moreover, Trump’s plan is still based on corporate incomes, instead of sales, and hence not as radical as the House plan in its changes to the current tax code.

Based on the policy reality, Trump may first resort to raising non-tariff barriers, by trade deal renegotiations, anti-dumping and countervailing investigations, as well as rule enforcement tightening. Trump reiterated on his first day in office that the US would withdraw from the TPP and renegotiate the NAFTA. The administration may also strengthen the enforcement of existing WTO rules, trade agreements, and regulatory, safety and labor standards to achieve trade protection. The “trade war” is likely to start in the form of “law war”.