Countering China’s Trade Practices With Investment Tax Policy

Panelists discuss ending the U.S. tax subsidy for Chinese inward portfolio investment as a tool to shrink the trade deficit, as well as the potential economic and policy implications of this approach for U.S. markets and the bilateral relationship with China.

This meeting is presented by RealEcon: Reimagining American Economic Leadership, a CFR initiative of the Maurice R. Greenberg Center for Geoeconomic Studies. This meeting is also part of CFR’s China Strategy Initiative.

GOODMAN: Well, good morning from Washington, I always say, because people online who are watching may not know where we are. (Laughs.) But we’re at the Council on Foreign Relations in Washington. Welcome to CFR, everyone. My name is Matt Goodman. I direct an initiative here at CFR called RealEcon, or Reimagining American Economic Leadership. We’re doing a lot of reimagining these days, as you can imagine. (Laughter.) And we’re just delighted to be helping to bring to the table a really interesting group of people on a really interesting subject.

Obviously, there’s been a lot of news about China and trade these days, but a lot of the discussion has been around tariffs or export controls, or even when it gets to investment issues it’s been more focused on foreign direct investment for both directions, not as much on portfolio investment or investment in U.S. Treasurys and other aspects of our investment. And the connections between all of that and the trade story, I think, is one that, while macroeconomists know about that, we don’t talk about it in policy discussions in Washington.

So my colleague, Benn Steil and Alex Raskolnikov—who’s online, I think—and they’ll be introduced by the moderator, Rebecca, in a second—wrote a really provocative, interesting piece in Foreign Affairs in February about a sort of new way of thinking about this and a new set of proposals about how to deal with this set of issues. And so I commend that piece to you, but you’re going to hear something about it here today. So with no further ado, other than to say this is on the record, so beware of that if you ask a question—but we hope you will ask questions—and I will, with no further ado, hand over to Rebecca Patterson, who’s the senior fellow here at the Council on Foreign Relations, a well-known investor, macro analyst, and just terrific colleagues. And over to you, Rebecca.

PATTERSON: Thank you so much, Matt. And thanks, everyone, for being with us today in person and virtually. I think we have well over a hundred, maybe close to 150 folks online as well. It’s great to be presiding over this discussion. We’re going to be talking about countering China’s trade practices with investment tax policy. It’s a mouthful for you. And, as Matt said, it is a fascinating time to be having this conversation, when the focus is so squarely on trade policy, to think about how the U.S. engages with China. And just this morning I was—I had a 5:40 media interview. So I’ve been up for a while already.

And the news with China and the U.S. with this trade war changes literally minute by minute. Yesterday we had President Trump suggesting that he could raise tariffs another 50 percent which, if I’m keeping track of the math, would take the tariff rate on China to well over 100 percent, which is a big number. And then this morning China said, we’re not going to negotiate. They had their national team, so called, state-related entities in the market supporting their stock market. The currency weakened 1 percent just overnight. And then President Trump, literally within the last few minutes, suggested that China wants to talk.

So I don’t know what’s true, but it is a dynamic situation to say the least. And so I think it’s incredibly important to be focusing on it because it matters not just for China’s economy or the U.S. economy, but the global economy and financial markets, as well as a lot of longer-term issues around economic security and other types of national policies. So I am a macro person. I’ve been a researcher and investor for about thirty years. But I am not a tax expert. So I am extremely happy to have these three wonderful people with me today to have the conversation.

Online with us today we have Alex Raskolnikov. He is the Wilbur Friedman professor of tax law at Columbia Law School, and has—his research over the last few years has focused primarily on political theory and economic analysis, including, very importantly, taxation.

And then also with us to my right, immediately, Phil West. Really one of the top international tax lawyers in the United States and, importantly for today’s conversation, was former tax counsel—international tax counsel at the Treasury Department. So has practiced both private sector but also within the government.

And then, of course, Benn Steil, in the middle, here with us today, a fellow fellow at the Council on Foreign Relations and director of international economics at the Council on Foreign Relations. And he and Alex coauthored the piece in Foreign Affairs that prompted the discussion we’re having today.

Hopefully, most or all of you have had a chance to read that paper, but don’t worry if you haven’t. We’re going to cover all the salient points and then some today. And the idea really is instead of, or maybe alongside, trade policy is there something to do with international tax policy that could be in the U.S. interest? So that is going to be our focal point. We’re going to spend about thirty minutes in conversation, and then we will open it up to folks in the room as well as people virtually for any questions you have. So along the way, jot down your questions. We’ll make sure we answer them. Just to echo Matt’s point, this is on the record.

And let’s just get right into it. And before we start getting in the weeds of tax policy, Benn, I’d love for you to set the table for us and just take us back to college econ 101. You know, we have the current account and the capital account in a country’s balance of payments. Trade policy is squarely focused on the current account. Today we’re talking more about the capital account. But how do those two things intersect? How would focusing on the capital account help America?

