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Brian O’Shaughnessy on the VAT

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The following is a paper written by Brian O’Shaughnessy, Chairman of Revere Copper Products and CPA’s Co-Chair for Manufacturing. 

 

Using VAT for Jobs, Health and Retirement

The media debate about VAT has missed the mark.  Strategically employed, VAT can legally promote and protect domestic production of anything mined, made, grown or serviced in any country.  The question is not whether we have new taxes, high taxes or low taxes.  The question is whether we have smart or dumb taxes in relation to promoting economic growth and international competitiveness.

VAT is a valuable tool used by 153 countries to gain a competitive edge in trade with the USA. 

Americans simply look at VAT as a Value Added Tax on goods and services at each stage of production.  In this narrow view, VAT is a consumption tax that is regressive.  Overlooked is the strategic importance of VAT to international trade, domestic jobs and real wages if used intelligently.

The VAT becomes just like a tariff when the proceeds are used to subsidize production in any country competing with another.  The average VAT worldwide is about 16%.  The proceeds of VAT can be used like any tax in many ways.  One way is to fund health care costs.  This remains true whether or not the nation’s health care system is socialized or private.

Let’s look at a real world example of how this impacts my company—Revere Copper Products.  Revere fabricates copper and brass products for further manufacturing and for building and construction markets.  Revere has a health care plan for its employee owners.  Imagine Revere workers on the factory floor producing a coil of copper.  The price Revere sells it for must cover their wages and salaries plus the cost of metal, energy, equipment, materials and supplies as well as taxes and their own health care costs.  When that Revere product is shipped abroad, the foreign country applies a VAT.  Some of the proceeds of that VAT are used to help pay for the health care cost of the citizens of that country, not ours.

In order to compete globally, my workers must produce at a cost that pays for their own health care costs and the costs of the workers in the foreign factory they are competing against.

The US Social Security retirement system works in much the same way.  Although US producers match the employee contribution, the US producer pays for it all as the employee’s contribution is simply deducted from compensation.  Again, US workers must produce at a cost that also covers their retirement when that coil of copper is sold.

When the USA negotiates a Free Trade Agreement with another country, both are required to reduce tariffs.  VATs and other border adjustable taxes are not considered “tariffs” even though they act as tariffs in reality.  The foreign countries tax our goods to pay for their domestic programs.  Canada and Mexico are good examples.  Around the period of the negotiations for NAFTA, both Canada and Mexico dramatically increased such taxes which then offset much of their agreed upon reduction of other tariffs.  The result was that the U.S. lowered import charges but they did not.

Europe and the rest of the world have also lowered tariffs as we did but increased VAT so their import charges are unchanged.  They are tradewise and strategically smart; we are not.

In order for VAT to be compliant with World Trade Organization (WTO) rules, the VAT is applied by other countries to their domestic production as well as imports.   But the VAT cost is largely offset for their domestic production by subsidies financed by VAT for health care, retirement, taxes, etc. that US producers do not receive.  US producers pay taxes but do not receive these countervailing subsidies.  We are not competitive as a result.

VAT also promotes exports.  When a product is exported, the VAT is not applied.  This means exported products are sold relatively tax free.  That’s because producers in foreign countries still benefit from the same health care, retirement and other subsidies even though no VAT was collected for exports.  Thus, while export subsidies are largely banned by the WTO, the VAT rebates accomplish the same thing.

Exports from other countries benefit from subsidies provided by VAT yet still have the average 16% VAT deducted from their full value.

So how can we compete through a smart tax strategy?  Let’s again look at a real world example of Revere.  If the US had a 12% VAT, it would generate about $4 million to the US Treasury from my company.  Revere’s health care costs are about $2.5 million per year and FICA about $1.5.  So at a 12% VAT, Revere’s health care and FICA costs could be subsidized by VAT revenues.  That would give Revere a 12% cost advantage against imports.  This 12% advantage gained from the subsidies would be retained for exports since VAT is not charged for exports. What is good for Revere jobs is good for jobs in the USA.

Imagine how competitive that mining, making, growing or servicing anything in the United States would become under such a tax regime?  

Companies outsource production to countries that have an attractive tax strategy.  Even though many other countries have higher overall tax rates than the U.S., they are still better places to produce goods or services because they have a “smart” tax strategy.  The national goal of many other nations is to achieve economic growth and attract jobs by facilitating outsourcing to them at our expense.  The VAT is a major part of their National Trading Strategy.

The USA does not have a National Trading Strategy.

