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.