STEIL: Right. So Alex and I start from the premise that the size, the persistence, and the composition of our trade deficit with China should be a matter of concern, and increasing concern. Primarily because over time it’s become more and more politically determined. In other words, China is making strategic decisions to elevate certain products to dominate the global trade market. This was much less of a problem back in 2001, when China acceded to the WTO, because its economy today is 1,400 percent larger. So we do start from the premise that this is something we do need to address. Particularly because China is massively subsidizing those entities and sectors that it wants to dominate. On average, China’s industrial subsidies are over ten times ours.

What’s different about our paper from traditional approaches to the problem is that, as Rebecca emphasized, we don’t treat it as a current account problem, that is primarily a trade problem, to be dealt with with traditional trade tools like tariffs. We treat it as a capital account problem, that is primarily an investment problem. The two things go together. When the United States runs a current account deficit with a country it also runs a capital account surplus. That is, China sells us stuff, gets dollars, invests it back in the United States. And the traditional commentary on that nexus is typically unidirectional, which, we contend, is completely wrong.

That is, China sells us stuff so it has to invest it in the United States. So the current account determines the capital account. From a macroeconomic perspective, that’s not true. The causation goes in both ways. So to the extent that China wants to make investments in the United States, it needs to raise dollars in order to do that. So it has to sell us stuff. So what Alex and I are proposing is significant reform to U.S. tax policy that will eliminate what is, in effect, a massive subsidy for Chinese investment in the United States.

What do I mean by that? If any of you in this room were to, say, buy an IBM bond, the interest you would receive on that bond would be taxed at roughly 37 percent. Phil might correct me if I’m wrong by a few percent. But if China’s massive sovereign wealth fund were to buy the very same bond, it would pay an interest rate of zero. That gives CIC, China’s sovereign wealth fund, a massive incentive to buy that bond rather than you. So we are effectively subsidizing China to buy up U.S. assets, which then has to be matched by an increase in Chinese exports to the United States in order to raise those dollars. So this actually increases the impetus for China to dump goods at below cost in U.S. markets.

So I’m going to let Alex introduce our tax proposal but I want to just emphasize, from a macroeconomic perspective, what I think the four major benefits of our proposal are. First, it will reduce the trade deficit with China. We produced some details in our paper about what we think the magnitude would be. Second, it would neutralize China’s current strategy, given the motivation for tariff avoidance—to ship goods to the United States through third countries to avoid the tariff—because the Chinese entity that owns the stuff being sent to us will ultimately be taxed anyway. So this strategy won’t work anymore.

Third, it will discourage the passing of U.S. assets to Chinese control. Again, right now we’re subsidizing that transfer. And finally, unlike tariffs—you know, President Trump insists that foreign countries pay the tariffs when they export to the United States. That’s not, in fact, true. With our proposal, the revenue that would be raised would be 100 percent raised from abroad. That is, U.S. investors would not pay it but the exporting entities would be paying the tax.

PATTERSON: Thank you for that. Alex, I want to turn to you just as the coauthor of this paper, and just to talk a little bit more about the proposal in a bit more detail. And then I want to bring in Philip, who I think has some slightly different views on this. You know, the idea is not new. As you all know, and mentioned in your paper, Senator Ron Wyden in 2023 introduced a bill that would take one of the steps that you’re proposing, that would deny this tax subsidy, this benefit, to China. I don’t know if it didn’t go very far because there wasn’t a lot of support or it just wasn’t a top priority for that session of Congress, but I wonder if you could talk a little bit, is there support in Congress to do this? What is that first step that Congress would have to take?

RASKOLNIKOV: All right. Thank you.

So I want to back off—back up a little bit, just to say a few things about this subsidy that Benn mentioned, because it may sound very bizarre to people who are not tax lawyers. Like, why would we ever do this? It’s not bizarre. It’s a part of a reciprocal—actually, a reciprocal international tax regime—(laughs)—that’s been in place for many decades and has been working fairly well. But it isn’t working well anymore for the United States, for the reasons that Benn just articulated. The second—so regime—the regime remains reciprocal in form, but because of vast disparities between Chinese investments in the United States and U.S. investment in China that have materialized over time, in substance it’s no longer reciprocal. Meaning that the benefits that one side gets are not matched by the benefits that the other side gets.

So the second thing I want to just emphasize before we get into the weeds is that we’re talking about the so-called portfolio investments. We’re not talking about companies buying—Chinese companies buying either U.S. companies or majority stakes in U.S. companies, or anything like that. We’re talking about fairly small investments as percentage of overall companies’ market capitalization or share ownership. It may not be small in dollars. You know, like 1 percent investment in Apple is billions of dollars. But as percent of Apple overall, it’s a small investment.

The third thing that I want to put out there right away is that what we’re suggesting is—as often true in tax—is not exactly an easy to grasp, you know, intuitive thing that can be explained in one sentence. But at the same time, we think that it’s worth thinking things through and trying to come up with an idea that would be, you know, not cost free, but, we think, much less harmful than things that can be explained in one sentence—like a 100 percent tariff on Chinese goods. Or another proposal that is being discussed, at least in the policy circles, is capital controls. You know, like, these are—these are massively harmful things. So there is—it’s important to keep in mind that, you know, it may be worth getting into some weeds and understanding a few things if the cost is going to be smaller, even though, clearly, there’s going to be costs.