Other nations make strategic use of VAT to subsidize domestic production so the USA can import cheap goods and export jobs. VAT and numerous subsidies including currency manipulation are all part of having a National Trading Strategy to capture jobs from other countries like the USA and ensure the growth of their Gross Domestic Product or GDP.

GDP is equal to Consumption plus Investment plus Government purchases and Net Exports (the amount that exports exceed imports).  Since US net exports are negative, we have a trade deficit which subtracts directly from our GDP.  This explains the lack of U.S. economic growth.  If net exports are positive, that drives GDP up and explains what is happening in China compared to the USA.

Wouldn’t a VAT increase prices in the USA by the same amount?

No.  In recent years, US producers have reduced prices in an attempt to offset foreign VAT and remain competitive.  This pressure on prices has put pressure on costs and helps explain why real wages have not grown in the USA and investment has been so flat.  Similarly, a US VAT would partly be eaten by foreign producers.  US producers, now subsidized like foreign competitors for health care and retirement costs, would not raise prices fully if given such an opportunity to regain market share.  A good estimate is that prices on a macro basis would go up by half of the VAT but vary by product.

So a VAT would cause real wages to go up and investment to increase.

Indeed, a US VAT would tend to strengthen the US dollar against other currencies.  This would present a timely opportunity to take substantial action to offset currency manipulation by China and other Asian countries which would weaken the US dollar.  Of course, that presumes we think strategically about international trade and have a National Trading Strategy.

As of March 2010, 19.7 million Americans are unemployed or underemployed in part time jobs because they can’t find full time employment.  That jobs gap for almost 20 million Americans is above the 4% level of unemployment considered to represent full employment.

The strategic use of a VAT is a good start to solve this problem.

The USA has a patchwork of inadequate trading tactics and no National Trading Strategy to compete for global trade and jobs.  That’s one good reason why the debate on VAT lacks focus.  Virtually every regulation, statute or law impacts international trade competitiveness but none less than the absence of a strategic VAT in the United States.

It’s all about trade.  Trade is what determines the location of jobs.

M. Brian O’Shaughnessy is Chairman of Revere Copper Products and has testified before Congress four times on international trade as well as before the International Trade Commission.  His company was founded by Paul Revere in 1801 and is the oldest basic manufacturing company in the USA.

Brian has appeared on BBC World News, CNN and been interviewed on Bloomberg on the Economy as well as PBS.

 

 

 

 

 

 

 

7 Responses to “Brian O’Shaughnessy on the VAT”

  1. Hugh J Campbell Jr CPA says:

    In spite of published posting times being normally 3 to 4 weeks, the following has failed to appear for over six months, on Ways and Means Committee Website, at:

    http://waysandmeans.house.gov/Calendar/EventSingle.aspx?EventID=252676

    Submission for the Record by Hugh J. Campbell, Jr. CPA (No Affiliation)
    Hearing on Tax Reform and Consumption-Based Tax Systems
    Committee on Ways and Means U.S. House of Representatives
    July 26, 2011,

    Mr. Chairman and Members of the Committee,

    It is a great pleasure for me to have this opportunity to submit this written testimony to the committee on a very important subject.

    In announcing this hearing, Chairman Camp said, “While the Committee thus far has focused on reforming the income tax, tax proposals that would move us away from an income base and instead adopt consumption as the tax base have continued to generate interest as well. Supporters of such approaches believe that taxing consumption rather than income could have important economic benefits, and so as part of our efforts to reform the tax code, the Committee needs to examine those proposals. This hearing will allow the Committee to learn more about two of the most-discussed consumption tax proposals, the FairTax and the VAT.”

    A reading of the aforementioned paragraph indicates that the Committee’s willingness to learn more about consumption tax proposals is based, in no small part, on the prospect of economic benefit. The Committee recognizes that in addition to generating revenue, an important purpose of a tax system is to generate economic benefit. Since eight of the nine individuals who testified in-person at the July 26th hearing mentioned growth, it is reasonable to assume that one of important economic benefits of a tax system should be growth.

    Since growth requires increasing rates of productivity and competitiveness, the following Jean Baptiste Say quote is highly relevant to a tax system with an aim of growth: “It is the aim of good government to stimulate production, of bad government to encourage consumption.”

