Recently, I mentioned that Trump's advisers had raised the issue of how the use of VAT taxes in some countries but not others might distort trade, if the VAT exempts exports but is applied to imports. I was thinking about writing something more detailed about this, but thankfully Gary Hufbauer beat me to it so now I don't have to:
More than 140 countries have adopted the VAT, sometimes with different names and usually with varying rates depending on the “merit” of the product taxed. ...
The United States remains the standout exception to the VAT sweep, for three reasons. Conservatives see the VAT as a “money machine” to expand the federal government. Liberals see the VAT as a regressive tax on poor families. States fear the VAT would encroach on their domain to impose retail sales taxes. Tax experts refute all three propositions, but to this day the US Congress shouts “no thank you” or worse to the VAT.
While the VAT enjoys little US support, two VAT features periodically provoke US condemnation (most recently by Trump): the rebate of VAT taxes on exports and their imposition on imports. These are called “destination border tax adjustments” because they result in the collection of VAT only in the destination of consumption, no matter where goods or services are produced.
Destination adjustments for the VAT were accepted by all members of the General Agreement on Tariffs and Trade (GATT) in 1979. But US observers had misgivings because GATT rules did not permit destination adjustments for corporate income taxes. Since the United States does not have a VAT but does have a high statutory corporate income tax (then 48 percent, now 35 percent), the asymmetry seemed unfair both to US firms and to some political leaders.
Trump’s argument is simple. Take the case of Mexico. Mexico rebates its 16 percent VAT when Mexican goods are exported to the United States, and collects the 16 percent tax when US goods are exported to Mexico. In Trump’s view this amounts to a 16 percent tariff that keeps out US exports, and a 16 percent subsidy that promotes Mexican exports. In this telling, the system clearly benefits Mexico at the expense of the United States—not only Mexico, but nearly all other US trading partners since VAT taxation is practically the world standard.
Economists argue in professional journals that destination adjustments make no difference to a country’s trade balance or trade performance. By this argument, VAT countries would do just as well if they made no border adjustments. Indeed, two scholars found no association between VAT taxes and exports in the experience of 168 countries over 50 years.
But since the arguments and evidence are difficult to explain, and directly contradict intuitive thinking, they are brushed off. Not only are they brushed off in US business and political circles but also abroad. This is evidenced by the fact that virtually all countries practice destination adjustments for their VAT systems, in hopes of promoting their exports or at least averting tax-inspired trade deficits. Whatever a Trump administration might demand, foreign countries will not abandon their destination adjustments.
The facts of international life leave the United States with three choices. First, the Congress can replace the corporate income tax with a business tax adjustable at the border, though not necessarily a VAT. The latest proposal along these lines is the “Blueprint” advocated by House Speaker Paul Ryan and Ways and Means Committee Chairman Kevin Brady. Second, the United States can accept the status quo,live with the corporate income tax as now structured, and take heart from economists who argue that foreign destination adjustments make no difference to the US trade balance. Finally, the United States could take Trump’s advice that the United States should “rip up” the WTO unless foreign countries abandon their destination adjustments. On that course, collateral damage from the ensuing trade war would make the VAT debate seem like a tempest in a teapot.
