The big downside to a trade war

  • 11 April 2018
  • NormanL
The big downside to a trade war

For all the headline grabbing pronouncements about what a potential trade war with China might do to the U.S. economy, there a few other consequences that should also be considered. Our friends at the Tax Foundation bring up a very interesting one -- a trade war could erase key benefits of the tax reform law the Congress and Trump administration enacted last year:

President Trump announced that the administration is considering additional Section 301 tariffs on another $100 billion worth of Chinese goods, escalating tension and threatening gains from tax reform in what many are now calling a trade war. This announcement comes on the heels of other tit-for-tat actions threatened this week, bringing the total of proposed Section 301 tariffs to $150 billion worth of Chinese goods. These escalations could potentially claw back many of the benefits that businesses and households expected to see from the Tax Cuts and Jobs Act (TCJA).

Considering just the reduction in the corporate tax rate, for example, the TCJA made businesses at least 40 percent more competitive globally (by reducing the rate from 35 percent to 21 percent). This, and other changes from the TCJA, should increase investment, employment, and incomes in the United States. However, if new tariffs were imposed, they would reduce trade and increase costs for U.S. firms and consumers, resulting in a negative impact on economic output and income.

In terms of relative size, in 2018, businesses and households could have expected the TCJA to reduce tax burdens by nearly $136 billion. On the other hand, 25 percent tariffs imposed on $150 billion worth of imports from China annually would act as a nearly $38 billion tax increase on American firms and consumers in 2018. Notably, this increase would be on top of increased costs from tariffs on steel and aluminum as well as washing machines and solar panels, resulting from other actions the Trump Administration has taken on trade this year.

What few people seem to understand is that tariffs are a type of tax. Do Republicans really want to be known as tax hikers? We're sure some of them won't care. But via The Week, we do have one item that could, and should, scare the dickens out of them. If China feels the need to push back hard, they could clamp down on one of their key exports to the U.S.: rare earth metals...

These are elements like dysprosium, neodymium, gadolinium, and ytterbium. They aren't actually rare, but they do play crucial roles in everything from smart phones to electric car motors, hard drives, wind turbines, military radar, smart bombs, laser guidance, and more. They're also quite difficult to mine and process.

It turns out the United States is almost entirely dependent on foreign suppliers for rare earth metals. More importantly, it's almost entirely dependent on China specifically for rare earth metals that have been processed into a final and usable form.

Basically, if China really wanted to mess with America, it could just clamp down on these exports. That would throw a massive wrench into America's supply chain for high-tech consumer products, not to mention much of our military's advanced weapons systems.

In fact, China isn't just America's major supplier of rare earth metals; it's the rest of the globe's major supplier as well. And in 2009, China began significantly clamping down on its rare metal exports. Once, China briefly cut Japan off entirely after an international incident involving a collision between two ships. This all eventually led to a 2014 World Trade Organization spat, with America, Japan, and other countries on one side, and China on the other.

That forced China to abandon its quotas. But it also shows China is willing to use its advantage in rare earth metals to play hardball if it's pushed far enough. And that's one of the main reasons observers are nervous.

This is just a possibility, not a certainty. But it's worth keeping in mind should the White House continue to engage in magical thinking that trade wars are easy, winnable, things. On the contrary -- they are very costly, and can become very, very damaging.