So that’s, sort of, the preamble. Now to our idea. Actually, it is a new idea. So Senator Wyden did propose legislation that hasn’t been enacted. But it’s only the first step of sort of our plan. And in fact, we’re saying that even if it were enacted it wouldn’t do much because there are other parts of the tax law that Chinese investors would easily take advantage of or use that would kind of make Wyden’s proposals, on a standalone basis, kind of not doing much. For example, the vast majority of Chinese investment in the United States is in U.S. Treasurys. And even if the special rule for Chinese government or sovereign wealth fund that Wyden wanted repealed for China were repealed, that investment would still be tax free under a different rule in the tax code.

So, what we have in mind is—you know, a series of steps that really is going to address the problem that Benn articulated. Which is, both Chinese government, and Chinese sovereign wealth fund, and major Chinese investors, all pay either zero tax on their returns or lower tax—even if it’s not zero—lower tax than U.S. investors. So that’s the idea.

PATTERSON: Great. Thanks. Oh, go ahead.

RASKOLNIKOV: As for—as for—as for the possibilities and the—of the enactment, and how things may work in Washington—so, Wyden’s proposal, it wasn’t just aimed at China. It was aimed at Russia, North Korea. So I don’t know, I haven’t talked to Wyden’s staffers, but it feels like a politically motivated proposal. What Benn and I are suggesting is economically motivated proposal. And so the support for that proposal will come from different—for different reasons, and possibly from a much broader set of people who, perhaps, think that—you know, that the massive tariffs is sort of the last resort measure. And if there are things that could be less harmful, then it’s worth trying. And Benn and I think that what we’re suggesting would be less harmful.

PATTERSON: Great. Thank you. And, yeah, certainly, just in the last few days, we’ve seen consensus forecast for the U.S. economy being lowered pretty sharply. Earnings per share growth forecast for U.S. companies being lowered sharply. A number of large investment banks now as their base case calling for a recession in the United States this year, on the back of the tariff announcement. So I think there is a general sense among many on Wall Street, if not in Washington, that this could be quite harmful for the U.S. in the short term, and perhaps longer.

Philip, I—Phil, excuse me—I want to bring you in on this. You know, as Alex was saying there’s several steps that would have to be taken to make this work. As someone who’s followed Chinese capital flows for many years—I know that sounds super exciting; it is to me—(laughter)—but, you know, trying to understand if they’re buying or selling Treasurys and how much is complicated by the fact that often there are different entities used, that the money can move through third parties such as the Caymans or Bahamas, et cetera. So, you know, how difficult is it to make this work? And just your general reaction to this proposal overall?

WEST: Sure. Thanks, Rebecca.

First, let me say I’m speaking for myself not my firm or any of its clients. And I’m not here to support any particular—or even the concept of measures against China. But I am here to tell you that if we are going to do something, this is not a good way to do it, OK? It is in the president’s proposals. The America first policy proposal that he put out February 21 of this year, suggests terminating or reconsidering our tax treaty with China. But, in my opinion, like the president’s proposal on tariffs, it’s a simple sounding solution that is not necessarily a good idea. And I think I can summarize in four reasons why it’s not a good idea.

First of all, the benefits are speculative. And I can talk a little bit about why that is, although I’m not an economist and I don’t have a crystal ball. But I think it’s fair to say that the benefits are speculative, especially when we consider that when disinvestment happens the potential exists for interest rates to go up. So if this has the effect that we want, that there’s significant disinvestment, the economists in the room can tell me I’m wrong, but I think there’s a risk that we’re going to end up paying more in interest proportionate to the disinvestment.

The costs are real. So, benefits speculative but the costs are real. It harms America and it harms Americans in ways I’ll talk about. It ignores a lot of things. The proposal to terminate our treaty ignores our particular treaty program, how we operate it, how we’ve operated it for many, many decades. And the proposals, whether it’s the Wyden proposal or the proposal to address the portfolio interest exemption that Alex mentioned, they have a long history. Alex talked about the reciprocal nature of the portfolio interest exemption. This means, basically, if you invest in the United States on a passive basis, not conducting a business here, the residence country, the country where you live, gets the primary right to tax you, not the source country where the income originates.

And that’s been an international tax norm for many, many years. We can say we’re going to change it for this particular kind of interest, for this particular investor, but the circumstances in which we have identified a particular country for—and singled them out for treatment is very rare. We’ve done it—the two occasions that I can recall, and I think they’re cited in the paper—we identify countries that participate in a boycott of Israel. It’s actually a broader provision, but the main area people focus on is the Israeli boycott. And for a time when South Africa had an apartheid regime, we limited tax benefits related to South Africa. But those are, you know, broad reasons that go to our values and our fundamental interests.

And to say we’re going to change it because we want to play around with the economics here, there’s a reason the Wyden bill wasn’t proposed—wasn’t passed. It is a very dramatic measure. You know, Wyden grouped China with Russia, Iran, and North Korea. One of those countries is not like the other, in my opinion. You know, we call—I think that America first policy paper calls China an enemy. I think a lot of people call it a competitor. But I think grouping it with North Korea and Russia and Iran sort of strikes me as strange.

