TPP – Competitive Disadvantage(s)

You might think Congress would look back at our prior “free” trade deals – pitting U.S. workers against lower wage countries – and have a more jaundiced view of the Trans-Pacific Partnership.  The most outspoken MOC critic of our trade deals is retired Sen. Fritz Hollings of South Carolina.  Hollings saw the industries in his state decimated and warned about the threat to higher paid manufacturing jobs by the trend to globalization.  Free Trade policy, he said, was just American corporations seeking a lower-cost labor supply.  (See, for example, Hollings on “Economists and Free Trade.”)  Sen. Hollings’ Op/Ed’s repeatedly cited the additional competitive disadvantage for the U.S. without a Value Added Tax, a handicap which compounds our labor cost disadvantage.  Let’s look at what the VAT tax disadvantage means for TPP.

According to the Congressional Research Service, in 2012 total U.S. exports to TPP countries amounted to $650 billion.  Total imports from TPP countries amounted to $800 billion.  Of that import total, 40% was from Canada, which operates with an average 13% GST (value added tax).  The VAT – being border adjustable – is subtracted from exports, which means the $316.5 billion in goods imported from Canada would cost $41 billion dollars more within Canada.

This is not a Canadian subsidy.  Rather, GATT rules (General Agreement on Tariffs and Trade of the World Trade Commission) respect the subtraction of VAT from exports to eliminate the burden of the cost of government from the price/value relationship of goods shipping to another country.  The importing country would add its own VAT (cost of government).  Therefore, the imported goods would be on an equal footing with goods produced in the importing country since the VAT is charged on domestic production.

All even, except in the case of the U.S., which does not employ its own VAT.  Imports to the U.S. from TPP countries arrive with a competitive price advantage to the exporting country…13% in the case of Canada.

The second largest TPP exporter to the U.S. is Mexico, which accounts for one-third of U.S. imports from TPP countries.  Mexico’s VAT is 16%, so these goods arrive 16% cheaper than they would be in Mexico itself.  The third largest TPP exporter to the U.S. is Japan, accounting for 16% of U.S. TPP imports; Japan’s VAT is 8%.  The VAT in the other TPP countries: Australia, 10%; Chile, 19%; Malaysia, 6%; New Zealand, 15%; Peru, 18%; Singapore, 7%; Vietnam, 10%.  Only Brunei and the U.S. do not use a VAT.

Because the U.S. does not employ a VAT, government costs are not subtracted from exports.  (GATT rules do not permit the subtraction of corporate income taxes.)  When U.S. exports arrive at a TPP country, that country’s VAT is levied on the total price of U.S. goods..including the implicit CIT.  That is a competitive disadvantage for U.S. exports.  All our trading partners utilize a VAT, as do over 150 countries today.  China’s VAT is 17% and Germany’s is 19%, just under the European average.  Were the U.S. to turn to a revenue-neutral VAT to replace the Corporate Income Tax and Social Security Insurance, the VAT would be in the range of 10%.

The U.S. Congress – in deference to our multi-national corporations – has expressed knee-jerk opposition to VAT.  There has been no outspoken support for VAT even with our presumed goal to retain and increase high-paying domestic manufacturing jobs.  The VAT itself is not a tool to deliver more expensive social programs, an expressed fear of many in Congress.  VAT should be seen for what it is…an efficient mechanism for raising revenue and partially leveling the playing field in trade.  How we use the funds raised and how much revenue we should raise are separate issues, and should be debated separately.

The debate over TPP should beg the question whether the U.S. should employ a VAT to replace other taxes and remove a competitive disadvantage in trade.

Would a VAT replacement of the CIT add a greater burden to consumers?  Taking the view that the consumer pays the CIT, a revenue neutral replacement of the CIT by a VAT should make no difference on balance.  However, there would be a shift of burden from smaller companies to multi-national corporations that are more dependent upon imports.

It is notable that economists are split on where the burden of the CIT falls.  Some argue that it is workers who suffer the burden because the amount of taxes paid could otherwise be used for increased wages.  Likewise some argue that the burden falls on the shareholders.  Others posit that..when a company prices its goods..a margin is added and an implicit tax obligation will inure; since the margin exists within the price of goods, it is the consumer that absorbs the burden of the CIT.

