Trump's tax threat

By John Burton

When he was campaigning as a candidate for the U.S. presidency, Donald Trump vowed that on day one of his administration you would declare China to be a currency manipulator, which gives the U.S. the authority to restrict Chinese imports by slapping tariffs on its products.

That is unlikely to happen, however.China does not meet, at least formally, all three of the criteria set by the U.S. Treasury Department that would label it as a currency manipulator. The criteria include having a bilateral trade surplus in excess of $20 billion, a current account surplus in excess of 3 percent of gross domestic product, and monetary intervention that causes foreign exchange reserves to exceed 2 percent of GDP.

China is only guilty on the first count. The criteria are so strict that only a handful of countries fall into the category of currency manipulator. But one of those countries is Korea. Although the Trump administration is unlikely to specifically target Korea (except in a few product categories), its de facto status as a currency manipulator leaves it vulnerable to any fallout from a trade war between China and the U.S.

Indeed, several of the economic policies likely to be pursued by the Trump administration could severely impact Korea. Although most attention has focused on potential protectionist moves by the U.S., such as the imposition of tariffs, a bigger threat to Korea could come from proposed changes in U.S. corporate tax policy.

U.S. House Speaker Paul Ryan is offering a tax plan that is aimed at bringing jobs back home to America from overseas without resorting to the harsh protectionist measures promoted by Trump.

Current U.S. tax laws actually discourages American companies from producing goods at home. The U.S. is one of the few countries in the world to tax corporate revenues and profits on a global basis. But there is one important loophole. If a company keeps overseas the money that it has earned abroad, it can avoid paying the taxman on those earnings.

The result is that American companies hold an estimated $2.5 trillion outside the U.S. This is money that otherwise could be invested at home and generate more jobs, one of the chief political goals of Trump.

Under the Ryan plan, American companies that export products from the U.S. would get tax breaks, while those American companies importing goods they have produced overseas would have to pay a form of a valued-added tax. This is the reverse of the present situation.

For example, one reason why Apple now produces most of its products in China is that it can import them into the U.S. without paying VAT, except for state and local taxes. Under current tax rules, if Apple produced most of its products in the U.S,it would have to pay full corporate taxes on its earnings – and the U.S. corporate tax rate is among the highest among advanced economies. So it is understandable why Apple would have an incentive to focus on overseas manufacturing.

Given the Republican control of the U.S. Congress and the Trump administration’s pro-business policies, it is likely that the Ryan tax proposal will pass in some form. It would reduce global fears that the U.S. will adopt a draconian protectionist trade policy based on unilateral tariffs hikes. Instead, the tax plan could be sold to the world as one that eliminates distortions in the U.S. tax regime and brings its closer to international practices.

Nonetheless, this could have a profound impact on Asia. If Apple started relocating production back to the U.S., it is assumed that its Asian-based component suppliers would follow suit. LG, for example, supplies displays for Apple smartphones and Samsung is expected to provide its OLED screens for the next-generation iPhone. Korean semiconductor producers are also likely to transfer some production to the U.S. to serve large customers such as Apple.

This development would have significant implications for Korea, which has seen its economy grow over the last four decades due to an export-led strategy. If Korean companies are forced to relocate some production to the U.S., it would contribute to the hollowing out of the country’s manufacturing base.

Producers of components, such as displays and semiconductors, are among the brightest sectors in Korean industry because of their world-class technology and manufacturing efficiency. But the components industry is likely to be among those most directly affected by the changes brought about by the U.S. tax reform.

Normally, a country could try to compensate for the loss of export industries by increasing domestic demand. But that will prove to be a tough challenge for Korea because of its high household debt and rapidly aging population.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at johnburtonft@yahoo.com.