    Featured in the June 24, 1980 NBC White Paper If Japan Can…Why Can’t We?, was W. Edwards Deming, whose blueprint for transformation was instrumental to the Japanese economic miracle after World War II. The NBC documentary asserted that “America’s declining competitiveness and rate of productivity would make the United States’ “guns and butter” policies of the past unsustainable and our children will be the first generation of American to have a lower standard of living than their parents”. Since this documentary aired over 31 years ago, the prospect of our children being the first generation of American to have a lower standard of living than their parents is not a new concern. Unfortunately, the shock-value this should have had, in 1980, did little to reverse our declining productivity and competitiveness.

    More than one of those testifying on July 26th referred to VATs being considered in the United States for more than four decades. This indicates that there has been over four decades of complacency in considering a tax system discouraging consumption and stimulating productivity.

    In Chapter 19 of the 1817 classic On the Principles of Political Economy, and Taxation, David Ricardo mentions, in addition to war, the removal of capital and a new tax as destroyers of the comparative advantage which a country before possessed in manufacturing. Ricardo’s inclusion of a new tax(s) among his destroyers of competitiveness speaks volumes regarding the increasing numbers of U.S. trading partners enacting consumption taxes over the last 40+ years and the increasing tax rates of these consumption taxes. Especially over the last 20 years, both the number of trading partners with consumptions taxes and increased tax rates assessed on imports have accelerated. A key take-away is that the new tax(s) referred to by David Ricardo do not need to be new U.S. tax(s). New and increasingly higher taxes on U.S. exports being assessed by our trading partners, qualify as new taxes. Unresponsiveness of prior Congresses/Administrations over more than four decades has kept a consumption tax element out of the U.S. Federal Tax System. As David Ricardo, the father of classical political economics warned, ignoring change has subjected U.S. businesses and workers to a similar plight as the frog in the boiling water parable.

    The U.S. trade deficit is America’s “leak in the dike” stunting our growth. As a result, favorable effects of: the Bush tax-cuts or Obama’s stimulus or monetary easing, have been disappointing and sub-prime. A U.S. Consumption tax, alone, is not the silver bullet for closing our trade gap, but it is an important start. Other Ricardian destroyers have reared their ugly heads, over the last two decades, de-coupling comparative advantage from free trade. These destroyers will be the subject of future submissions to the Committee, when hearings on the applicable subject matter take place.

    The committee has two options: hold on to the old or embrace the new.

    I hope that the following relevant quotes from luminaries will be helpful to the Committee:

    “The U.S. trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to `political turmoil.’ Pretty soon, I think there will be a big adjustment.” – Warren Buffett, January, 2006

    “It is not the strongest species that survives, or the most intelligent but the most responsive to change” – Charles Darwin

    “It is not necessary to change…survival is not mandatory” – W. Edwards Deming

    A commonality possessed by Ricardo, Buffett, Darwin and Deming is their ability to be systems thinkers and therefore dots-connectors. The 40+ years of unresponsiveness by prior U.S. Congresses/Administrations must be overcome to restore the United States to its former greatness.

    • Tom T. says:

      The VAT tax and consumption taxes fine but everyone has to know that they are way too regressive.

      We have super low tax rates on the very rich elite in our economy (Mr. Romney’s personal case as an example) and all the arguments that this money “creates” jobs is disingenuous. What we saw at the break of the economic crises was that this money could move out of our economy in an instant. It was one of the reasons the fed took the unprecedented step of “insuring” that money market accounts did not go below par value. This money fled our economy and helped create a huge liquidity crisis that caused the fed to take this extraordinary step.

      Concentration of wealth into the hands of the few encourages this Wall Street behavior at the expense of Main Street. The elite look for all talking points that protects their money whether justified or not.

      I am not so sure that this kind of resistivity (non existent) in our tax code is good for the economy. Tax breaks and tax loopholes don’t seem to have helped our economy but rather put it more at risk.

      On a side note, the Jewish tradition has a remedy to this historical human economic problem called the “Jublilee”. To me this shows that this is a revolving human problem. Indebtedness is the current world’s tool of slavery.

      http://judaism.about.com/od/prayersworshiprituals/f/jubilee.htm

      The VAT tax is great as far as imports because it will capture some of the money on lost on economic activity to foreigners to still fund our government’s functions.

      I read an article that “investors” have 18 trillion dollars off shore. This does not support the argument that lower taxes on the super rich creates jobs. Does anyone have any good figures on this type of money?

      Tom T.

