The Boomerang Effect and Other Trade Dispute Implications

New research from the Federal Reserve Bank of San Francisco and other intergovernmental agencies sounds a cautionary note regarding the longer-term impacts of the U.S. tax cuts enacted late last year. The San Francisco Fed concludes that forecasts of significant increases in U.S. gross domestic product (GDP) growth as a result of tax reform “may be overly optimistic” because the “effects of fiscal stimulus on overall economic activity are much smaller during expansions than during downturns.”

The research appears at a time when daily headlines about tariffs and trade wars have some CFOs and tax leaders wondering how much caution they should apply to longer-term planning activities as a result.  To be sure, relatively few, if any, economists expect a 21st Century replay of the Smoot-Hawley Tariff Act, which is widely viewed as exacerbating the Great Depression. However, although periodic trade re-alignment is ultimately beneficial to treaty partners, trade conflicts and disputes – whether or not they rise to the level of a full-blown “trade war” – can be highly disruptive to global economic stability, supply and value chains and even tax planning.

Here are three trade-conflict essentials to keep in mind:

1. Trade conflicts can have a number of negative effects: Trade disputes can lead to longer-term economic instability and fiscal policy uncertainty. As more tariffs and trade barriers are levied, global companies often must respond by finding new sources for products; these changes may require extensive, and expensive, changes to supply chains.
2. The implications of trade conflicts take time to materialize: In full-blown trade conflicts, tariffs and other protectionist measures exert a boomerang effect in the form of a future retaliation and its related ripple effects. As such, it is difficult to determine precisely how current tariffs will affect bilateral and multilateral relations among trading partners, as well as fiscal and tax policies. These ripple effects will occur; however, the intensity and reach of these ripples remain to be seen. 
3. Trade and tax are correlated: Trade policy disruptions have the potential to eventually affect taxation at every level. In trade, tax and customs obligations are often intertwined; consider the interplay of value-added tax (VAT) with other excise taxes and custom duties. And keep in mind that a full-blown trade conflict would affect transfer pricing methods and country-by-country adjustments – as well as the effective tax rate for some multinational companies.

Whether or not trade disputes progress into trade wars should be of secondary concern for CFOs and tax executives. It is more important to recognize that these types of trade problems often have been followed by fiscal policy challenges and tax policy adjustments, and then plan accordingly.