As to the argument that a VAT consumption tax would be regressive..this could readily be nullified via adjustments to the threshold and progressivity of the income tax and via the Earned Income Tax Credit for those at the bottom.

We are entering into the height of the presidential primary season, ripe for conceptual debates about tax policy.  But, so far, among the Republican candidates we see only talk of lowering taxes, and little to none on the impact of tax policy on trade.  Only one presidential candidate has offered a VAT (Rand Paul), and, while he perhaps wisely named it a BAT (business activity tax), no debate question covered Paul’s concept of replacing the CIT with his BAT consumption tax.  To date, no Democrat has raised the issue of a consumption tax.  Hillary Clinton will probably not mention VAT, even though President Clinton has previously endorsed the concept of VAT replacing other taxes.

VAT remains a hot potato.  Even though its clear advantage for trade should mean economic growth and domestic jobs.  There is tacit support among union leaders (Richard Trumka, AFL-CIO; Andy Stern, SEIU).  The elimination of double-taxation of dividends would be good for stock valuations (and Wall Street).  But, until there is a national political leader who champions this sweeping tax reform and rallies the public behind it, VAT is destined to remain unmentionable.

Sen. Rand Paul’s Plan…A Good Start for Tax Reform

Tax policy is a hot potato and controversial.  It can propel a presidential candidate into the headlines, but it can also make the candidate an easy target for opponents and pundits alike. Sen. Paul’s bold proposal is a fine beginning and merits productive discussion.  Hopefully it will not be dismissed by knee-jerk opposition.

The way we tax ourselves should be separated from the purposes to which we apply the revenue we need.  Ideally, on the personal income tax side this plan would have eliminated – purely – all deductions.  Sen. Paul, in sensible practicality..to head off congressional opposition..has incorporated deductions for mortgages and charitable contributions.  The mortgage deduction will placate the real estate lobby, but it will also create the precedent for other industries to lobby for their gain.  The proverbial camel’s nose under the tent.

Critics are circling over the potential shortfall in total revenues.  Once revenue needs are clearly defined, if more revenue is needed the plan can be fixed by increasing the 14.5% rate in the Business Activity Tax, a value-added tax, and by adding one or two tax brackets on the personal income tax side.  The addition of another personal tax bracket or two will change the definition from a “flat” tax with a single percentage for both business and personal taxes, but would provide the necessary flexibility to ensure progressive distribution of the tax burden.  The tax base will be clean.

Importantly, Paul’s Business Activity Tax will finally harmonize the U.S. tax system with all of our trading partners; over 165 countries now use the border-adjustable VAT to our current competitive disadvantage in world trade.  With Paul’s BAT, the cost of government paid by the BAT will be subtracted from U.S. exports and added to imports, neutralizing that government burden in the price/value comparison of goods and services crossing borders. 

Bottom Line: Sen. Paul’s plan is an excellent beginning.  Let’s not let the pundits and political opponents kill it this time.  Let’s fix it.

VAT – (OECD) Latest Worldwide Stats

An update on Value Added Tax usage is provided by the Organization of Economic and Community Development in “OECD Consumption Tax Trends, 2014; VAT/GST and Excise Rates, Trends and Policy Issues.”

VAT is the world-class tax designed for international trade.  Over 160 countries have implemented VAT to neutralize the cost of government for goods and services that cross borders.  Under GATT rules (General Agreement on Tariffs and Trade), Value Added Taxes are added to imports to equalize the burden of government for imports and domestic production.  Likewise, VAT’s are subtracted from exports…to remove the cost of the exporting country’s government from the price/value comparison of goods and services.

The unweighted average VAT rate of the OECD countries (excluding the U.S.) is 18.7 and for the major U.S. trading partners varies from 5% for Canada and Japan, to 19% in Germany, 19.6% in France, and 20% in the United Kingdom.  China, which is not an OECD member, has a 17% VAT.  In the OECD countries in Europe, Value Added Taxes raise 20.2% of total tax revenue on average, equivalent to around 6.6% of GDP.

For the full OECD report see: http://www.oecd-ilibrary.org/taxation/consumption-tax-trends-2014_ctt-2014-en

As the above statistics amplify, the U.S. is the outlier in not employing a VAT.  This could change, as the new Congress promises to reconsider tax reform.  Readers of this website know that VATinfo advocates 100% replacement of the Corporate Income Tax by a VAT.