      • Hugh J Campbell Jr CPA says:

        Tom T.,

        You are correct that VAT are way too regressive, as most 20th century VAT have been designed; but innovation can make them much less so. Two examples of innovation that I speak of follows:

        - A new VAT can replace current regressive taxes, e.g. the employee’s share of employment taxes. One such consumption tax was proposed as an entry in TIAA-CREF’s recent “raise the Rate” contest, link follow:
        http://www.youtube.com/watch?v=OrAYT2GXXP0

        - A new VAT can replace the most regressive brackets of our current Federal income tax system with the progressive (higher brackets) continuing as is, as proposed by Michael J. Graetz, Columbia Alumni Professor of Tax Law, Columbia University, whose Tax Reform and Consumption-Based Tax Systems testimony is available at:

        http://waysandmeans.house.gov/UploadedFiles/Graetz_Testimony.pdf

        You are spot on, regarding:” Tax breaks and tax loopholes don’t seem to have helped our economy but rather put it more at risk.” This is because U.S. tax-cuts have traditionally been the spoils of the domestic political wars Americans engage in every two to four years and they are not designed to effectively affect behaviors that would actually create DOMESTIC economic growth.

  2. Mike Lamb says:

    If you are 40 years old or more then you know by now that the VAT would not replace any other taxes, it would only be piled on top of all the rest of the taxes we now have. All taxes are regressive taxes and they all accumulate to the benefit of those at the highest wealth levels. We need fewer taxes, not more. No matter how much tax money you give the politicians and Wall Street Bankers they will always want more since they never pay them but that money accrues to them. Vote for Ron Paul for less taxes, not more. God Bless America.

    • Hugh J. Campbell Jr. CPA says:

      Mr. Lamb,

      Thank you for your comments, which presents me with another opportunity to provide additional information on the merits of VATs.

      Counties of all economic and political ideologies, Communist, Socialist and Capitalist are whipping the U.S. in the economic area, whipping Americans at our own game, just like we whipped England and most if not all have VATs. Testimony to the merits of VATs is the publication: “The Growing Importance of VAT – The Biggest Private-Public Partnership”, available at:

      http://www.pwc.be/en/book/assets/A-guide-to-VAT_presentation-PwC-2010.pdf

    • Tom T. says:

      Mike, I would respectfully disagree with you here. The concentration of wealth in our country is not by accident. It is by design. That design includes loopholes for the kind of income the very rich have and the middle class has little access to. Changing that structure is imperative if we want to stop the abuses Wall Street inflicts on Main Street. Crying out that experience shows us that all taxes are permanent is just flat out historically incorrect. Our economy has seen much better times when tax rates have been much more progressive.

      Ron Paul is an interesting figure but he is just plain wrong on a lot of things. Going back to the gold standard is one of them. Going back to the gold standard would not have prevented our latest financial crisis— the big policy mistake was allowing the investment banks access to the commercial banking system. We had to bail out the commercial banking system because it was full of depositors. The Investment bankers skimmed off their cut from the financial instruments that came largely from the commercial banking sector. They then leveraged all of those investments to increase their rate of return. They leveraged so much that the amount of money they had in the game was not enough for the ultimate “call” that took place on the assets. The government bailed out AIG because it insured many of these transactions and the run on its assets and default on its insurance policies on these highly leveraged financial instruments would have created havoc in our capitalistic system. The free market created a huge problem for the nation due to errant policies and one the taxpayers had to bail out. The investment bankers took their profits and ran claiming they could not be held accountable via ex post facto laws.

      There has been no accountability to speak of because our politicians have not required it. They are protecting the wealthy elite crooks in this economy because the wealthy elite crooks are funding their campaigns.

      Your simplified view will once again allow the big money to escape accountability and that is what I think the big money wants. It is slogans over substance.

      Our politicians HAVE to balance our nation’s checkbook. They are not going to do it by decreasing taxes and borrowing from those with money. It is just going to dig the hole deeper. That is exactly what our trade deficit does.

      I sure wish Ron Paul had a real solution that would work instead of the platform he has. It would be nice to have an intelligent choice in the election instead of ones who have benefited by all the loopholes designed by our corrupt or incompetent politicians.

      Tom T.

      • Joe Brooks says:

        Tom, I am in agreement with you on the Pauls. Here is someone you may be able to support. I have been doing so since seeing him at CPA’s Dayton summit. It was quite a jolt to hear truth from a politician. Of course, he had been out of politics for around 2 decades and in the real US work environment.

        Pretty long, he discusses nearly all of the issues facing America, but you will come away with a good sense of Buddy Roemer’s identity:

        http://www.c-spanvideo.org/program/301333-1

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