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.

POTUS Campaign | “Free” Trade & VAT Tax Reform

It is little wonder that middle-class workers are flocking to the speeches of Sen. Bernie Sanders and Donald Trump.  Twenty-five years of “free” trade agreements have eroded the hope of millions of Americans for higher-wage manufacturing jobs, which have fallen by nearly one-third since 1990 accompanied by stagnant wages.

What policies might help to stop the bleeding?  Mr. Trump sees tariffs, which could threaten world trade and cause economies to implode.  Secretary Hillary Clinton and Sen. Sanders envision higher education as a ladder to higher paying employment, but that is a longer-term solution based upon speculation that those jobs can and will be created in sufficient numbers.

Most effective in the short-term would be a shift in the way we tax corporations to match our global competition.  Changing to a Value Added Tax as a replacement for the Corporate Income Tax would go a long way towards making American workers more competitive.  How?  Because VATs are border-adjustable, i.e., subtracted from exports and added to imports to eliminate the cost of government from the price/value relationship of goods crossing borders.  For example, China has a 17% VAT that is added to their imports, and 17% is subtracted from the price of their exports.  That is a big difference, coming and going.  Likewise, Germany has a 19% VAT that has enabled their higher-wage country to still be very competitive with higher wages.

Among the presidential candidates, the only remaining contender proposing this shift in how we tax ourselves is Sen. Cruz.  Whether you like his other positions or not, this tax reform deserves your support.  Sen. Paul has proposed a similar plan.  This should not be a partisan issue.  Gov. Jerry Brown ran for president in 1992 based upon the same tax reform.  President Bill Clinton has endorsed the concept, and so have many labor leaders.  Will Hillary Clinton…or Donald Trump?

It’s time we got smart about how we tax ourselves, if we want to compete in the world economy.  It’s time for VAT.

“Free” Trade & Tax Reform | Carrier’s Move to Mexico

Here’s the good news for employees at the Carrier plant in Indianapolis — the next Carrier air conditioner they buy will be cheaper.  The bad news is Carrier’s jobs are moving to Mexico, and the employees’ next jobs will likely pay them less.  (See: “Carrier Workers See Costs, Not Benefits, of Global Trade,” The New York Times, March 20, 2016)

“This is strictly a business decision!,” CEO Robert McDonough told an assemblage of Carrier’s workers about the outsourcing plans that will cost them their jobs. This explanation was met with boos and curses. To help discarded employees, the company promised to pay for four years of additional education, but many older workers feel it is too late for them.  Carrier wages averaged $20 or more per hour, and jobs at the adjacent Amazon warehouse average just over $15 per hour.

We can presume that Mr. McDonough, as most public company CEO’s, is under pressure from parent United Technologies management and stockholders to increase profits any way they can.  And, with global competition, “You can blink and see your market position erode,” he said.  In a subsequent address to a gathering of financial analysts Mr. McDonough went further: “We’ve shifted an abundant part of our manufacturing footprint to relatively lower cost countries, about two-thirds.  Still, there’s some opportunity there.”

We can’t blame UT management for the outsourcing decision, which is a consequence of government policies and free trade agreements.  But it is also important to note that corporations have pushed Congress for these trade agreements, which enable outsourcing in the search for higher profits.  Then, too, there is no faster way for top management to increase the value of their stock options than to dramatically lower the cost of labor through outsourcing.  The result is a deck stacked against the American worker, now in competition with cheaper wages in other countries.

It is little wonder that middle-class workers are flocking to the speeches of Sen. Bernie Sanders and Donald Trump.  Twenty-five years of “free” trade agreements have eroded the hope of millions of Americans for higher-wage manufacturing jobs, which have fallen by nearly one-third since 1990 accompanied by stagnant wages.

What policies might help to stop the bleeding?  Mr. Trump sees tariffs, which could threaten world trade and cause economies to implode.  Secretary Hillary Clinton and Sen. Sanders envision higher education as a ladder to higher paying employment, but that is a longer-term solution based upon speculation that those jobs can and will be created in sufficient numbers.

Most effective in the short-term would be a shift in the way we tax corporations to match our global competition.  Changing to a Value Added Tax as a replacement for the Corporate Income Tax would go a long way towards making American workers more competitive.  How?  Because VATs are border-adjustable, i.e., subtracted from exports and added to imports to eliminate the cost of government from the price/value relationship of goods crossing borders.  For example, China has a 17% VAT that is added to their imports, and 17% is subtracted from the price of their exports.  That is a big difference, coming and going.  Likewise, Germany has a 19% VAT that has enabled their higher-wage country to still be very competitive with higher wages.

Among the presidential candidates, the only remaining contender proposing this shift in how we tax ourselves is Sen. Cruz.  Whether you like his other positions or not, this tax reform deserves your support.  Sen. Paul has proposed a similar plan.  This should not be a partisan issue.  Gov. Jerry Brown ran for president in 1992 based upon the same tax reform.  President Bill Clinton has endorsed the concept, and so have many labor leaders.  Will Hillary?  Will Donald?

It’s time we got smart about how we tax ourselves, if we want to compete in the world economy.  It’s time for VAT.

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.

Value-Added Taxation in Canada: GST, HST, and QST (5th edition), Ryan global tax services, publ. by Wolters Kluwer, 12/2015

Value-Added Taxation in Canada is an in-depth analysis of the Goods and Services Tax (GST), its harmonized counterpart (HST) currently applicable in Nova Scotia, New Brunswick, Newfoundland and Labrador, Ontario, and Prince Edward Island, and the Quebec Sales Tax (QST). The book combines discussion on the theoretical and practical questions posed by Canada’s value-added taxes, with an emphasis on the implications for private and public sector taxpayers. The authors have integrated commentary on the impact of all three taxes (GST, HST, and QST) in each topical area. These taxes are referenced extensively throughout the book, providing insight into the legislation and administrative policy at both the federal and provincial level.

This fifth edition of this essential reference has been updated to reflect applicable legislation, regulations, government policies, and proposed amendments as of September 2015.

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.

Mankiw, N. Gregory, “One Way to Fix the Corporate Tax: Repeal It,” The New York Times, 08/23/14

“Perhaps the boldest and best response to corporate inversions is to completely rethink the basis of corporate taxation. The first step is to acknowledge that corporations are more like tax collectors than taxpayers. The burden of the corporate tax is ultimately borne by people — some combination of the companies’ employees, customers and shareholders. After recognizing that corporations are mere conduits, we can focus more directly on the people.

A long tradition in political philosophy and economics, dating back about four centuries to Thomas Hobbes, suggests that the amount that a person consumes is the right basis for taxation. A broad-based consumption tax asks a person to contribute to support the government according to how much of the economy’s output of goods and services he or she enjoys. It doesn’t matter whether the resources for that consumption come from wages, interest, rent, dividends, capital gains or inheritance.

So here’s a proposal: Let’s repeal the corporate income tax entirely, and scale back the personal income tax as well. We can replace them with a broad-based tax on consumption. The consumption tax could take the form of a value-added tax, which in other countries has proved to be a remarkably efficient way to raise government revenue.”

http://www.nytimes.com/2014/08/24/upshot/one-way-to-fix-the-corporate-tax-repeal-it.html?emc=eta1&_r=0&abt=0002&abg=1

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