Trump Wants to Exempt US from Mexico’s VAT? The Real Antidote Is a VAT of Our Own.

For the first time in seven presidential election cycles, Value Added Tax has entered the arena of a presidential campaign.  Not since Gov. Jerry Brown focused his 1992 presidential campaign on sweeping tax reform including a VAT had a would-be president boldly suggested a VAT.  In this cycle, both Sen. Ted Cruz and Sen. Rand Paul brought forward tax plans with value-added consumption taxes.

During the first debate with Hillary Clinton, Donald Trump pointed to the trade advantage of Mexico’s 16% VAT, which is subtracted from exports.  Mr. Trump suggested he would negotiate an exemption for the US from Mexico’s VAT.

A more realistic solution to the existing price wedge of the VAT between the US and Mexico — and over 160 countries using VAT’s — would be for the US to adopt a VAT of its own in replacement for other taxes, i.e., the Corporate Income Tax (CIT).

Why does every US trading partner employ a VAT?  Because it eliminates the cost of government represented by the tax from the price/value relationship of goods crossing borders.  VAT is added to imports (to match the domestic VAT percentage), and subtracted from exports to permit the importing country to add its own VAT without doubling up on the exporting country’s tax.  That is, VAT is a border-adjustable, destination based tax perfectly suited to this era of globalization.

The usual argument made against the US using a VAT is that it would be used to raise tax revenues to fuel social programs and put the country on a path to socialism.  Opponents allude to the high percentage of tax revenues raised by VAT’s in France and Scandinavian countries.  But, there is nothing that prevents a VAT from being used as a revenue-neutral replacement for other taxes, or for that matter, within an overall revenue cut.  Fear of VAT extends mostly from the notion of using VAT as an “add-on” tax base which it need not be.

Nor is there any justification to assume that the revenues raised by a US VAT would increase as a matter of course.  Among the major US trading partners within the 35 OECD members, the percentage VAT revenue to GDP did not explode over the fifteen years from 2000 to 2014 (the last year reported):

VAT Revenue  % GDP 2000 2111 2014   VAT % Total Tax Revenue 2000 2011 2014
France 7.4 7.0 6.9     16.7 19.7 15.4
Italy 6.5 6.2 6.0     15.4 14.4 13.8
Germany 6.9 7.3 7.0     18.4 19.4 19.3
Japan 2.4 2.7 3.7     14.4 14.4 13.8
Spain 6.1 5.3 6.0     16.6 12.6 16.6
United Kingdom 6.6 7.4 6.9     18.1 20.5 21.2
Canada 3.2 4.1 4.1     9.2 13.3 13.1
Mexico 3.1 3.7 3.9     18.7 19.0 n/a

Source: OECD Consumption Tax Trends, 2014

The meaningful trend among our trading partners is to increase revenues from the consumption tax while reducing CIT revenues.  Japan, for example, raised its VAT rate from 5% in 2013 to 8%, and has planned to raise it to 10% in 2017.  Concurrently, however, Japan reduced the CIT rate from 39.5% to 32.11% in 2013 and will drop its rate further to 29.74% in its 2016 fiscal year.

If the US were to replace the CIT by a VAT, it would put the US on a more competitive footing by eliminating a trade disadvantage.  This change would be positive for economic growth.  With zero corporate income tax, profits parked abroad by multi-national corporations would flow to the US.  The incentive for inversions would disappear along with the corrupting process of lobbying for loopholes.  Trump’s economic advisor, Peter Navarro, has a handle on the VAT concept.  For a full explanation of the impact on US trade, VATinfo has posted a 9-minute video with an explanation and support of VAT from Bill Clinton.

Marco Rubio Attacks Ted Cruz on Tax Reform

Sen. Rubio’s attack on Sen. Cruz has taken an unfortunate turn. Sen. Rubio has called Sen. Cruz’s tax reform plan “sneaky” and a “liberal scheme” supported by President Obama and Nancy Pelosi. That’s laughable on the face, but may sadly prove effective.

Opponents of VAT fear that its simplicity would encourage more taxation and spending, but they focus on the VAT being an “add-on” tax and not a replacement for other taxes. As Larry Summers said, “Liberals think VAT is regressive and conservatives think it’s a money machine. We’ll get a VAT when they reverse their positions.” With proposals from Sen. Cruz and Sen. Paul replacing the Corporate Income Tax by a VAT, perhaps this is a sign that the time has come.

The VAT itself is not a tool to deliver more expensive social programs.  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 U.S. is at a major competitive disadvantage without a VAT of its own. All our trading partners utilize a VAT, as do over 160 countries today.  Far from a “European-style” tax, VAT is the world class tax system for international trade.

Our trading partners tack on significant VAT percentages to our goods and services as they cross their borders, a de facto tariff. For example, China adds 17% VAT to their imports from the U.S. and Germany adds 19%, just below the European average. Were the U.S. to replace the CIT by a VAT, it would remove this competitive disadvantage; U.S. exports would be cheaper and our imports..which arrive with the exporting country’s VAT subtracted..would face the same taxes as domestically produced goods and services.

Eliminating the CIT would end the incentive for multi-national corporations to park profits in lower-taxed countries. Forget inversion mergers. With zero CIT, the U.S. would become the lowest income tax country and capital would flow back to our shores. Foreign multi-national companies, too, would seek to move profits retained elsewhere to the U.S. Gone would be the double-taxation of dividends; stock market values should soar.

VAT remains a hot potato. To date, no Democrat for the presidency since Jerry Brown in 1992 has dared to raise 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.