JUST BECAUSE some foreign government might, IN ANY WAY subsidize something I import from it, is NO REASON for my government to either subsidize its domestic competitors OR tax (tariff) the imported good.
MY GOVERNMENT should NOT tax (tariff) or subsidize, no matter WHAT foreign governments do.
For example, if country uses child labor and pollutes their environment while making a product for 1/3 the amount we can make it here, what would you do ?
You can say:
- It does not matter, because I can now get those products for 1/3 the price
- I am not a supporter of child labor in this country, but am willing to support it in another country.
- I believe we should take of our environment here, but what happens in another country stays in that country
- I believe that we should not have any restrictions on child labor nor misuse of the environment here or in other countries.
Or, you can say, purely from a utilitarian stance, that allowing another country to sell a product at 1/3 the cost compared to being made here because we choose to protect child labor and our environment is unfair to businesses here and we will in some way either ban or restrict certain products by law and/or tarfiff.
The difference between a VAT tax and a tariff is that a VAT tax, taxes consumption and a tariff is a tax on the import of an goods whether or not that good is consumed. Tariff are detrimental in two ways then. The first being that they distort price signals by making taxes uninformed. Second, is that they add taxes on top of sales tax and VAT.
But couldn’t VAT be used, at least in theory, to indirectly give a country an advantage by making it possible to lower other kinds of production taxes—like capital taxes, payroll taxes, and so on—which still remain a cost in exports? You seem to touch on this in your section about income taxes, but I’m not sure it fully addresses the point (or maybe I’m just not understanding the answer). Is there some non-intuitive economic principle that would make this kind of tax substitution incapable of creating even a theoretical form of subsidy?
No becasue it still all comes back to relative prices. If Country A puts a tariff on automobiles that will, through the exchange rate lower the Country A currency price of Country A exports and the country A currency price of Country A imports leaving the trade balance unchanged (though balanced at lower level of imports and exports).
Any trade advantage any country tries to create for itself at the expense of its own taxpayers is FINE by me! As long as they don't stop (I HATE change).
VAT is not a subsidy at the price level, but can be at the industry profit level. To see this clearly, you have to take the hyperbole example, and work back from there. If the US decided to completely shift its tax strategy to a 100% consumption tax, and abandon the income tax altogether, every trading partner in the world would scream bloody murder. This idea is a hugely fringe idea touted by the like of Paul Rand, but not completely unheard of. Think of the consequences of this on international trade:
US manufacturers that specialized in exports would pay effectively zero taxes to any federal government. They would not have to pay any income tax, since income tax doesn't exist in the US. They would still have to pay the destination VAT, but, 1) this would have to be lower than the tax burned paid by destination country producers, who have to pay income tax and VAT to their federal government; and 2) the burden of consumption tax is theoretically borne by the consumer, anyways.
EU manufacturers, on the other hand, would pay income tax to the EU, and pay the heavy consumption tax in the US (15% to 20% or so?). Even if that consumption tax is borne by the US consumer, it isn't in any way borne by US exporters. In that environment, it is difficult to say that US firms specializing in exports are not receiving a tax subsidy from the US federal government, in that they are avoiding federal taxes altogether on their productivity (they would still be paying taxes on their inputs in a VAT, but may not be directly paying for inputs if taxes are only collected on finished products, like a sales tax). It would encourage US companies to specialize in exporting into the EU at the expense of EU domestic producers. I can't imagine our trading partners being super happy about that arrangement.
If this is true at the hyperbole example, it is difficult to argue that this is not also at least partially true at the margin.
Many countries do charge VAT on shipping costs too. So if the shipping costs are the same in each direction (rarely the case in reality), the delta on that $30k car is greater in the country that taxed the cost on international shipping which is presumably higher than domestic shipping. Still they are increasing costs / reducing choices on their own population not on the US. Doesn’t mean I want my govt to do that to me.
I think the issue from the American point of view is that European countries, say Germany, subsidize their auto makers (for Germany around $13 Billion a year) from taxes they get, including VAT taxes. So American cars coming into Europe have a VAT tax added some of which is used to subsidize the European auto makers.
Interesting. If we would institute a 20% VAT tax, it would seem that that would be perfectly fine, after all, many countries, including Europe do that in addition to their income tax.
This would tax consumption on both internal and external products.
And I would assume that this would be a good thing.