And the number of times we’ve terminated a treaty is worth noting also. In my recollection, we’ve terminated two treaties. And they’ve both been for tax reasons, not other reasons. We terminated the Malta treaty temporarily because they weren’t exchanging information, and we had suspicions of rampant tax evasion. And we terminated our treaty with Hungary because we also were concerned that the tax provisions were being avoided through the preservation of a treaty that didn’t have something called the limitation on benefits provision, which we won’t talk about because you’ll all go to sleep.

But I want to—if I make one point here, here’s the point I want to make. It’s a bit of a digression, but this whole approach allows us to ignore the major issue here. The major issue here is we need China’s investment. And we need China’s investment because we need to borrow. And we need to borrow because we fund deficits. And we fund deficits because we don’t have the political courage to raise the revenue necessary to support our expenditures. And the one point—we can talk about—you know, it’s not Elon Musk taking a chainsaw to AID or the IRS, certainly, which is going to lose us money, that’s going to reduce expenses. On the revenue side, let me—you know, we don’t have the courage to look at a carbon tax. We don’t have the courage to look at a consumption tax.

There’s something—the problem with the consumption tax, you may have heard the old saw, Republicans hate it because it’s a new tax. Democrats hate it because it’s regressive. And the day we’ll get one is when Republicans realize it’s regressive and Democrats realize it’s a new tax. (Laughter.) You know, the consumption tax has a big problem with raising revenue, which is to make it non-regressive you need to exempt a lot of things, and that hollows out the base. But, you know, it is worth talking about. There was a destination-based cash flow tax that got some currency, and maybe that’s something worth talking about.

But here’s the one point I want to make: If you haven’t been paying attention to the fact that the Senate passed its reconciliation bill using a current policy baseline, that is the one thing you should come out of this meeting focused on. Because if any of our clients took $4 trillion off their P&L by waving a magic wand, they’d be prosecuted and they’d be convicted. But we’re letting our Senate do that by saying, let’s pretend that extending the 2017 tax cuts has no cost. That is what happened last week. Everyone in this room, everyone in the country, ought to be very, very concerned about that. When we face up to that, maybe we won’t need China’s lending to us. And there are a lot more things I can say, but let me stop here.

PATTERSON: Thank you. And for those of you who want to get in the weeds of current policy versus current law and what our deficit outlook is going to be regardless of how the bill is written and passed, I’m in the process of organizing an event in early May. I think we have confirmation that former Treasury Secretary Jack Lew is going to join me to have that conversation. And he is a perfect person to do that with. So keep an eye out on CFR invitations for that because, I agree with you, it’s a hugely important issue in a lot of ways.

Now, China today, if I’m right, owns just under a billion dollars’ worth of U.S.—or, sorry, no. A trillion. Excuse me. A trillion. I get my Ts and Bs—once you get into those kinds of numbers—just under a trillion dollars’ worth of U.S. Treasurys and government assets. And they’re the second-largest holder of U.S. government bonds, after Japan. And so it is—them buying less is something we need to think about in terms of how it could flow through to the bond market, push up interest rates, possibly, which would affect borrowing costs for households, companies. And obviously, since the U.S. market is the dominant market in the world, it flows through to global economies and markets. So it is an important consideration, absolutely.

I do want to give Alex an opportunity to respond to some of these thoughts, because I’m sure you have been thinking about these things as you and Benn have put this paper together. You know, things like the Common Reporting Standards, things like shell companies, the ways that this money is moving, are there other ways to get at it? If this is not the perfect solution, is it the best of the bad options we have? What are your responses and thoughts to Phil? And, you know, you all joining us today probably didn’t appreciate that we’d get to have so much fun debate over this topic, but it’s good. (Laughter.) It wakes us up in the morning.

Alex, let me hand it to you.

RASKOLNIKOV: Exactly. Debate is fun. I actually think Benn is probably a better person to take up the point about the raising interest rates and, you know, who buys U.S. Treasurys, and what’s going to happen when China buys them less. And then I’m going to—and then I’m going to talk about tax.

PATTERSON: OK. Go for it.

STEIL: OK. So, three broad responses to—oh, I’m sorry. I apologize. Three broad responses to Phil.

First of all, he’s conflating the budget deficit with the trade deficit. They’re two different things. Is there a positive correlation between them? Yeah, a small one, but they are two fundamentally different macroeconomic entities. We shouldn’t be mixing them in this discussion.

Second, the idea that we shouldn’t pursue this policy because it might push up interest rates, in my view, is ridiculous. The only reason you could possibly say that is that you believe that the current account deficit with China should stay at the level it is now or increase, because anything that you do—whether it’s tariffs, trade barriers, taxation—anything that you do that pushes down the current account deficit will push down the capital account surplus. So anything that you do that reduces that trade deficit with China is bound to have an impact on interest rates. There is nothing at all unique about our proposal that puts an upward pressure on interest rates. Absolutely nothing. Capital account and current account move together. This is an accounting identity.

