David Stewart:   0:00
Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: NAFTA versus USMCA. The United States and its North American neighbors are in the process of finalizing a new trade agreement. The current agreement, the North American Free Trade Agreement, or NAFTA, has been in effect for over 25 years. The House of Representatives passed an updated version called the U.S.-Mexico-Canada Agreement, or USMCA, in December, and the Senate approved it January 16th. To talk to us about the two agreements, I was joined in the studio by Tax Notes contributing editor Robert Goulder. We recorded this interview shortly before the USMCA's passage in the Senate. Let's go to that interview.

David Stewart:   0:42
Bob, welcome back to the podcast.  

Robert Goulder:   0:44
Thank you, Dave.  

David Stewart:   0:45
Alright, let's start off with an easy question. What are tariffs? Are they taxes?

Robert Goulder:   0:50
Absolutely 100 percent. No shades of gray. A tariff is a tax, plain and simple. Most fundamentally, it's just a tax that an importing country puts on a foreign good that's entering the local marketplace, the local stream of commerce. Think of a cargo ship that shows up at a port. You take the cargo container and they have machines that lift it up and put it into what's called dry dock. And there's goods -- let's call them widgets -- in that container box, and there's somewhere off in some foreign country is an exporter, and somewhere on the U.S. side is an importer, and that person has bought and paid for those goods, and they want to get them released from the U.S. Customs Authority. And the tariff is the tax that they have to pay to the federal government to get the goods released into the local stream of commerce.

David Stewart:   1:35
Alright, so now we have, in order to minimize tariffs, we have free trade agreements such as the current NAFTA. So, can you tell me about what this new USMCA is? Is it just a replacement for NAFTA?

Robert Goulder:   1:46
Well, that's how everyone's thinking about it. Many people are referring to USMCA just as NAFTA 2.0. Although, to make that statement casts you as a cynic really, because it cuts against the political narrative that you're hearing from both sides really. We've got a presidential election coming up later this year and both sides, the Republicans and the Democrats, are running on how bad NAFTA was and how good USMCA is going to be once it becomes ratified.

David Stewart:   2:13
I remember in 2016 NAFTA was this bogeyman. How did NAFTA become everyone's punching bag?

Robert Goulder:   2:19
Yeah, great question. Not everyone agrees on what I'm about to say here, but the answer comes down to job losses, particularly industrial jobs, factory jobs. Look at the U.S. auto sector, for example. The truth is that today, in 2020, the U.S. makes far more vehicles than it did in 1993, the year before NAFTA was signed. But we employ many fewer people to do that. There's been huge job losses, and they've not been spread all over the country. When you look at the so-called "Rust Belt," states like Michigan, Ohio, Wisconsin, Indiana, Pennsylvania, those five states, traditionally strong Union states, often voting for Democrats because of the Union tie-ins, they all voted for Trump in 2016. And he was very successful at repeatedly uttering this animosity towards NAFTA saying, "NAFTA took your jobs away. NAFTA is why you're unemployed. NAFTA is why you and your family and your children are looking at a worse future. Let's change it. Let me change it with something better."

Robert Goulder:   3:19
The thing is, when people really look at this and they look at those job losses -- and no one denies that the job losses are for real. But to what extent are the job losses accurately pinned on somebody in Canada or somebody in Mexico taking your job? Well, there's a group in town, a think tank if you will, the Peterson Institute for International Economics. They did a comprehensive study on this, and they concluded that about 5 percent of job losses in the U.S. auto sector can really be blamed on NAFTA and foreign competition. The other 95 percent, the vast majority, is due to automation. So if you're looking for somebody to point a finger at and blame for a declining industrial base and the factory jobs that go along with it, maybe you ought to blame a robot instead of a Mexican.

David Stewart:   4:06
So that both sides seem to be in agreement that NAFTA has to go and USMCA is in the process, can you give us a sort of timeline of this USMCA?  