However, if we simply take the VAT tax, but provide for VAT reduction on certain domestically produced products, it turns into a very very bad thing.
Even though, with a few exceptions here and there on particular products, this is what pretty much every other country does when trading with us.
How would you fix this problem ? I do not like how Trump is addressing this situation, but I have not heard anyone propose anything but status quo, which is simply not free and fair trade.
"If all prices rise by the same percentage, the real economic decisions people make don’t change."
No, this is simply not true. If the price for everything doubles, and your income stays the same, no one will make the same economic decisions, unless the amount you spend is not significant relative to your spending.
If the price of all cars go up by 50%, people will keep their old cars longer and/or by cars on the less expensive part of the car curve.
If we want people to smoke less, add a large tax to all cigarettes. Not difficult to change how people spend their money.
So, the premise of "We need to focus on two key economic principles" is wrong.
Not saying that I think that VAT is an export subsidy, but the logic presented here is flawed.
All prices double, some prices double, cars go up by 25% - any of these keep the relative price the same, but all will change the economic decisions people will make.
Whether we institute a VAT on all products or a subset of products, economic decisions made by real people will change. You cannot look at relative prices in a vacuum, they need to be put into a context of income, savings, life goals, personal preferences, etc.
Excellent post. Unless I'm mistaken, European income taxes are roughly comparable to US income taxes. Thus as a practical matter the European VAT doesn't replace income taxes, it results in total European taxes being higher than in the US.
Thanks. Better illustration would be BMW as both an importer and exporter in both countries. BMW is the largest US car exporter by value. The point is that despite VAT, they are happy to export SUVsfrom the US to the EU and import sedans from Europe.
This is good but I think people really need to understand how it works better.
Personally I'd add a whole explainer and understand that the key thing is the the VAT you pay for your inputs counts as a tax credit and it's basically an anti-fraud measure. So if everyone along the chain is paying, it lowers the incentive to just do things off the books and not pay.
JUST BECAUSE some foreign government might, IN ANY WAY subsidize something I import from it, is NO REASON for my government to either subsidize its domestic competitors OR tax (tariff) the imported good.
MY GOVERNMENT should NOT tax (tariff) or subsidize, no matter WHAT foreign governments do.
I think this is the key practical consideration.
I don't believe in absolutes.
For example, if country uses child labor and pollutes their environment while making a product for 1/3 the amount we can make it here, what would you do ?
You can say:
- It does not matter, because I can now get those products for 1/3 the price
- I am not a supporter of child labor in this country, but am willing to support it in another country.
- I believe we should take of our environment here, but what happens in another country stays in that country
- I believe that we should not have any restrictions on child labor nor misuse of the environment here or in other countries.
Or, you can say, purely from a utilitarian stance, that allowing another country to sell a product at 1/3 the cost compared to being made here because we choose to protect child labor and our environment is unfair to businesses here and we will in some way either ban or restrict certain products by law and/or tarfiff.
Thx Brian. Great stuff.
It's surprising how financially illiterate you can be as a journalist for the financial times
... says a guy in Electronic Engineering/Engineering Physics/Industrial Engineering to a guy in Econ/Econ/EconPolicy/Physics-PoliticalScience.
What's surprising you didn't find time to differentiate "financial literacy" from "economic literacy". I'm guessing you have neither.
The difference between a VAT tax and a tariff is that a VAT tax, taxes consumption and a tariff is a tax on the import of an goods whether or not that good is consumed. Tariff are detrimental in two ways then. The first being that they distort price signals by making taxes uninformed. Second, is that they add taxes on top of sales tax and VAT.
But couldn’t VAT be used, at least in theory, to indirectly give a country an advantage by making it possible to lower other kinds of production taxes—like capital taxes, payroll taxes, and so on—which still remain a cost in exports? You seem to touch on this in your section about income taxes, but I’m not sure it fully addresses the point (or maybe I’m just not understanding the answer). Is there some non-intuitive economic principle that would make this kind of tax substitution incapable of creating even a theoretical form of subsidy?
No becasue it still all comes back to relative prices. If Country A puts a tariff on automobiles that will, through the exchange rate lower the Country A currency price of Country A exports and the country A currency price of Country A imports leaving the trade balance unchanged (though balanced at lower level of imports and exports).
Any trade advantage any country tries to create for itself at the expense of its own taxpayers is FINE by me! As long as they don't stop (I HATE change).