Third, when Phil says that the benefits of our plan are speculative, no they’re not. They’re uncertain. The magnitude is uncertain. But that is completely different from saying that they’re speculative. At the end of our paper we do invoke research that has been done linking, for example, withholding taxes with portfolio investment. And we have produced an estimate, an estimate—an uncertain estimate—of what the impact would be of eliminating this tax subsidy to China and simply using the standard U.S. foreign investment tax withholding rate of 30 percent. And we believe that it would reduce the current account deficit with China by about 16 percent. That is not speculative. It’s an uncertain number.

RASKOLNIKOV: OK. On the tax side, I am going to mostly agree with factual statements that Phil made. We just disagree about the implications of those things. And in fact, when Benn and I started thinking about this I had all the same reservations and concerns that Phil just expressed. We have a longstanding tax treaty program with tens and tens and dozens of countries. It is very unusual to single out one country the way we suggest. In fact, at first, I think this probably cannot be done. After a while, I realized that it very much can be done. And terminating tax treaties is extremely rare. All true. All of this is true. So in the normal times—I mean, Benn and I didn’t write this paper ten years ago, or even five years ago. In the normal times, this would be pretty extraordinary, what we’re suggesting.

When we’re comparing this to alternatives, which is 50 percent, 100 percent tariffs, or capital controls, our whole point is, look, we have this subsidy. Again, it’s there for a reason. It’s not crazy. But it is there. We have this subsidy. And eliminating the subsidy, while costly, is going to be less costly than either massive tariffs or capital controls. It can’t be done simply, but it can be done. We walk through the sequence of steps. Some of them involve legislative changes. Some of them involve United States joining the common reporting standards that you mentioned, Rebecca. Which is a good idea anyway, but is especially good in this case. Some of it will involve creating new withholding tax rules that are not there today.

So it’s not simple, but it can be done in one package. It’s not inconceivable. And the results are exactly what Benn said. Yes, they are uncertain, because nothing like this—nothing like this has been done before. So, yes, there is uncertainty. But there is a—there are reasons to think that there will be a meaningful impact. So I will stop there.

PATTERSON: OK. I know Phil is dying to get in, but before he does I want, for the benefit of this group—because I want to make sure people are educated if they are not tax experts already—Common Reporting Standards. When I read the paper, it seemed like that is an obvious thing to do, from someone with no deep knowledge of tax. How come it hasn’t been done? Clearly, it’s not easy or simple, or it would have been done. So I just want to understand why that is. Let Alex answer, and then, Phil, I’m going to let you get in on that and other stuff.

RASKOLNIKOV: It hasn’t been done because, putting aside the situation with China that we’re talking about today, it is not in U.S. interests. It’s not going to add—as some government agencies considered and decided—it’s not going to add to the information United States can collect because United States pioneered the kind of thing that Common Reporting Standards later came up to do, which is collecting information. For us, for the United States, is the information about U.S. investors abroad, U.S. investor accounts in foreign banks and so on. And we have our own regime. And, you know, it was a great American idea to create—to institute this regime called Foreign Account Tax Compliance Act, where we’re already collecting this information. So we don’t need this to learn more about Americans with foreign accounts. But if we want to know more about Chinese foreign accounts, then we need to join Common Reporting Standards.

WEST: So here’s the irony. Do you know how we get that information? Through tax treaties. If we’re not members of the Common Reporting Standard regime, we still can use our tax treaties for information exchange purposes. So I know some people think the less tax administration the better, the smaller the IRS the better, the less tax enforcement the better. I think most thoughtful people don’t think that. And our tax treaties—if we terminate a tax treaty with China we’re going to be less able to get an exchange information with China. That’s one of the ways I said this harms Americans.

You know, tax treaties do a lot of things besides reduce withholding tax rates. In fact, they’re called conventions for the elimination of double taxation and the exchange of—and tax cooperation, or the exchange of information. They’re not—they don’t talk about in the title the reduction of withholding tax rates. They allow the elimination of double taxation. They facilitate dispute resolution. A lot of our firms’ practice is working with companies that are subject to tax in two different countries. We don’t have a tax treaty. There is no mechanism to resolve those claims of double taxation. So it’s just one of the many reasons.

Look, you know, we talked about tax treaties. We have a very selective tax treaty regime in the United States. Many countries have a hundred or more tax treaties. We have fifty or sixty tax treaties. And one reason why we have few is we don’t enter into them for political reasons. We don’t enter into them as plums to give other countries when they come saying, you know, it’d help us if we had a tax treaty with the United States. We enter into them when there’s a reason, a tax reason, an economic reason relating to investment. So, you know, you could make the case—and I’m not an economist, so I’m not going to debate Benn on the economic points. You know, when the uncertainty becomes zero I think that’s the definition of speculative.

And similarly, what they say the definition of a bad tax regime is, it’s a complex regime that raises little revenue—complex regime that raises little revenue, or doesn’t achieve its objectives. What Benn and Alex are describing would be very complicated. Again, there’s a reason the Wyden bill didn’t pass. You’d need to change the portfolio interest exemption. You’d need to terminate the treaty. You need to change the treatment of—Alex, how much work have you done on the Hill to try and get legislation done? Because, you know, I’m telling you, this is a complicated endeavor. And if it doesn’t have a high level of certainty that it’s going to move the needle, I would question whether it’s worth the candle.