Robert Goulder:   4:14
Sure. It's an interesting story. You had the election in 2016 and then shortly after the inauguration, President Trump appoints a new U.S. trade rep known as the USTR. And that's Robert Lighthizer, a longtime trade attorney here in town in D.C. He takes office and immediately is instructed by President Trump to start renegotiating NAFTA with his counterparts in Canada and Mexico. And that process takes roughly a year plus, a year and a couple of months. It more or less runs from spring 2017 to fall 2018. So there's a ceremony, I think it was September of 2018, in the White House Rose Garden, where President Trump appears with Robert Lighthizer, and they unveiled this new thing called USMCA. The quirky thing is, we had a midterm election coming up, and the Democrats took the House, so it wasn't just enough for the document to be signed. It was signed at the G-20 summit down in Buenos Aires by Trump and Justin Trudeau of Canada and President Nieto of Mexico.  

Robert Goulder:   5:13
And just a few weeks later we had the midterms and the Democrats took the House. And when Nancy Pelosi takes over her position as the Speaker of the House, she says, "Well, we as Democrats, we have issues with NAFTA. But we also have issues with this deal that Lighthizer has negotiated with the Mexicans and the Canadians. And while we support the idea of replacing NAFTA, we're going to withhold our support unless we can modify the agreement." Bear in mind, it had already been signed off by the other two countries.

Robert Goulder:   5:45
And in fact, in Mexico, it was actually ratified this past summer.  There was a bill that went through the Mexican Senate. USMCA passed overwhelmingly. The vote was 114 to 3 in the Mexican Senate. Very little pushback. And that tends to go against this argument that we were really going to get tough with the Mexicans, and we're going to make them agree to all of these concessions. If this deal is so bad for Mexico, why did it pass through their Senate with such overwhelming support? In Canada it was never ratified, but it was all teed up to be ratified. They had their own election, and there was a bill of ratification that had to be delayed because technically what Canada does is they suspend Parliament when they have a national election. But Trudeau supports both NAFTA and USMCA, and he's going to have no problem getting this thing passed in Canada.  

Robert Goulder:   6:33
So, really, it's up to us. We're the impediment. And it's taken a long time, ever since the midterm elections, for the Democrats to figure out how they wanted to change USMCA. And get Lighthizer to go back to Mexico and go back to Canada and say "Here are the new terms that Speaker Pelosi is demanding. We're going to have to do a redo."  

Robert Goulder:   6:53
The optics of it is that it's a huge political victory for President Trump, and everyone is wondering why would the House Democrats, fresh off of impeaching President Trump, why would they hand him this political victory? And that's where things get really interesting because they're trying to own the "we don't like NAFTA" issue. The Democrats are trying to out-Trump Trump. They've identified this as an issue in the next election, and it's interesting what they did. They went to the labor unions. They went to the AFL-CIO, one of the country's largest organized labor unions, and they said, "Hey, AFL-CIO, do you support that original version of USMCA that Lighthizer brought back from his initial negotiations?" And, of course, the AFL-CIO said no.  

Robert Goulder:   7:36
It's been about 20 years since organized labor in America has thrown their political backing behind a free trade agreement. I researched this and was actually hard to find. When is the last time organized labor in the U. S. supported one of these agreements? You have to go back to a very small trade agreement between the United States and the country of Jordan in the Middle East.They don't make a lot of stuff. There's not a lot of industrial base in Jordan, and that was, I think, the year 2000. That's how far back you have to go to find organized labor in the U.S. supporting a free trade agreement. And here's what Pelosi said. She went to the AFL-CIO. She said, "What do you want? What's on your wish list? What do you want changed in USMCA? And if we can get those changes, then we want the unions to support this agreement." Because then that gives the Democratic politicians in the 2020 election the ability to say, "Now for the first time, you have the unions actually going along with the trade deal." But they're going to say it's Pelosi's trade deal, not Trump's trade deal.

David Stewart:   8:36
So, this is an agreement between countries. It sounds a lot like a treaty, but it's not going through the U.S. treaty legislative process, which would just be in the Senate for ratification. How do free trade agreements get approved in the U.S.?

Robert Goulder:   8:47
Well, they look a lot more like conventional legislation than they do a full-on treaty. So the Senate Foreign Relations, for example, is not going to have primary domain over this. It's going to be the economic part. It's going to be the Senate Finance Committee. So you're going look to people like Chuck Grassley, who I think is the chair of the Senate Finance Committee, who's going to be leveraging this thing through the Senate to try to get it approved. So, it looks like a treaty, and it feels like a treaty. But procedurally, it's going to resemble just basic legislation.