VAT is not a subsidy at the price level, but can be at the industry profit level. To see this clearly, you have to take the hyperbole example, and work back from there. If the US decided to completely shift its tax strategy to a 100% consumption tax, and abandon the income tax altogether, every trading partner in the world would scream bloody murder. This idea is a hugely fringe idea touted by the like of Paul Rand, but not completely unheard of. Think of the consequences of this on international trade:
US manufacturers that specialized in exports would pay effectively zero taxes to any federal government. They would not have to pay any income tax, since income tax doesn't exist in the US. They would still have to pay the destination VAT, but, 1) this would have to be lower than the tax burned paid by destination country producers, who have to pay income tax and VAT to their federal government; and 2) the burden of consumption tax is theoretically borne by the consumer, anyways.
EU manufacturers, on the other hand, would pay income tax to the EU, and pay the heavy consumption tax in the US (15% to 20% or so?). Even if that consumption tax is borne by the US consumer, it isn't in any way borne by US exporters. In that environment, it is difficult to say that US firms specializing in exports are not receiving a tax subsidy from the US federal government, in that they are avoiding federal taxes altogether on their productivity (they would still be paying taxes on their inputs in a VAT, but may not be directly paying for inputs if taxes are only collected on finished products, like a sales tax). It would encourage US companies to specialize in exporting into the EU at the expense of EU domestic producers. I can't imagine our trading partners being super happy about that arrangement.
If this is true at the hyperbole example, it is difficult to argue that this is not also at least partially true at the margin.
Many countries do charge VAT on shipping costs too. So if the shipping costs are the same in each direction (rarely the case in reality), the delta on that $30k car is greater in the country that taxed the cost on international shipping which is presumably higher than domestic shipping. Still they are increasing costs / reducing choices on their own population not on the US. Doesn’t mean I want my govt to do that to me.
I think the issue from the American point of view is that European countries, say Germany, subsidize their auto makers (for Germany around $13 Billion a year) from taxes they get, including VAT taxes. So American cars coming into Europe have a VAT tax added some of which is used to subsidize the European auto makers.
Interesting. If we would institute a 20% VAT tax, it would seem that that would be perfectly fine, after all, many countries, including Europe do that in addition to their income tax.
This would tax consumption on both internal and external products.
And I would assume that this would be a good thing.
However, if we simply take the VAT tax, but provide for VAT reduction on certain domestically produced products, it turns into a very very bad thing.
Even though, with a few exceptions here and there on particular products, this is what pretty much every other country does when trading with us.
How would you fix this problem ? I do not like how Trump is addressing this situation, but I have not heard anyone propose anything but status quo, which is simply not free and fair trade.
"If all prices rise by the same percentage, the real economic decisions people make don’t change."
No, this is simply not true. If the price for everything doubles, and your income stays the same, no one will make the same economic decisions, unless the amount you spend is not significant relative to your spending.
If the price of all cars go up by 50%, people will keep their old cars longer and/or by cars on the less expensive part of the car curve.
If we want people to smoke less, add a large tax to all cigarettes. Not difficult to change how people spend their money.
So, the premise of "We need to focus on two key economic principles" is wrong.
Not saying that I think that VAT is an export subsidy, but the logic presented here is flawed.
That’s not all prices doubling…
All prices double, some prices double, cars go up by 25% - any of these keep the relative price the same, but all will change the economic decisions people will make.
Whether we institute a VAT on all products or a subset of products, economic decisions made by real people will change. You cannot look at relative prices in a vacuum, they need to be put into a context of income, savings, life goals, personal preferences, etc.
As an European used to pay VAT for everything, it really surprises me the misunderstanding of this tax in the United States.
Excellent post. Unless I'm mistaken, European income taxes are roughly comparable to US income taxes. Thus as a practical matter the European VAT doesn't replace income taxes, it results in total European taxes being higher than in the US.
Thanks. Better illustration would be BMW as both an importer and exporter in both countries. BMW is the largest US car exporter by value. The point is that despite VAT, they are happy to export SUVsfrom the US to the EU and import sedans from Europe.
This is good but I think people really need to understand how it works better.
Personally I'd add a whole explainer and understand that the key thing is the the VAT you pay for your inputs counts as a tax credit and it's basically an anti-fraud measure. So if everyone along the chain is paying, it lowers the incentive to just do things off the books and not pay.