VAT, Tariffs, and Border Adjustment Taxes

Like most Americans I’ve heard of VAT taxes, but I didn’t really understand how they work. The difference between VAT and sales taxes is important though when it comes to President Trump’s policies on immigration (“Trump’s Wall”) and his proposed “border adjuestment taxes” on Mexican imports to the US.

VAT compared with US sales tax

A value-added tax (VAT) is a type of consumption tax that is placed on a products whenever value is added at a stage of production or at its final sale. Goods and services are VAT taxed at the national government level. Over 100 countries in the world, most of them ‘developed’ nations, charge VAT.

VAT tax rates may vary for different products, but at every stage of consumption during the production process as well as when the final goods or services are sold, VAT is levied at an equal  percentage rate. This tends to equalize the final price of each product and encourages trade among countries.

US sales tax is very different.  Sales taxes all over the this country tend to be a uniform flat rate on all goods, but not services, taxed on state and local levels. Each locality determines its own sales tax rate. Thus the arbitrage in sales tax rates tends to result in higher tax evasion by both  and buyers.

A VAT tax more transparent in terms of corporate bookkeeping and tends to reduce (although not eliminate) the incidence of tax evasion.

Note that if a particular  product such as gasoline or cigarettes is singled out for a special tax rate, this is called an excise tax rather than a sales tax.

Excise taxes are a type of consumption tax—like VAT taxes. Excise taxes may have a particular use the funds collected, while sales taxes are usually general revenues.

VAT compared with tariffs & border adjustment taxes

VAT attempts to tax consumption, rather than income. This description applies more to the income of corporations than to income of private citizens.

Because VAT applies to consumption, if a VAT tax were implemented into US corporate tax law, a US corporation would be able to deduct VAT tax on the production parts of its business, e.g., buying equipment and other assets, and the raw materials and any inventory used for its business.

But under VAT rules, a US corporation could not deduct other things that aim to bring in income, e.g., “advertising, interest on loans, rent, and employee benefit costs.”

The Trump/Republican plan for decreasing the “nominal” (i.e. pre-tax-deductions) tax rate for US corporations from 35% to 20% is by charging VAT taxes.

The Trump/Republican plan aims to be further reduce some corporations’ tax rates to 15% by allowing companies to deduct wages. However, corporate deductions for the cost of wages are not allowed under VAT rules. Deducting wages as part of a US VAT tax would skew US corporate taxes in our favor.

Likewise, charging a border adjustment tax on other countries, such as Mexico, would do the same thing.

The World Trade Association, of which we are a member, will disallow a border adjustment tax on direct income taxes charged Mexico by the U.S. as well as any U.S. VAT tax that allows US corporations to deduct wages.

What about that 20% “border adjustment tax” on Mexico?

According to economists like Martin Wolf at the Financial Times and those at Forbes magazine, VAT tax is a two-way tax. It is charged on both imports to and exports from a nation. Those who live in a VAT tax country pay VAT at home and abroad. So do foreigners who buy from that country.

A border adjustment tax, on the other hand, is a tariff. A tariff is a one-way consumption tax on imports into the US.  It doesn’t include tax on US exports to Mexico. A tariff is a form of “protectionism” that aims to advantage one country at the expense of another.

If the US imposes a 20% border tax on Mexican imports, this is what happen. The balance of trade between our countries will become skewed. Mexico will be the loser because it currently makes $50 billion from exports to the US each year.

But the US will lose too! Those Mexican exports we’d tax include much of the food we eat as well as goods we import from Mexico.

A bonanza for some wealthy US corporations

Meanwhile, because of a VAT tax on corporate consumption during the production process, wealth inside the US will simply shift from one type of US corporation to another.

The kind of US corporations that sell products within the US but import products from other countries like Mexico for use in production or to sell to retail consumers, will pay the highest corporate tax rate.

The kind of US corporation that exports all products will much pay less tax— or even no corporate income tax at all.

The kind of US corporation that buys and sells only American would still have to pay a 20% tax. Even the “all-American” corporations might lose 5% under the new US corporate tax reform plan.

As Warren Buffett so notably complained, many large US corporations already pay 15% or less taxes for their effective, i.e. “actual” income taxes after current corporate deductions.d

The likelihood is that the currency exchange of US dollar vs. peso will continue to see a stronger dollar in the short term. In the long run, as trade with Mexico shifts elsewhere, the exchange rate will settle back down. Additional loss to the U.S. will come from “immigration reform” to promote hiring more expensive American labor.

Many wealthy members of the 1% , such as the Koch brothers and the Walton family of Walmart, i.e., the ones that depend on imports for their businesses, will not like this corporate tax plan at all. Neither will most Americans who have to pay higher prices for consumer goods along with the higher income tax rates to pay down the US national deficit.

And for those conservatives who hate the idea of wealth redistribution via government, this new Trump Administration tax plan could turn out to be the biggest wealth transfer ever seen in this country—or anywhere else in the world.

Note: For more about Border Adjustment Taxes see this short video by Robert Reich

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