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U.S.-UK Trade War Unlikely: Capital Economics

Potential U.S. - UK Trade war

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The U.S. could soon impose tariffs on UK imports in retaliation for a UK tax on U.S. companies operating in Britain, raising fears the move would represent the first shots in a trade war between the two nations.

It was widely reported this week that the U.S. would consider levying tariffs worth £235MN on UK imports in response to any taxes levied by the UK on U.S.-based technology companies operating in the country.

The UK in April 2020 introduced the Digital Services Tax (TST) in an attempt to raise revenues from large multi-national enterprises whose revenue is derived from the provision of a social media service, a search engine or an online marketplace to UK users.

It is expected to hit names such as Facebook, Google and Amazon and the Office for Budget Responsibility expects the tax to raise £300MN per year.

"There is a risk that this round of tariffs is just the first step in a tit-for-tat battle. The OBR has forecast that the DST will raise £700MN in future years, which could prompt the U.S. to increase tariffs," says Thomas Pugh, UK Economist at Capital Economics.

The UK government says the tax is needed in order to level the playing field between local businesses and multi-nationals as there is a perceived misalignment between the place where profits are taxed and the place where value is created.

But the Office of the U.S. Trade Representative began investigating the tax last year and "determined that the United Kingdom’s DST is unreasonable or discriminatory and burdens or restricts US commerce".

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The investigation found the proposals break international tax principles by taxing revenues rather than profits, as well as resulting in double taxation, undermining certainty in the tax system, and extending UK taxes beyond British territory.

However, economists at independent research house Capital Economics are not convinced that the tariffs eyed by the U.S. in response to the DST are likely to form the opening blows in a broader and potentially enduring trade war.

"We doubt this is the opening salvo in a new trade war between the UK and the U.S. Negotiations on a global DST are ongoing and the UK has said it will repeal its DST if a global agreement is reached," says Pugh.

Pugh adds U.S. President Joe Biden "seems more keen to build on alliances than President Trump was".

The need for a unified front on trade is particularly relevant to evolving foreign policy towards China, with both the UK and U.S. expressing a desire to "get tough on China".

"That said, we don't expect a UK-U.S. trade deal anytime soon either," says Pugh.