Trump’s ‘border adjustment tax’ big unknown for Canadian oil and gas

Until Congress draws up tax reform legislation, impossible to estimate impact of border adjustment tax

The Canadian oil and gas sector – producers, service companies, and manufacturers alike – is wringing its hands at the prospect of an American border adjustment tax, but economists say the concern is premature and could be completely unwarranted.

The border adjustment tax is part of a wholesale restructuring of American business taxation championed by Speaker Paul Ryan last year and picked up by the Trump transition team. Like most tax reform, the devil is in the details, and those haven’t been revealed yet, according to Dr. Phil Verlager, a senior American economist who has been been writing about energy markets since 1971.

“We haven’t seen it built. The limited amount we’ve seen is that June release from the [House] Ways and Means Committee and speaker Ryan,” said Verlager in an interview. “There are no special exemptions for NAFTA countries [like Canada].”

The most salient element of the Ryan plan for Canada is that business tax now becomes “border-adjusted” – applied to all domestic consumption, but not applied to goods or services produced in the United States and exported elsewhere, according to the Tax Foundation.

What might be the border adjusted tax rate? Canadian economist Jack Mintz thinks the rate would be the equivalent of a 15 per cent value-added tax (like Canada’s GST), but if the states adjust their tax rates too, it could be as high as 20 per cent.

“That would fall on crude coming into the United States, whether it’s from Canada, Venezuela, Middle East, Mexico – it’s all going to be subject to this higher tax,” said Mintz in an interview.

Mintz says he has already spoken with Canadian companies doing business in the United States that are quite concerned about the impact of a border adjusted tax on their competitiveness.

But there is a potential offset to the proposed tax.

Both Mintz and Verlager agree that, in theory, if domestically produced and consumed goods are taxed and exports are not, then the extra demand for US dollars will cause a currency revision by the same amount of the tax.

“The US dollar will probably rise through this and in principle, with the higher exchange rate, with this tax at 15 per cent, the exchange rate could go up 15 per cent. Imported prices coming into the United States would be unaffected once you take into account the exchange rate adjustment,” said Minz.

Verlager adds that because global oil and natural gas are priced in US dollars, prices should hold steady. Some Canadian producers might lose on existing hedges, but most are rushing to get out of them.

“Assuming no changes to the world oil price, Canadian exporters are in the same position as they were before,” Verlager said.

A tax/currency adjustment washout is the best case scenario for Canadian exporters of petroleum products, and related goods and services.

But there is the possibility of a worst case scenario, say Mintz and Verlager.

Because Speaker Ryan’s blueprint for tax reform hasn’t yet been translated into legislation, there is still time for lobbyists to influence the granting of exemptions and special treatment.

Verlager expects Republicans to ram legislation through Congress by the end of Jan. Getting it through the House of Representatives won’t be a problem, but the Democrats have enough seats in the Senate to filibuster and delay passage. Republicans have already held two days of meetings to set their strategy, which will be to attach the tax reform bill to a “budget reconciliation,” which only requires 50-plus-one votes to pass.

“If it is going to pass, it is going to pass very quickly because a lot of companies and a lot of lobbyists really want to fight this. The Republicans owe them little,” said Verlager in an interview.

“There’ll be hearings but essentially this is going to railroaded through.”

Minz says even if the bill passes without being carved up by lobbyists and special interests, there is still no guarantee of the full exchange rate adjustment. That will be determined by a wide range of market variables policymakers have no or little control over.

“If the corporate tax reform bill is passed, it’s not going to affect everything that comes into the country. Let’s say it only applies to half of business income in the United States. You potentially could end up with the exchange rate adjustment being only half of the tax rate,” said Mintz.

 The biggest worry for Canadian firms in the short-term is uncertainty, made all the worse by Trump’s threats to apply a punitive border tax to specific companies, like Toyota and its Mexican-built Corollas.

“Tax reform is a rules-based approach, a single system that applies to everybody in principle. When Trump selects particular companies, it’s not rules-based anymore,” said Mintz.

Where the US tax system will look like in two weeks or a year is anyone’s guess. The changes could be mildly positive, benign, or mildly negative for Canada.

Or, as Verlager wryly points out, the entire process could become a runaway train bomb, blowing up entire economies the way a stronger US dollar did in the early 80s and late 90s, when higher interest rates caused debt defaults, slower economic growth, and $10 oil.

“That really would have a big impact on Canada,” he said.