Why Trump counts VAT as a tariff

The administration now formally classes foreign Value-Added Taxes (VAT) as discriminatory non-tariff barriers, and that classification underpins much of its new trade doctrine. Trade officials argue that border-adjusted tax systems in Europe and Asia penalise American exporters and subsidise foreign goods, and they use the claim to justify sweeping reciprocal import levies. The argument mixes up an ordinary consumption tax with a protectionist duty.

From complaint to doctrine

The complaint is old; the policy is new. American officials have grumbled about VAT rebates since the 1960s, but last week's reciprocal trade memorandum names such taxes explicitly among the barriers that American duties should match. Standard VAT rates in the European Union run from 17 per cent in Luxembourg to 27 per cent in Hungary, so a matching levy on European goods would be far larger than anything the administration has imposed so far. Reports ordered on inauguration day are due by April 1st, which gives the doctrine a date on which it could become a tariff schedule.

The reach goes well beyond Europe. The United States is the only rich member of the OECD without a national VAT or goods-and-services tax, so almost every trading partner has one. Japan levies a 10 per cent consumption tax, Canada a 5 per cent federal goods and services tax, and China a standard VAT of 13 per cent. Even the Gulf monarchies, long tax-free, have adopted one in recent years. A doctrine that treats VAT as a barrier therefore gives Washington a grievance against nearly the whole world at once.

How a VAT works

A value-added tax is levied where goods are consumed, and it falls equally on everything sold inside a country, whether made at home or imported. A European country with a 20 per cent VAT charges it on a German-built BMW and an American-built Ford alike. Refunding VAT on exports simply lets goods leave free of the home country's consumption tax, so that the buyer's country can apply its own. Calling that border adjustment a tariff gets basic tax accounting wrong.

American states already work on the same principle. A car sold in Ohio pays Ohio sales tax whether it was built in Kentucky or Bavaria, and a car shipped abroad from Ohio pays none. Trade rules have allowed indirect taxes to be adjusted at the border since the early days of the General Agreement on Tariffs and Trade, precisely because doing so treats domestic and foreign goods identically.

The trade neutrality follows in steps. Suppose a country introduces a VAT with full border adjustment. Its consumers face higher prices on domestic and imported goods alike, so the tax gives neither an edge at home. Its exporters get the tax refunded, but they were never paying it on foreign sales in the first place, since the tax is levied on domestic consumption. If the introduction did somehow boost net exports, the currency would tend to rise until the advantage disappeared. Nothing in the chain gives one country's goods a lasting price advantage in another's shops.

Washington tried its own version

The United States has spent decades trying to copy the effect for its income tax, and lost. Export tax breaks created in the 1970s and 1980s were ruled illegal subsidies, and after the World Trade Organisation authorised European retaliation, Congress repealed the last of them in 2004. House Republicans spent the first half of 2017 pushing a border-adjusted corporate tax that would have given American exporters exactly the treatment they envy abroad, and dropped it after importers and retailers objected. Their complaint was precise: the tax would have raised the cost of every imported good unless the dollar rose by the full amount, and few retailers were willing to bet their margins on the currency doing its textbook job.

The best case for the grievance

Defenders of the doctrine have one serious point. The United States raises much of its revenue through income taxes, which are not rebated on exports, while European governments rely more on VAT, which is. An American exporter pays corporate tax on its foreign sales and then its goods bear the importing country's VAT. The trouble is that the European exporter also pays corporate tax at home, and Martin Feldstein and Paul Krugman showed in a 1990 paper that a broad VAT is essentially neutral for trade, because wages, prices and exchange rates adjust to it.

A grievance with no end

By treating consumption taxes as export subsidies, American trade policy builds an artificial case for large retaliatory tariffs. Reciprocal duties set equal to foreign VAT rates would, in effect, tax foreign producers twice and raise import prices for American consumers. The burden would fall hardest on goods with few American substitutes, from German machine tools to French cheese, and on the retailers that import them.

There is also no concession a partner can offer. A government can cut a tariff by decree, but abolishing a VAT that raises a large share of its revenue would force it either to raise income taxes or to cut spending. Watch whether the April reports treat VAT as a bargaining chip to be traded for other concessions, or as a fixed grievance to be matched in full.

Levers with an exit, and without

Past uses of tariffs as leverage had a clear exit. In August 1971 Richard Nixon imposed a 10 per cent surcharge on imports to force America's partners to revalue their currencies, and he lifted it that December once the Smithsonian agreement delivered new exchange rates. The surcharge worked as a bargaining chip because everyone knew what would make it go away. A tariff pegged to VAT has no such price. The only settlement on offer is one that partners cannot deliver, which turns a negotiating tool into a permanent tax on imports.

Negotiators on the other side know this, and will plan for duties rather than a deal. Because the grievance rests on ordinary tax systems that trading partners are unlikely to abandon, it cannot be settled, and American shoppers should expect tariffs to keep rising whether or not foreign trade barriers actually change, with European and Asian consumer goods the first to carry the extra cost once the April reports land.