The Trump campaign released an Economic Plan today. On trade, they raise one issue that has been of concern to respected trade policy people and has been lingering for quite a while:
Ending the Unequal Value-Added Tax Treatment Under WTO Rules
In addition to the obvious problem of relatively high corporate tax rates pushing American capital offshore, there is a more subtle tax problem pulling US corporations offshore. It relates to the unequal treatment of the US income tax system by the World Trade Organization (WTO).
The WTO consists of 164 members and officially began its oversight of the global trading order in 1995. America helped negotiate and agrees to its trading rules, but in a “one country, one vote” system, the US has effectively surrendered its sovereignty to a group of countries that do not always (or often) have America’s interests at heart. While the US is the largest economy in the world, it has the same WTO voting rights as countries like Albania with economies a tiny fraction of that of the US.
Here is the key unequal tax treatment issue: While the US operates primarily on an income tax system, all of America’s major trading partners depend heavily on a “value added tax” or VAT system. Under current rules, the WTO allows America’s trading partners to effectively create backdoor tariffs to block American exports and backdoor subsidies to penetrate US markets. Here’s how this exploitation works:
VAT rates are typically between 15% and 25%. For example, the VAT rate is 25% in Denmark, 19% in Germany, 17% in China and 16% in Mexico.
Under WTO rules, any foreign company that manufactures domestically and exports goods to America (or elsewhere) receives a rebate on the VAT it has paid. This turns the VAT into an implicit export subsidy.
At the same time, the VAT is imposed on all goods that are imported and consumed domestically so that a product exported by the US to a VAT country is subject to the VAT. This turns the VAT into an implicit tariff on US exporters over and above the US corporate income taxes they must pay.
Thus, under the WTO system, American corporations suffer a “triple whammy”: foreign exports into the US market get VAT relief, US exports into foreign markets must pay the VAT, and US exporters get no relief on any US income taxes paid.
The practical effect of the WTO’s unequal treatment of America’s income tax system is to give our major trading partners a 15% to 25% unfair tax advantage in international transactions. (While in principle, exchange rates should adjust over time to offset border adjustment, in the near term, exchange rate manipulation leads to major effects on trade flows.)
It is thus not surprising that US corporations want to move their factories offshore and then export their products back to the US and to the rest of the world. An American subsidiary located overseas gets the VAT benefits on its exports back to the US. Of course, such exports to America from the offshored production facility add to the US trade deficit. Such offshoring of capital investment also subtracts from GDP growth.
Like many countries, Mexico has shrewdly exploited the VAT backdoor tariff to further its competitive advantage. While Mexico’s VAT existed prior to NAFTA, the Mexican government increased its VAT by 50%, from 10% to 15%, shortly after the NAFTA agreement was signed in 1993 and in the same year the WTO commenced. With the Mexican VAT now raised again to 16%, this discourages US exports to Mexico, encourages US manufacturers to offshore to Mexico, and has helped to increase our annual trade deficit in goods with Mexico from nearly zero in 1993 to about $60 billion. This is yet another case in which Corporate America wins, but Mr. and Ms. America lose.
Barack Obama and Hillary Clinton have failed to act on this problem. It’s not even on Clinton’s radar screen.
Donald Trump would deal swiftly and firmly with the unequal treatment of corporate income taxes that heavily penalizes American corporations under the rules of the World Trade Organization.
The WTO’s VAT Rules Are A Poster Child of Poorly Negotiated US Trade Deals
The WTO’s unequal tax treatment of US exports is a prime example of how US trade representatives often fail to recognize the consequences of the bad deals they negotiate on behalf of the American people. Our negotiators were naive at best in failing to protect the US against the adverse effects of the VAT – they very well should have seen such strategic “VAT gaming” coming.
At the bargaining table, US representatives should have demanded, in no uncertain terms, equal tax treatment for US exports. Since the WTO would be meaningless without the presence of the world's largest importer and third largest exporter, we had the leverage then – and have the leverage now – to fix this anomaly and loophole. In contrast, sophisticated foreign countries bargained hard to achieve what is effectively a border tax adjustment loophole. They have repeatedly refused to give that loophole up.
As a further nuance, no WTO rule effectively prevents state-controlled banks from propping up big exporters like steel companies that are losing money. Since VAT is paid to foreign governments and since those governments are typically the health care delivery systems, US exporters end up paying both for the health care of America’s own workers and for a portion of the healthcare costs of these other countries through the VAT payments they make on the exports they sell – because of America’s naïve trade negotiators. The US Congress has already passed three different pieces of legislation to try to eliminate this unequal tax treatment. However, each time the WTO – led by heavily exporting countries – has rejected the American proposal.
Donald Trump understands that the only way to correct this unfair tax treatment is for the US to use its status as the world’s largest economy, the world’s largest consumer, and the world’s largest importer to put pressure on the WTO to change this unequal treatment. Without the US as a member, there would not be much purpose to the WTO, but prior occupants in the White House have been unwilling to lead on this issue despite its significant negative impacts.
Hillary Clinton did nothing as Secretary of State to address any of these issues and has no plan to end this unfair treatment.
If every country used a similar VAT, it seems like there would be no trade impact. But what if most countries use a VAT as described above, while other countries do not? What exactly is the trade impact in that situation? How do we measure that?
I'm also curious about what the Trump campaign's proposed solution is. Do they want the U.S. to adopt a VAT similar to what many other countries use? Do they want WTO obligations amended to allow for DISC/FSC type workarounds?
ADDED:
On twitter, I asked one of Trump's economic advisers about this. I said:
"The VAT issue raised here is a long-standing one. Can you say anything about your proposed solutions?"
He responded:
"That's what the negotiations will reveal."
I think that tells you what you need to know.
