President Trump and his administration often express their concern about trade with China by referring to the size of the US trade deficit with China, which has been growing since 1985 and totaled $375 billion in 2017. Last year, we wrote that bilateral trade deficits are not a good way to keep score on trade policy. The numbers obscure where value is added to products and only really count where the product last made a transformation.

Something Made in China could have more than 70 percent of its value created by Americans in the United States, as with the popular example of the iPhone. There’s another reason to avoid hanging importance on the deficit: many US firms do business through affiliates in China rather than rely solely on exports.

American phones and cars (and many other products) sell well in China. According to the Internet Society of China industry association, there were 310 million active iPhones in China in 2016, amounting to one out of six smartphone users. US-headquartered Apple generated $48 billion in revenue from China in 2016, mostly in iPhones. But these iPhones cannot be found in US-China bilateral trade data because, regardless of the high level of US content in the form of design, engineering, software, and high-value components, iPhones sold worldwide are assembled in China. A product sold where it is assembled is considered domestic, and counts neither as an export nor an import. Apple records the revenue associated with iPhone sales and service, with no effect on the US-China trade balance.

General Motors’ 2017 annual report shows that the company sold 3.6 million cars in the United States and 4 million cars in China. Yes, you read that correctly. In the same year, only 1.2 million cars were imported to China from any firm or exporting country. General Motor’s entire manufacturing and distribution network in China is, for the most part, absent from trade statistics.

Conversely, how popular are Chinese brands in the United States? Answer: not very.

The iPhone is ubiquitous in China, yet Chinese-brand smartphones are rarely found in the United States. Same for cars: the streets of Shanghai are filled with Buicks, yet Americans have only seen Chinese-nameplate cars in the United States at auto shows. What’s going on here? Why, if we have such a large trade deficit, is the presence of US brands in China so much more prominent than Chinese brands here?

The US Department of Commerce’s Bureau of Economic Analysis (BEA) conducts surveys on US enterprises with global operations. Companies are asked to report key statistics on the operation of their foreign affiliates, such as sales and exports/imports. The BEA survey reports that, in 2017, US subsidiaries sold $223 billion worth of goods and services in China, and those sales have grown at an annualized rate of 18 percent since 2009.

For many firms, sales by the foreign subsidiary are more important than exports. US goods exports to China were $101 billion, while US affiliates sold $172 billion of goods in China. Bottom line, goods exports are only one way of reaching consumers, and looking only at exports gives an incomplete picture of a commercial relationship.

Unfortunately, the government of China does not collect data on the operation of Chinese subsidiaries in the United States, so we cannot do a direct comparison. But it is known that Chinese direct investment in the United States is small compared to US direct investment in China, and Chinese affiliates have limited presence in the United States.

Many firms operate subsidiaries in foreign markets as a complement to their export operations, as the foreign operation provides distribution and after-sales service support. For others, the foreign affiliate is an essential link in their business plan, such as an express package delivery service firm’s distribution center. “Operating close to the consumer” is a maxim followed by firms large and small, in no small part because local knowledge is a key to success. The Chinese affiliates of US firms use a combination of local and importer goods, and local and imported talent, to achieve success in the marketplace.

The US-China commercial relationship is more than just bilateral trade in goods. How will the Trump administration’s restrictions on Chinese imports, and China’s likely response, affect the larger relationship? While President Trump believes China’s large trade surplus shifts the balance of power in a tariff war to the United States, China can respond by punishing US affiliates, who are sitting ducks in a trade war.

Scott Miller is a senior adviser at CSIS. Previously, Miller was director for global trade policy at Procter & Gamble. 

This article originally appeared on TradeVistas.org. Used with permission.

What’s the most positive word uttered by politicians on trade? Exports. What’s the most negative? Deficit.

More specifically, when many politicians talk about trade, they often promote exports as an inherently good thing, and decry the US trade deficit as evidence that other countries are taking advantage of us.

But that characterization leads the general public to suspect that imports are a problem, and somehow Americans would be better off if we were to import fewer goods and services from abroad. Before we rush to a conclusion, let’s take a look at what we import.

We import products we need to make other products
Half of the goods we import are orders from US companies (that is, manufacturers) as the inputs they need to operate their own production processes in the form of intermediate components or raw materials.

The US Department of Commerce provides a useful way to look at imports by classifying them by their end use. In 2015, 48 percent of US imports consisted of capital goods (machinery and machine tools, semiconductors, parts, equipment, etc.) and industrial supplies (chemicals, fuels, lumber, plastics, metals, etc.). More than half of imports fall into these two categories if we include imported auto parts and engines (i.e., not finished vehicles) to the capital goods total.

Firm decisions
In each transaction, firms must determine the most appropriate inputs, ingredients, and other supplies to make their products, taking into account form, quality, price and a dozen other criteria their suppliers must meet. There may be a variety of reasons they choose to import those supplies. The material or equipment they need might not be readily available from a domestic source, or perhaps it’s not available in sufficient quantity, or isn’t made exactly to the right specification.

Because the firm (which employs US workers in US factories) has access to their choice of inputs, its finished products are a better value for consumers and that usually translates to greater sales and more secure jobs for the firm’s employees.