One last point. This idea that there’s a disconnect between the treatment of Chinese investors and U.S. investors really conflates source and residence taxation. You know, we don’t tax foreign investors on a lot of things they do when they invest in the United States. We tax Americans because they are Americans. We don’t tax non-Americans on many different things. And to say that Americans pay tax on Treasury interest but Chinese or French or German or U.K. investors don’t really mixes apples and oranges. You know, we tax Americans not because they’re earning Treasury interest, but because they’re Americans. And the Chinese investors are subject to tax on this kind of income under Chinese law. So that’s the last I’ll say.

PATTERSON: Thank you. I do want to keep an eye on the time, because we pride ourselves on sticking to our schedule and getting people back to the rest of their day on time. So I would like to open it up now for questions from the audience, both here in the room and online. Do we—before we get online, is there anything in the room? Yes, please. It’s on already, you just have to—

Q: Great. Thanks so much for all of this.

Phil seemed to illustrate one of the debates you guys are having. Benn and Alex started saying this was a political choice, and then Phil got irritated with lumping China in with Iran, North Korea, and Russia, and threw out two words, “enemy,” “competitor.” Before our wild last week, isn’t that kind of the debate? Where is China on that? We’re a long way from being autarkic from them, but at the same time we’re not quite buddies anymore.

RASKOLNIKOV: Yeah. I agree. I agree with that. And, of course, this whole—this whole paper is based on the assumption, as we said at the beginning, that we’re kind of in a different world than we were ten years ago. I don’t think that Benn and I would say that we have to view China as an enemy to adopt our proposal. They are a competitor, and an unfair competitor, for the reasons Benn articulated at the very beginning. And so that’s what we’re dealing with. Of course, it’s true that that U.S., as Phil said, taxes Americans and foreigners differently in many different ways. But in this particular sense, China does have—Chinese investors and their sovereign wealth fund do have an advantage. As I said at the beginning, there’s a reason for this regime. But today, given the economic realities, we think there’s a reason to rethink it.

I also feel—I never worked on the Hill. Just like you’re going to defer to the economists, I’m going to defer to you on the political feasibility. Although, I would—but if we talk about technical complexity, it’s there, but it clearly can be solved. So as far as political complexity, again, I think if we look at what happened over the past week maybe if there are measures that can be less disruptive and massively costly to the world, they will be worth considering. So that’s that’s—and it’s true that treaties are valuable. We’re talking about changing the treaty with China. I think we already—as just was said—we’re already not the best friends. So, yeah, China is not going to be happy, but they’re not happy already.

WEST: Let me level-set with a data point. We did not terminate our treaty with Russia.

RASKOLNIKOV: Yeah, because we imposed, you know, massive sanctions on Russia. (Laughs.)

WEST: Well, and that’s the reason we—that’s the reason given for not imposing tariffs on Russia, I understand. But you know, who moved to suspend our Russian treaty, was Russia came to us and said, you know, these provisions—it wasn’t the United States. So I just put that out there to illustrate how—you know, our treaty program is kind of precious. It’s small. And we have limited resources. And I don’t know how many of you focus on the fact that Senator Rand Paul has blocked every treaty for the last ten years—every tax treaty for the last ten years. We’ve gotten a few through by taking up floor time, but it’s—if we ever want to get another treaty, and we start making our treaties depend on non-tax substantive—you know, non-substantive tax reasons—whether we enter into them, whether we terminate them, whether we modify them—the treaty program is fragile. It’s small. And to start tampering with it in an environment in which, you know, one senator can block all action on a treaty, I would urge extreme caution.

RASKOLNIKOV: Yeah.

PATTERSON: And, honestly, this is why I’m excited we have this group here today, because, as we’re seeing with the tariffs and the trade war that’s quickly developing, none of this is cost free. None of this is easy. There is no free lunch in policy or economics. And so understanding the pros and cons of all these ideas, I think, is a good use of time, to figure out at the end of the day what’s going to get us the most benefit with the least cost. Maybe neither of these are it, but I think we’re at a moment in time where we should be deeply thinking about all of them.

I want to keep an eye on the clock. I think we have a question from online, if I can.

OPERATOR: Yes. We will take a virtual question from Arthur Kroeber.

Q: Hi there. Thank you very much for this very interesting discussion.

So I have to say that I find—as a someone who’s been studying the Chinese economy for many years—I find this proposal a very strange one on a couple of grounds. So, first of all, it’s very clear that China has a lot of explicit policies to subsidize manufacturing, essentially to create surpluses. They do not have any kind of desire to accumulate U.S. assets in the form of Treasury bills as a policy objective. So I do think that the causality there is very, very clear, that China has a pretty mercantilist trade and industrial policy. And that’s what leads to the accumulation of these international assets.