David Stewart:   9:16
Now, this isn't all happening in a vacuum. What other developments are we seeing in the trade area while this is all going on?

Robert Goulder:   9:23
Well, we could do a whole show on that. The Trump administration has been very active in the trade realm, far more so than any of its predecessors. In some ways, this is a throwback to the days of the 19th century, when the country relied on tariffs as a major revenue stream. Now we're messing with trade issues, not for the sake of revenue, but for the sake of the positive knock-on effects of employment, assuming those effects will actually be positive. 

Robert Goulder:   9:47
So what we've seen is, right out of the gate, President Trump did something that was very unusual. He went to Wilbur Ross, his commerce secretary, and said, "Do a study about whether foreign imports of aluminum and steel are a national security threat." And of course, he wanted the answer to be yes, and there was a report that came back that said, "Yes, when you're importing steel and aluminum and you're reliant on other countries to provide those raw materials, this actually is a national security issue. Because should there be a war, you're going to need lots of people domestically bashing metal to make things like tanks and planes and aircraft carriers. And if you're relying on other countries to supply the raw materials then that's a national security threat." 

Robert Goulder:   10:28
So he turned around and imposed these very large and unprecedented tariffs on aluminum and steel. They applied across the board to all countries. Initially, there was a carveout for Canada and Mexico. Eventually, that exception expired. Shortly after Canada and Mexico agreed to USMCA, Lighthizer said, "Okay, we'll scale back the steel on aluminum tariffs as they apply to Canada and Mexico." But they apply to everybody else.

Robert Goulder:   10:55
And then we get into China. That's a whole can of worms there with back and forth, tit-for-tat trade retaliation against China. I would say that trade issues with China and trade issues with North America are very different. When you look at China, there are large geopolitical issues there that simply don't exist when you look at trade issues with Canada and Mexico. Our neighbors, thankfully, are for the most part passive, friendly, and benign. They're not trying to replace us as a global superpower. They're just trying to sell us stuff. So, in theory, you could be pro-tariff when it comes to the China scenario and you could be totally anti-tariff on economic policy grounds when it comes to North America.

David Stewart:   11:37
Alright, turning back to the USMCA, how does it differ from its predecessor NAFTA?

Robert Goulder:   11:42
Well, the thing that I'd like to focus on are known as the rule of origin provisions, and these have to do with where parts come from, particularly auto parts. Maybe it's just because I'm a Detroit guy, but let's talk about cars and car parts. So under NAFTA, there was this thing called the RVC, which stands for regional value content. And that's a requirement that a certain percentage of a car has to be made from parts that are sourced in North America. And under NAFTA, the agreed upon threshold was 62.5 percent.  

Robert Goulder:   12:16
So, think of a car being made anywhere in North America -- U.S., Canada, or Mexico. It rolls off the assembly line and is ready to be sold somewhere, perhaps exported to one of the other North American countries. Imagine if you could take a very sharp scalpel and somehow deconstruct that car into different pieces. Think of it as like forensic accounting or forensic economic analysis. Here's this car. Where do all the pieces come from? If more than 37.5 percent of the parts come from a country other than the U.S., Mexico, or Canada, that car then cannot be shipped to another NAFTA country without incurring a tariff. So you lose tariff-free treatment by having too many foreign parts. And the way I got to 37.5 is just by taking 100 percent and subtracting 62.5. OK, so you see that.  

Robert Goulder:   13:08
So what this means is that the car manufacturers had to reconstruct/reconfigure their supply chains to satisfy that requirement because they desperately wanted to avoid tariffs when shipping these cars within North America. And it was hard for them to get there, because when you look at a car, if you think about it, almost all the speedometers will come from Germany, and almost all the tires that you see, regardless of how they're branded and stuff, they're coming from South Korea. And almost all the seat belts come from Japan. And there's just the laundry list of these parts that are not made in North America. So getting to that 62.5 percent threshold is really tricky. So that was under NAFTA.  

