The Trump administration isn’t satisfied with the mayhem it has already inflicted on global trade and investment. Its next step, President Donald Trump says, will be to introduce comprehensive “reciprocal” tariffs. US import taxes are low by global standards, officials correctly point out. So trading partners had better lower theirs to the same rates. Otherwise, starting next month, they’ll face higher matching tariffs on their exports to the US.
By Trumpian standards, this sounds almost sensible. Reciprocity was a cornerstone of the old-fashioned approach to trade liberalization, so advocates of freer trade might be tempted to applaud. Except that the right way to lower trade barriers is through orderly negotiations not chaotic peremptory commands. And except that the president is actually opposed to old-school reciprocity; his goal is not to level the trade playing-field but to tilt it in favor of the US while extracting tribute from other countries. And except that he isn’t just talking about responding to other countries’ tariffs; in deciding how harsh the sanctions should be, US officials are weighing many other factors — including value-added taxes.
This last preoccupation is an interesting novelty — and— it suggests a modest proposal. The administration sees VAT, a kind of sales tax, as a combination of a tariff on imports and a subsidy for exports. Members of the European Union collect it at rates that range from a little under 20% to 25% or more. Team Trump believes this justifies additional US tariffs at an equivalent rate. A better response would be: “Yes, it’s outrageous and the US must retaliate. But not with a tariff, frankly. That’s pretty feeble. We’ll fire back with a big, bold VAT of our own.”
Consider. A VAT would raise a ton of revenue, which would allow taxes on personal and corporate incomes to be cut bigly. Plus, so we’re told, it’s like a tariff on imports and a subsidy for exports, one that would neutralize the predation of the EU and many other like-minded leeches. In short, a VAT could slash income taxes while sticking it to foreigners. What’s not to like?
Much as I’d welcome a US VAT — taxing incomes less and consumption more makes sense — honesty compels me to say that a consumption tax is not in fact a legitimate trade-policy grievance. This issue has long caused confusion. VATs do seem to be punishing imports and subsidizing exports because buyers of imports pay the tax whereas exporters get rebates for the VAT they’ve paid on their inputs. But these so-called border adjustments are necessary to keep the tax neutral from a trade point of view. With the adjustments in place, Europe’s VATs treat foreign and domestic suppliers to Europe’s markets the same, and foreign and European suppliers to other markets the same. Without the adjustments, this wouldn’t be true. VATs comply with WTO rules because they are “non-discriminatory.”
Admittedly, various complications muddle the picture. One is that governments also collect other kinds of tax. Depending on how those taxes are designed, they might not be trade-neutral. For instance, if a government taxes its producers more heavily than other governments tax theirs (and fails to make border adjustments equivalent to those built into VAT), it puts them at a competitive disadvantage both at home and abroad. If that government reforms its tax code, collecting the revenue it needs by cutting its producer tax and increasing its VAT, it is indeed helping its producers — but by making its tax system less discriminatory, not more.
In any event, even policies that overtly discriminate against imports won’t succeed in changing the balance of trade. Tariffs suppress imports, and subsidies can increase exports, but this will raise the demand for dollars; the currency will appreciate, making imports cheaper and exports more expensive, offsetting the initial interventions. A good rule of thumb is that policies that suppress imports also suppress exports. Studies working through the relevant theory and accounting identities, and others showing that it stands up empirically, have been in the literature for decades. They haven’t been persuasively challenged.
Which is why the best reason to introduce a US VAT has nothing to do with trade. Income taxes penalize future consumption relative to current consumption through a form of double taxation. (Savings drawn from taxed income generate returns that are also taxed.) A consumption tax such as VAT taxes future spending at the same rate as current spending. Removing the savings penalty is likely to boost saving and investment. Over time, this will lead to faster growth in output and incomes.
In the US, the most popular argument against introducing a VAT is that other taxes wouldn’t be rolled back and the proceeds would simply be added to the government’s existing collections. It’s just another way to grow the government. Well, sad to say, and regardless of DOGE, the US will eventually have to raise taxes one way or another to get its borrowing back under control. For present purposes, though, set that aside. Avid tax cutters like Trump and his allies in Congress could credibly promise to use all the proceeds from any new tax to cut those already in place. Recall that’s exactly what they say they’ll do with their tariff revenues — which, lest one forget, are taxes by another name.
A VAT would be so much better. Broadly based, so less disruptive for US producers; pro-competitive not anti-competitive; simple to administer (hence its popularity outside the US); not subject to constant renegotiation; and capable of raising substantial revenue — to repeat, as a way to cut taxes on income and profits. Sure, prices would rise initially, just as with tariffs, but this would be a temporary setback. The president and his team would keep explaining that what really matters is promoting exports, reducing imports, and making foreigners pay.
According to Trump, the rest of the world uses VATs to keep the US down. So retaliate with a VAT.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
More Global Markets Topics >