The other thing is that they’ve been doing a lot over the last decade to diversify away from U.S. Treasurys into things like Belt and Road investments, and so forth. So I think the causality there is, you know, pretty clear. The other thing is that, as most economists will tell you, bilateral trade deficits are really not something that you can meaningfully adjust, right? The reason that the U.S. has a trade deficit is because it spends more than it saves. And a lot of this happens to be expressed through China’s surplus with the U.S., but if you try to squeeze—do things to squeeze the deficit with China, without dealing with the underlying savings investment analysis, all that’s going to happen is that is going to show up somewhere else in your trade account. And what we’ve seen from the last trade war is that tariffs on China have just resulted in a lot of trade diversion through other countries. China runs a very large trade surplus. Their accumulation of Treasurys is not a function of their surplus with the U.S. It’s a function of their global surplus.

So I guess the question is, in what way would you actually see that this proposal would significantly affect China’s underlying behavior in terms of their industrial policy and the things that they do to create these trade surpluses? And, on the other side, how would this materially affect the U.S. savings investment balance, which is the ultimate cause of the U.S. deficits globally, not just with China?

PATTERSON: Benn, do you want to take a stab?

STEIL: Yeah. Yeah. The idea that our deficits are entirely constituted by spending more than we save gets a lot of this cause and effect backwards. Since the U.S. dollar is the world’s leading international currency, countries—in order to accumulate dollars—have to buy up debt assets. The United States has to produce those debt assets. So we have to run a current account deficit with the world as a whole in order to supply the world with the dollars that it is demanding. So it’s not just the fact that we are all spendthrifts in the United States. The world is demanding our debt.

With regard to China’s holdings of U.S. securities, they’re not just Treasury securities. China’s portfolio investment in the United States amounts to $1.87 trillion.

PATTERSON: Thank you.

STEIL: And only about half of that is Treasury securities. So these are significant holdings. I don’t particularly care about what China does on the industrial subsidy side, because we can’t control it. But we can influence the incentives, the monetary incentives China has to do this. If they’re not going to receive a tax subsidy from the United States for investment in this country, they have a lot less monetary incentive to dump goods here, because the dollars are of less use to them.

PATTERSON: But then to Arthur’s point, if they’re—if they can just get around that by selling subsidized goods through other countries or to other countries—whether that’s in Southeast Asia, Europe, somewhere else—and at the end of the day that still results in them pulling in Treasurys or other U.S. assets, primarily because a lot of these goods are traded and invoiced in dollars, don’t we still have somewhat of the same problem?

STEIL: To the extent that that’s true, then our proposal works because we give China less of an incentive to accumulate dollars, however they accumulate dollars. So what we’re talking about, again, I want to emphasize, is eliminating a subsidy for Chinese exports that we are providing. We’re right to condemn China’s mass subsidies for their dumping goods abroad. But we can’t control that. What we can control is our own subsidies for Chinese exports.

PATTERSON: OK. I see we have another—we have two more questions. Phil, you wanted to get in briefly?

WEST: Super quickly. You know, to view this as a subsidy, just for frame of reference, remember, as a pragmatic matter for negotiating purposes we have a statutory 30 percent rate. Very few people pay that rate on anything. And so to say that this is a subsidy to China—this is the norm. This is the baseline. And we would be increasing—and I know we talk about—economists talk about incentives. But just for a frame of reference, it’s not like, oh, they’re getting a special subsidy. This is the norm, and the baseline that everyone basically pays zero on passive investment.

PATTERSON: All foreign portfolio investment into the U.S.

RASKOLNIKOV: But that norm became a particular problem with China. That’s the whole point here.

PATTERSON: Right, given the size of the bilateral imbalance—

RASKOLNIKOV: Imbalance, exactly.

PATTERSON: And the—right. OK. All right. Rafael, you had a question, and then we’ll get you, Kyle.

Q: Yeah. So I have just a quick point and a question. What—if I’m understanding your argument, Phil, is that, basically, tax reform is very, very difficult, if not impossible? Because what they’re proposing is kind of a slice of a fundamental—I think you have it right. They want to move from a—to a territorial-based tax system in some ways. No? Wait, let me finish. But the premise is that, A, it’s hard. And, B, what we need is a—I guess, a consumption or more revenue. So let me make the point on revenue.

The revenue of the United States government to GDP has been the same for the last seventy years, since the postwar period. It goes from about 16 percent to about 19 percent. It doesn’t move. And that’s across widely different marginal tax regimes. So what you’re actually talking about is a fundamental tax reform. And then so what you’re saying is that it’s almost impossible to do this, which is—you know, it’s discouraging, because probably we need it. And probably the United States should be viewed not as a country but as a continent with fifty sovereigns underneath.

And so when we get into the point of, for example, fighting with the Europeans on VAT, it’s not fair because Oregon has no sales tax and Florida has no income tax. And they’re widely different. And they are sovereigns. So we really get into deep, fundamental issues. I think this is a small slice, but you’re getting at the right thing. But if you say that it’s discouraging and it’s hard to get it done on the Hill, then we have no hope.

WEST: Well, I don’t have a crystal ball, but I do have a rearview mirror. (Laughter.) And my rearview mirror tells me—you just said the revenue hasn’t moved. I don’t see any profiles in courage that are encouraging up on the Hill.

PATTERSON: I appreciate the point on the fifty sovereigns, and the disparities between the states on revenue collection, and how we have to figure out how to make all that work on a federal level in Congress with something like this. I think it’s a point well taken.

