Is Trump Right About the VAT?
European sales in America enjoy a cost reduction, whereas American sales in Europe pay the value added tax. From this perspective, Trump has a point.
Donald Trump insists the United States will match tariffs any other nation imposes on American goods and services. To this end, he has asked federal agencies to study the possibility of what he calls “reciprocal tariffs.” In making the announcement, he included the value added taxes (VATs) popular in Europe as a model for this kind of reciprocity. He described VATs as “more punitive” even than tariffs. This characterization can only be described as unconventional, but neither is it entirely wrong. Even if the president’s analysis has merit, it is not apparent that U.S. tariffs are an appropriate response.
VATs are similar to sales taxes except that instead of the sales tax’s single levy on the final sale of a product, VATs are levied on the value added at each stage of the production process. Rates applied differ widely across countries that use them. At the lower end is Switzerland, with an 8.1 percent rate. At the higher end is Hungary, with a 27 percent rate. Germany, Europe’s largest economy, imposes a 19 percent rate. The average for all Europe is 21.6 percent. Almost all are high compared to the nearest American equivalent, the sales taxes states and cities impose on the final sale of many goods and services.
The federal government in the United States has steadfastly rejected the use of a VAT. Two reasons stand out. On the practical side, such a levy would impose on the sales taxes that many states and cities rely on heavily for revenue. If Washington were to move toward a VAT, these state and local jurisdictions would immediately engage their ample political power to stop it, which is no doubt why Congress has never seriously considered such a levy. The second reason Washington has avoided the VAT is ideological. It is regressive. Rich people seldom spend all their income. The money they set aside from consumption remains free of VAT or sales taxes.
However, less well-off people often must spend all or most of their income on necessities. A VAT would fall disproportionately on them and would run entirely counter to the progressive nature of the country’s income tax code, which imposes the highest rates on higher-income citizens. This regressive nature does not seem to bother European governments.
On one level, Trump sees a tariff-like quality to the VAT because American products entering Europe must pay tax on their entire value-added, whereas European products entering the United States do not face such a levy. The Europeans, with justice, counter this sort of reasoning by saying that Americans face no special barrier or cost and that everyone selling in Europe faces the tax, whether a domestic or foreign producer.
But this is not the end of the story. Because most VAT structures excuse the tax on goods and services that leave the country, the system gives exports a kind of subsidy, not a cash payment to be sure, but a not insignificant tax break. European sales in America enjoy a cost reduction, whereas American sales in Europe pay the VAT. From this perspective, Trump has a point. An American tariff about the size of the VAT would even the cost to products crossing borders.
A tariff, however, may not be the best way to achieve this cost parity. After all, it would force the cost difference on the American buyer, whether a business or an individual. It would also invite tariffs on American goods and services entering Europe, to which Trump would then reciprocate, leaving these two huge economies to spiral into a trade war to no one’s benefit. An accommodation is preferred.
No doubt Trump would like American tariffs or the threat of tariffs to get European governments to free American products of the VAT. That is hardly likely since it would rob European government coffers of a significant revenue source. An accommodation that might work is for Europeans to give up the VAT break on exports. In doing so, they would capture a new revenue source and use American tariffs or the threat of tariffs as a way to persuade their exporters that one way or another they will have to pay, so the money may as well go to their own governments.
Whether such a solution would satisfy the Trump White House is anyone’s guess. Such an answer just might blunt the tariff drive since it is clear that Trump’s preference for tariffs has nothing to do with raising revenue. It would certainly avoid risk. Nonetheless, it is a fool’s game at this stage in the process to guess.
Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, the New York-based communications firm. His latest books are Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live and Bite-Sized Investing.
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