Does Donald Trump secretly covet a VAT? This is a reasonable question, judging from Trump’s Twitter activity and other public statements. On multiple occasions the president-elect has asserted that other countries’ VAT regimes function as a trade barrier that favors our foreign competitors and punishes U.S. businesses that export into overseas markets.
Strictly speaking, Trump’s claims about VAT are false. VAT is neither a trade subsidy nor a trade barrier. In fact, VAT is economically neutral. Tax burdens from the origin country do not carry over with exports as they’re transported to their place of consumption. That’s the beauty of the border adjustment, which is an indispensable feature of every destination-based VAT. The border adjustment establishes a level playing field between domestically manufactured goods and foreign imports.
But these niceties are beside the point. For purposes of this discussion, we are indulging in the realm of perceptions. And anyone who has taken a passing interest in U.S. tax policy should know that perceptions, fairly or otherwise, can be just as influential as reality.
The relevant issue here is whether Trump – and, by extension, the Republicans who control Congress – believe that America’s lack of a VAT is holding our country back in global trade. Let’s explore what we already know about Trump’s thinking on this issue.
Trump on China’s VAT
On December 2 Trump accepted a congratulatory phone call from Tsai Ing-wen, the president of Taiwan. Their 10-minute conversation included a discussion of “strengthening bilateral relations.” The call sent the foreign affairs community into a tizzy. The airwaves were soon flooded with nervous chatter about whether Trump would jettison the one-China policy, which has been the U.S. government’s formal stance since the 1970s.
China views Taiwan as a breakaway province and becomes easily incensed at the slightest hint of sovereignty. (That’s why Taiwanese athletes compete in the Olympics under the banner of “Chinese Taipei.”) Beijing was quick to condemn the incident with Tsai. Trump immediately shot back via his Twitter account:
“Did China ask us if it was O.K. to devalue their currency (making it hard for our companies to compete), heavily tax our products going into their country (the U.S. doesn’t tax them) or to build a massive military complex in the middle of the South China Sea? I don’t think so!”
As we’ve learned, Trump will accept phone calls from whomever he wants. That’s entirely his prerogative, but what was his point about China’s tax system?
Trump is saying that China taxes U.S. exports, while America refrains from doing the same to Chinese imports – and that imbalance works to our disadvantage. Make no mistake, what Trump is talking about here is VAT, specifically the border adjustment. Yet it’s odd that he mentions it in this context.
It’s understandable that our next commander in chief should be bothered about currency manipulation and military expansion in the South China Sea. These are important concerns that Trump is correct to call out. It’s unclear, however, how China’s imposition of a consumption tax merits inclusion with these other weighty matters.
After all, VAT is fairly routine stuff these days. The concept is hardly a recent phenomenon. VAT has been around for decades, and it’s ubiquitous outside the United States. China is among more than 160 nations that tax domestic consumption in the form of a VAT. Taiwan also has a VAT, if that matters.
In Trump’s worldview, the fact that China has a VAT is apparently an offense on par with those other nefarious actions. This is baffling to people who follow international tax policy, regardless of their political affiliation. Remember, the context for this discussion is economic perception – not reality.
The most plausible explanation why Trump raised the issue is that he considers VAT a significant trade advantage for those countries that impose the tax, and a major disadvantage for countries without the tax (i.e., the United States). In the high-stakes game of global trade, the former group of nations are presumed to be winners and the latter are losers – and Trump hates losing.
Look again at the parenthetical remark from Trump’s tweet: “The U.S. doesn’t tax them” (referring to Chinese exports). Is he suggesting that we should? If so, Trump seems to imply that America needs a VAT because it’s how you get the desired border adjustment, and thereby eliminate what he considers an unfair trade advantage.
The catch is that Trump is wrong. VAT is not a trade distortion; it just looks like one to a country that doesn’t have a similar border adjustment.
Trump on Mexico’s VAT
Like millions of other Americans, I sat through the first presidential debate on September 26. For most of the evening the candidates traded predictable barbs. NBC’s Lester Holt offered the expected questions about Trump’s tax returns and Hillary Clinton’s private email server. The debate was generally uneventful until one bizarre moment that caused tax junkies across the country to sit up and take notice. Trump started complaining about Mexico’s VAT, as follows:
“Let me give you an example. They have a VAT tax. We are on a different system. When we sell into Mexico, there’s a tax. When we sell in, automatically, 16 percent, approximately. But when they sell into us, there’s no tax. It’s a defective agreement. It’s been defective for a long time, many years, but the politicians haven’t done anything about it.”
Let’s dissect this statement. As with his Taiwan tweet, it’s informative about how our president-elect views tax burdens and cross-border trade.