WEST: Yeah. The only other thing on the sales tax is, you know, the EU consumption taxes, for example, their residents are subject to those just like, you know, on a destination base, our sales into the EU are subject to them. So it’s not like there’s some disparity there.

PATTERSON: Kyle. And then we’ll go back online if there are others online.

Q: Your paper estimates between 500 (billion dollars) to $800 billion in Chinese disinvestment. If the proposal is realized, is your view that that’s an orderly drawdown principally through non-reinvestment? Are there any risks of disorderly drawdown?

PATTERSON: I’m happy to kick that one off. When I first read this paper, I grabbed Benn and I said: What? You know, because my immediate thought was if this was well understood, and if there was a sense that the reaction function—or, at least, the perceived reaction function could be a major change in the amount China is buying, it means that the U.S. would have to find other buyers of Treasurys and whatever other U.S.-denominated assets. And would they be equally insensitive to the yield or price? Or would we end up having to pay a higher yield to get that bond supply purchased? And so my fear is that you could have a, quote/unquote, “Liz Truss moment” on the back of a policy, even if it’s not passed, if it’s just being seriously pursued.

I think, speaking with Benn and a little bit with Alex, my sense is they’re not—and I don’t want to put words in your mouth. I’d like you to jump in. This isn’t something necessarily being proposed at this moment in time, which is probably a good thing, like, today, given what we’re doing with the budget deficit. But it is an idea to throw on the table when we think about the alternatives, and we’re thinking about the pros and cons of each. Is this one that might have fewer cons versus others, and maybe some pretty significant pros? Albeit, estimated not proven. But I hear you. I think in the current environment it could be a risk. And I would put that in my cost-benefit analysis, that this would be a risk one would have to think through carefully.

STEIL: We not only didn’t write this paper in the current environment, and we’re certainly not endorsing the current environment, we wrote it before the election, OK? So that was a very different political environment. But if you want to look at a policy action that could have precisely the sort of effects that you fear, it’s what we’re doing right now. A hundred percent tariffs on China will mechanically produce a massive drop in Chinese investment in the United States. Again, because the current account deficit is a mirror image of the capital account surplus. So there’s nothing unique about our proposal that pushes up interest rates. What the president is doing right now, if he goes forward with it, will have that effect on steroids.

RASKOLNIKOV: And what is Senate doing right now, and, you know, House may well follow along, is massively worse. You know, equating 4.6 trillion (dollars) to zero, that’s what’s going to get the bond market going and has a—I mean, I the Liz Truss moment—much, much more likely. So in the large scheme of things, this is—this is relatively small.

PATTERSON: And I want to make sure, because we do have time, if there’s another question. But I almost feel like that’s a beautiful place to end, because the panel agrees on that, I believe. (Laughter.) That in the current environment that, you know, basically disregarding the Congressional Budget Office scoring process, choosing current policy instead of current law, it might look better on paper in terms of what Congress says this bill will do to our deficit, but the reality is we will still be issuing a greater amount of debt, we will still have to find buyers for that debt. And if demand does not rise in line with supply, yields go up. That’s just how the math works. So I think we all agree on that point, that this is something people should watch carefully and it poses a risk.

But as much as I’d like to end on a happy kumbaya note, I do—we have two minutes. So I just wanted to make sure—I didn’t see any placards up. Oh, yes, please.

Q: Hi. Alyssa Bernstein.

So the USTR just put out a long report explaining unfair trade practices from almost every country. All of them that aren’t penguins, I believe. And so that makes me wonder why apply this just to China? Why not—how did you decide just China—China and a couple others, I believe? And why not do it across the board?

STEIL: Well, I’ll jump in on that one. Because the size, persistence, the trajectory, and the composition of the deficit with China is literally unique. And increasingly, as I said at the outset, it is being determined on purely political grounds. I mean, the WTO, like the GATT before it, was initiated to integrate market economies. It was not created to accommodate a massive state-controlled entity like China. So we single out China not because we consider it inherently to be an adversary of the United States, but simply because of the enormity of the economic problem that’s being created given out the nature of our current trading relationship with China.

WEST: Interestingly, that’s not what Senator Wyden—how he chose to—

PATTERSON: That was different, right.

RASKOLNIKOV: Yes, exactly. This is not with Senator Wyden. We were not trying to do what Senator Wyden was trying to do. And, you know, I mentioned it before. This is a kind of—this is a proposal about economics. It’s not about politics.

PATTERSON: Right. Yeah. No, it’s good to clarify that.

With that, I would like to thank all of you for joining in today online and here in person in Washington, D.C. I’d like to thank very much all of my panelists—Phil, Benn, and Alex, making time in between his courses up at Columbia. Thank you very, very much. Your students are lucky to have you. And we’re lucky to have your research. And it’s wonderful to be able to have these debates around an incredibly important topic.

This recording will be put in as a transcript on CFR.org. So you can take a look at that if you want to review anything later on. But thank you so much for coming today. Appreciate your time. Thank you.

RASKOLNIKOV: Thank you. (Applause.)

(END)

This is an uncorrected transcript.