Robert Goulder:   13:51
What Trump and Lighthizer wanted to do is basically protect the domestic auto parts sector a little bit more than they were already doing. So they lifted that threshold to 75 percent. Initially, they wanted it to be 85 percent and the car companies complained and said, "We just can't do that. It's not possible to have an RVC threshold at 85 percent." They eventually settled on 75 percent. So, again, is this going to be good for the auto parts sector? Well, presumably it is because when that car rolls off the assembly line, more of it will be made in North America.  

Robert Goulder:   14:31
Now, two caveats here. One, that does not, in and of itself, help U.S. jobs because the parts that help you satisfy the RVC threshold don't have to be made in the United States. They could be made in Mexico or Canada. It's not a national value content requirement. It's a regional value content requirement. That's the first point.  

Robert Goulder:   14:51
The second point is just because a car rolls off the assembly line, say in  Mexico, doesn't mean it has to be sent to a car dealership in the U.S. or Canada. Some car makers are actively thinking about not changing their supply lines, forgetting about the USMCA threshold here, and selling the cars down in South America. Sell it in Brazil. They're doing analysis about whether it's worth ignoring USMCA and just whatever sales you lose in North America, maybe you can make up those same sales by sending these things to Brazil. That's another point.  

Robert Goulder:   15:25
The third point is, even if you're not going to take the cars and sell them in a third country market, what if you just suck up the tariff and pass it on to the consumers? That's a real scenario. In fact, may be the most likely scenario. There's a part of the government, the ITC, the International Trade Commission, that spent a lot of time studying the details of USMCA. And they came to an interesting conclusion. They thought that there would be a very moderate boost to auto parts manufacturers, but a corresponding increase in expected retail prices. So, the official economic analysis coming from the federal government is that prices are going to increase, which is a theme that resonates throughout the entire trade area with all of these tariffs that Trump is imposing, regardless of whether it's aluminum or steel or China.  

Robert Goulder:   16:12
Who really pays the tariff? Eventually it gets passed on. If there's a distributor, they pass it on to the wholesaler. The wholesaler passes it on to the retailer. The retailer passes it on to the final customer. We are expecting cars to become more expensive. At least new cars. Used cars is a whole other issue. But we're expecting new cars over the coming years to become more expensive because of USMCA. Even though in theory, yes, it's going to be good for parts manufacturers.

David Stewart:   16:38
Now, I understand there's other provisions in the USMCA, one being a minimum wage for Mexican workers. Is that right? And how does that help U.S. workers?

Robert Goulder:   16:47
Well, if it were true, it would help U.S. workers a lot. If you sit down and talk to people from the unions, one of their continual grievances is that the average wages paid to an American or Canadian worker are much, much higher than the wage paid to a corresponding Mexican worker. And some minor part of that might be currency differences. Most of it is just there's cheap labor down there. What can you do to shrink that gap? This has been an ongoing problem for labor. They look across the border, they think, "OK, that's fine buying and selling, engaging in cross-border trade with Mexico. But how do we shrink the gap between the typical American worker and the typical Mexican worker?" Because they do have unions down in Mexico. But they're not like the unions that we know in this country. A typical Mexican union is controlled by the employer, not the employees, which substantively kind of undercuts the whole purpose of having a union. It's a very different labor environment down there. there.

Robert Goulder:   17:43
So one of the things that they wanted to do with USMCA was to have a rule that kind of is a counterpart to the RVC thresholds that we were talking about before for car parts. There's something called an LVC requirement. That's a labor value content rule. And this is a whole new concept that did not exist under NAFTA. It's new and unique to the USMCA. So it's sort of some untested waters here. We're not really sure how it's going to work in practice, but the idea is that if you take this car that comes off the assembly line, at least 30 percent of the component pieces of that car have to be made by workers earning on average $16 an hour. Now, that does sound like a minimum wage. So the popular media picked up on this, and it sounds like USMCA is going to impose a minimum wage on the Mexican workforce.  