For starters, we should note that it’s inaccurate to label Mexico’s VAT a “defective agreement” with the United States. There’s nothing defective about it, and moreover, it’s not an agreement in the first place. A country’s decision to enact a national consumption tax is strictly a matter of domestic legislation. In no sense does VAT represent a bilateral accord with one’s trade partners.
Trump’s statement makes it sound like Mexico got away with something and America was duped -- as if their consumption tax were an ill-advised bilateral instrument. That’s not the case; VAT has nothing to do with NAFTA. Mexico’s VAT is not paid by anyone who is not a Mexican consumer (i.e., local residents as well as visiting nonresidents who happen to consume goods or services while traveling there).
Under VAT, the consumers of goods and services will bear the same tax burden regardless of where an item was produced. Goods produced in Mexico are subject to the same VAT as the U.S. exports that Trump referenced in the debate. Anyone hoping to find defective or discriminatory treatment of U.S. exports will be sorely disappointed. As stated previously, VAT is a destination-based tax that looks only at the place of consumption. Not to beat a dead horse, but VAT is blind to a product’s geographic origin.
What about Trump’s claim that “when they sell into us, there’s no tax.” Technically, that’s also not entirely accurate. Mexican goods imported into the United States are subject to retail sales taxes that exist at the state and municipal level in 45 states, plus the District of Columbia. These retail sales taxes are also destination-based and apply equally to U.S.-made items and foreign imports.
Let’s give Trump the benefit of the doubt and disregard state-level sales taxes. What precisely is it that Trump finds “defective”? The root of his grievance lies in the differential treatment of cross-border trade that results from the fact that Mexico has a VAT and the United States doesn’t. Point taken, but that situation exists solely because we don’t have a VAT. To the extent this is a problem (and Trump clearly thinks it is), the blame doesn’t reside with Mexico.
If we accept Trump’s reasoning, the solution to the perceived trade imbalance is not for other countries to abandon their border adjustment, but for America to match it.
Connecting Donald’s Dots
To the best of my knowledge, Trump has never specifically voiced support for VAT. His assorted comments about the Chinese and Mexican VATs were of a critical nature, but implicit in that criticism was a type of envy. Was Trump arguing that those VAT regimes are bad, or was he hinting that America needs to do the same thing?
Ironically, Trump’s rationale departs from the standard arguments one hears in support of VAT. Many conservative thinkers like the VAT because it exempts savings from the tax base, and in so doing encourages capital formation and economic growth. Many progressive thinkers like the VAT because it’s proven to be a reliable source of tax revenue that can finance desirable public spending programs. Trump’s thinking doesn’t track with either of those settled approaches. Instead, he wants a VAT because of the border adjustment, which he inaccurately considers to be a tariff.
How likely is Congress to give Trump what he wants? It’s difficult to say. Any legislation that vaguely resembles VAT will naturally be a long shot with Congress. Democrats don’t like that the tax is regressive, while Republicans don’t like that the tax is efficient at raising revenue and could fuel an expansion of the public sector.
Despite that orthodoxy, there are two proposals before Congress for a traditional credit-invoice VAT. Sen. Benjamin L. Cardin supports an add-on VAT. Cardin would use the revenue generated from VAT to substantially reduce individual and corporate income taxes. Rep. James B. Renacci supports a substitution VAT that would replace the corporate income tax in its entirety. Neither plan has gained much support apart from a few policy wonks who see merit in adopting a broad-based federal consumption tax.
Far more likely to grab Trump’s attention is the tax reform blueprint released earlier this year by Republicans in the House. The plan has the endorsement of two influential lawmakers: House Speaker Paul D. Ryan and House Ways and Means Chair Kevin Brady. Ryan is known to be a close ally of Vice President-elect Mike Pence, who presumably will have Trump’s ear.
The most notable element of the blueprint is that it would transform the corporate income tax into a cash flow tax. The drafters of the blueprint were careful to avoid labeling their tax reform plan a VAT. What they mean is that their creation is not a credit-invoice VAT, like the Cardin bill or the Renacci plan. While that’s true, cash flow tax is undeniably similar to a subtraction-method VAT with a supplemental wage allowance. The cash flow tax would also be destination-based, meaning it would require a border adjustment. (A separate issue is whether the border adjustment provided for under the blueprint would violate WTO trade rules because its structure deviates from the classic VAT.)
Only time will tell whether the visceral appeal of a border adjustment is enough to sell Trump on the cash flow tax as an alternative to our conventional corporate income tax. The conclusion to be drawn at this time is that our president-elect seems fascinated with other countries’ “unfair” trade advantage, and he wants to replicate those same benefits for U.S. businesses. Never mind that the trade advantage is illusory.