Imports support jobs
That’s something you don’t hear politicians say. Increased demand for industrial inputs – whether imported or not – is a sign of economic strength, even if it leads to an increase in the trade deficit.

Because small and large producers alike can make appropriate choices about their inputs – and use imported inputs as needed – they are more competitive in world markets. Conversely, if imported goods became artificially more expensive because of a tariff, firms risk being made less competitive; they would sell fewer finished products, and ultimately employ fewer workers.

Imports support US lifestyles
There is a lot to like about the other half of what we import, too. Imported consumer goods, from electronics to clothing to jewelry, give us greater buying power and a broader array from which to choose. And don’t forget imported food, which means fresh avocados for your big-game guacamole as well as delicacies from around the world at your local store.

Sure, it’s good when American companies export goods and services to the world. But imports make many American-made products more competitive as well as enriching our lives as consumers – they are part of the secret sauce of what makes our economy work so well.

Scott Miller is a senior adviser and holds the William M. Scholl Chair in International Business at the Center for Strategic and International Studies. Previously, he was director for global trade policy at Procter & Gamble.

The US Congress and the Trump Administration agree that the US corporate tax system is a drag on the competitiveness of American companies and the American economy. Tax reform is therefore a top priority for 2017.

Under current law, corporations are taxed on their income earned worldwide and the U.S. top rate of 35 percent is the highest among advanced economies.

But the United States is the only industrial economy to maintain a worldwide system, which encourages American corporations to move their headquarters operations out of the country (inversions), and discourages them from bringing their foreign-earned profits home for re-investment.

Previous reform proposals pushed for a territorial system, taxing income where it is earned. Territorial systems commonly used by major economies are more efficient and eliminate the incentives to move legal headquarters. Territorial taxation can, however, be subject to attempts to shift profits to low-tax jurisdictions, known as “base erosion.” Consequently, such proposals are usually accompanied by rules that attempt to limit profit-shifting activities.

Shifting to Destination-Based Taxation

House Republicans have developed a tax blueprint called a “Better Way” that would enact a destination-based tax on cash flow.

Instead of taxing worldwide income (the current law) or taxing income in the jurisdiction where it is earned (a territorial system), the House plan would tax companies’ cash flow where their goods and services are sold, regardless of where production, management, or income is located.

Further, the destination-based system proposed is border-adjustable. In simplest terms, the destination-based cash flow tax would impose a flat 20 percent tax rate on earnings from sales of output consumed within the United States.

How does this affect companies? Since the tax falls only on output consumed in the U.S., the cost of imported materials would no longer be deducted from taxable income (as part of the cost of goods sold), while all revenue from exports would be deducted and therefore not subject to federal tax.

It’s All About That Base

Why are House Republicans proposing this change? First, this approach eliminates the distortions of a worldwide system without needing new rules on base erosion.

Second, and probably more important, the cash flow tax broadens the tax base dramatically. Because the U.S. currently runs a trade deficit of about $500 billion per year, border adjustment would generate nearly $1 trillion in additional revenue over a ten-year period.

Broadening the base is critical to achieving lower tax rates, from 35 percent to 20 percent, (and a range of other pro-growth reforms like expensing of capital spending) while staying close to revenue neutral. A conventional tax on income does not offer enough base-broadening measures to deliver a large rate reduction.

The House “Better Way” proposal is likely the starting point for a debate on tax reform, and a change of this magnitude may or may not survive the legislative process.

Back to Trade Policy

Individual firms will do their own assessment of the effects on their business. Exporters will probably find a cash flow tax beneficial. Importers including retailers, oil refiners, or apparel companies will probably see the proposal as a major tax hike.

The fact that differently-situated companies will face different effects may divide the business community, cutting into the nearly unanimous support for pro-growth tax reform.

Moving away from income taxation to something closer to (but not precisely) a tax on consumption is clearly a substantial policy change. It’s also one that is big enough to affect trade flows, and therefore likely to spark trade controversy.

Is an Adjustable Border Tax Protectionist?

Proponents say, “no,” that the tax is neutrally applied based on where the good or service is consumed.

But there would be an incentive to import less. Also, in the near term, the change may boost inflation, as importers raise their prices to suppliers and consumers to maintain margins.

Medium-term, currency exchange rates will likely adjust to absorb some of the impact, which would lead to an even stronger U.S. dollar.

Does an Adjustable Border Tax Square with US Trade Obligations?

WTO rules permit border adjustments for indirect taxes, such as credit-invoice value-added taxes (VATs). But the House plan operates like a direct tax, and it’s a near certainty that it would be challenged by trading partners.

Many of us recall the 2002 WTO case in which a US provision regarding tax treatment for Foreign Sales Corporations was found contrary to trade rules, leading to a change in U.S. tax law. The United States could be vulnerable to losing a WTO case on border tax adjustability. The Trump administration and Congress would have to make some decisions that could include repealing border adjustability, or turn the cash flow tax into a subtraction-method VAT, or ignore the WTO ruling altogether, which would give other nations the right to retaliate.

Stay closely tuned to forthcoming policy debate. The plan raises important issues about tax competitiveness, but also broader U.S. economic engagement with the world.

Scott Miller is a senior adviser and holds the William M. Scholl Chair in International Business at the Center for Strategic and International Studies. Miller was previously the director for global trade policy at Procter & Gamble.