This sweeping reform would make U.S. goods more competitive abroad and at home.  The CIT has been corrupted with loopholes, a veritable Swiss cheese tax code that now barely collects 8% of federal revenues, down from 32% in 1952.  VAT replacing the CIT would cleanly end the double-taxation of dividends.  Multi-national corporations stashing profits abroad to avoid the CIT would return overseas capital to domestic banks.  All these benefits would stimulate the economy and grow domestic jobs.  The regressive impact could easily be addressed via the Personal Income Tax with credits.

Forbes: Tax Reform to End Inversions & Grow Economy/Jobs

 

There is a bold but promising solution to end corporate tax avoidance schemes including inversions: sweeping tax reform, replacing the corporate income tax with a clean consumption tax with zero exceptions.

Forbes Op/Ed by Steve Abramson, VATinfo.org

 

 

Tax Reform: End the Corporate Income Tax to Grow Economy & Wages

The Corporate Income Tax, today, collects just 1.8% of GDP, and accounts for only 8% of total federal revenues.  By comparison, at its peak in 1952 the CIT amounted to one-third of federal revenues.  Corporations have employed every legal resource to reduce their tax liability, and while some multi-national corporations park profits in lower-taxed countries, others with less ethical boundaries claim overseas subsidiaries in tax havens and transfer their profits to a mailbox.

With the CIT having been perversely minimized, the VATinfo website has endorsed the concept of sweeping tax reform, at once eliminating the Corporate Income Tax and replacing it with a Value Added Tax, and combining it with a progressive Personal Income Tax employing a large standard deduction and no other deductions.  VATinfo’s rough “Smart Tax” calculation…based upon IRS tables with insight provided by IRS and the Tax Policy Center at Brookings Institute…projected that a VAT tax rate of 9% would be required to replace the CIT and offset a Personal Income Taxes cut for incomes under $100,000.  (The plan envisioned eliminating the PIT for filers with Adjusted Gross Income under $50,000…two-thirds of all filers; reducing the PIT by 56% for those with AGI between $50,000 and $75,000; reducing the PIT by 17% for those with AGI between $75,000 and $100,000.)

In December 2013, the National Bureau of Economic Research released a working paper, “Simulating the Elimination of the U.S. Corporate Income Tax,” with very reinforcing conclusions.  Foremost is the understanding that when U.S. capital moves to a lower-taxed country, U.S. workers suffer a loss in labor demand and real wages.  And, the reverse would be true were the U.S. to end the CIT.  The study projects that capital would flow to the U.S. resulting in “a rapid and sustained 23 to 37 percent higher capital stock.”  “Higher capital per worker means higher labor productivity and, thus, higher real wages.  Indeed, in the wage-tax simulation, real wages of unskilled workers end up 12 percent higher and those of skilled workers end up 13 percent higher.”

The NBER study concludes that while the economic gains from eliminating the CIT would fall short of replacing the revenue loss entirely (requiring an increase in taxes on wages, or a consumption tax), there would be relative distributional gains accruing to both skilled and unskilled workers, i.e., addressing income inequality.

Solar Panel Maker Seeks Duties v. China (Trade Problem VAT Would Fix)

What a shame!  At one time it looked like the manufacture of solar panels would be an arena in which the U.S. could work towards energy independence, grow manufacturing jobs and compete successfully.  However, China, following a trade model of government subsidies and dumping has managed to put most American solar panel manufacturers out of business.  Those manufacturers that remain in the U.S for the most part import Chinese solar modules and only assemble the finished panels here.  One of the holdouts, SolarWorld Industries America, the German subsidiary, has petitioned the Commerce Department to impose new duties on solar modules that with loopholes currently escape duties.  (See NYTimes, 01/01/2014.)

Think about this:  China imposes a 17% VAT on imports, and, by virtue of the Value Added Tax mechanism, also subtracts the 17% tax burden from exports.  This creates a very large price wedge in itself against solar panels manufactured in the U.S. for domestic consumption.  Were the U.S. to similarly employ a VAT (in sweeping tax reform as a revenue-neutral replacement for the Corporate Income Tax and other taxes), domestic manufacturers like SolarWorld would be far less disadvantaged vs. Chinese and other foreign imports.  SolarWorld’s need for duties might even be entirely mitigated.