Robert Goulder:   18:33
Not really true. And here's why. First of all, it's only 30 percent of the car. If we were serious, it would be 100 percent of the car. So there's still 70 percent of the component pieces that can be made by people making next to nothing, you know. The other thing is, it's not a wage floor. It's a wage average. So they're going to look at a pool of employees, add their salaries or their wages together, and then divide per capita by the number of people in the pool. So you can inflate that number depending on who you include in the pool. So if you have a business manager, a floor manager, an engineer, people who are earning very high wages, if you include them in the pool, well, you've just inflated it artificially over the 16 percent threshold. So I wouldn't say that it's totally meaningless. It is some upward pressure on wages. Time will tell whether it really works.

Robert Goulder:   19:24
And also, who's going to know if there's any violations? One of the underlying issues here is that when a country like Mexico agrees to these labor market reforms, who's going to know if there's a violation? So they do have a department of labor. But they recently had a budget -- the new president down there, President Obrador. He cut their budget significantly, so there's an estimate floating around out there about how well equipped is the Mexican labor department to investigate alleged violations of these USMCA terms. And they realized they have about 8 percent, not 80 or 18 percent, 8 percent of the budgetary resources necessary to enforce USMCA. So you have to step back and think, "What good are all these promises that the government is making if the party responsible for enforcing the rules and administering the rules has 8 percent of the budget necessary to do the job?"

David Stewart:   20:21
Now, you mentioned some belief that there might be increases in car prices. Are there any projections that the USMCA will have a positive effect on economic growth?

Robert Goulder:   20:29
Oh my. That's a whole can of worms here. So, the ITC studied this and they came up with a number of positive GDP growth, spread over a six-year term. They thought that it was going to add 0.35 percent to the U.S. GDP, which is good. We all want GDP to go up, not down. We like economic growth. That's a good thing. However, if you peel back the executive summary of that ITC report and look at how they got there, it's a bit troubling. They assigned a very large score, a GDP growth score, to the diminishment of economic uncertainty. Whenever you have an uncertain economic environment, businesses are less likely to invest. They're less likely to hire. They don't want to commit to long term investments that they can't unwind from very easily.  

Robert Goulder:   21:17
So, certainly trade and commercial uncertainty is a type of a trade barrier. And what they've done is, they said, "Well, once all these countries ratify USMCA, all the trade certainty is going to go away, and that's going to be a huge boost to growth." But that's a little bit circular, sort of a self fulfilling thing, because you have people going around tweeting that we're going to have all these tariffs and business people are freaking out. It's almost as if in the big picture here we've ginned up some sort of uncertainty, and then we're taking credit in the revenue score for getting rid of that uncertainty. Because if you take out the little kick for uncertainty on purely substantive merits, USMCA would call for a drop in GDP. It is not pro-growth relative to NAFTA. If you have a baseline that is the status quo of the current rules with NAFTA relative to that baseline, USMCA will cause GDP to drop. It's only by factoring in this gain from diminished uncertainty that it appears to be good for the economy.

David Stewart:   22:23
Well, I think that's a good place to leave it. Bob, thank you for being here. We'll definitely have to check in again --

Robert Goulder:   0:00
Yes. 

David Stewart:   22:28
-- as we see how this plays out.

Robert Goulder:   22:29
More to come.

David Stewart:   22:30
Thank you.

David Stewart:   22:32
And now, coming attractions. Each week we preview commentary will be appearing in the Tax Notes magazines. I'm joined by Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith:   22:42
Thanks, Dave. In Tax Notes Federal, Jason Schwartz discusses how entities can qualify as two types of distressed mortgage securitizations. Seth Entin explains the tax ramifications of the IRS's decision to reject the U.S. citizen's check the box election made as a nonresident alien. In Tax Notes State, Jonathan Iversen discusses 2019 tax and fiscal developments in Alaska. John Swain discusses the constitutionality of tailored taxes. And in Tax Notes International, Marco Rossi discusses Italy's proposed beneficial ownership register. Frederick Boulogne and Jack Carlson examine how the EU's second anti-avoidance tax directive will affect payments from EU entities to subchapter S corporations in the U.S. And finally, in the Opinions page, Robert Goulder considers whether the OECD's pillar 2 can survive as a standalone minimum tax and Carrie Elliot discusses the insurance mandate, taxing power, and public goods.

David Stewart:   23:40
You can read all that and a lot more in the January 20th editions of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us a podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.