Major U.S. trading partners have already indicated they might retaliate to new U.S. trade tariffs recently announced by President Trump. New tariffs could, therefore, lead to a “trade war.” However, game theory also suggests that U.S. trading partners could eventually respond with “trade opening,” depending on the ultimate payoffs to each party in the trading partnerships.
We estimate that an all-out trade war would reduce GDP by 0.9 percent by 2027 and by 5.3 percent by 2040. Wages would decline by 1.1 percent by 2027 and 4.8 percent by 2040, relative to current policy. A trade opening would have the opposite effect: GDP would increase between 0.2 to 0.7 percent by 2027 and between 1.3 to 4.0 percent by 2040. Wages would increase between 0.3 to 0.8 percent by 2027 and between 1.2 - 3.6 percent by 2040, relative to current policy.
The downside risk of a trade war, therefore, is larger than the upside potential from a trade opening.
PWBM’s Dynamic OLG model simulates the partially-open U.S. economy in a way that is more consistent with economic behavior than standard “model blending” exercises. The difference between the two techniques becomes more pronounced over time due to the nation’s expanding debt path.
The recent Tax Cuts and Jobs Act (TCJA) contains two key international tax provisions: the tax on Global Intangible Low-Taxed Income (GILTI) and the reduced tax rate on Foreign Derived Intangible Income (FDII). These provisions were designed to encourage United States-based multinationals to locate intangible intellectual property in the U.S. rather than in foreign jurisdictions. However, an aspect that is overlooked is that these same provisions also create incentives for U.S. firms to acquire tangible assets abroad and to sell tangible assets in the U.S. Future monitoring of these activities is required to assess the extent to which U.S. multinationals will shift production overseas in response to the incentives created by GILTI and FDII.
An important part of the discussion surrounding the passage of the Tax Cuts and Jobs Act (TCJA) was the accumulation of untaxed profits in U.S. corporations’ foreign subsidiaries, which were estimated to be as high as $2.8 trillion in 2017. Before 2018, these earnings were generally not subject to U.S. taxes unless they were paid to the U.S. parent corporation as a dividend (“repatriated”), leading many companies to accumulate profits abroad. The TCJA introduced a deemed repatriation provision, which provides a tax “holiday” for foreign earnings by taxing them at a reduced rate of 15.5 percent on cash and eight percent on other assets. Speaker Paul Ryan argued that the TCJA’s tax holiday for foreign dividend payments directly affects the economy because, “money will come back and that will help economic growth.” Indeed, many companies have already committed to significant repatriation amounts, with Apple notably pledging to pay $38 billion in tax on repatriated income.