Categorized | Tax

VATs used to Accomplish Same Goals as Currency Devaluation

The VAT is used as a trade strategy to accomplish the same benefits as currency devaluation.  The VAT strategy is called “fiscal devaluation” and I’ll explain it at the bottom.  It took me three years to understand the power of the VAT in trade strategy, so I understand why it takes others a while to think through it.  But the price differential result (as between domestic and imported products) is substantial.  And we need it to neutralize what other countries have done.

We in the U.S. are still in grade school in the trade strategy game.  A good part of our problem is the first ideological knee jerk stops further thought.  But further thought is needed, and really fascinating.

A substantial part of the U.S. trade deficit comes from the fact that other countries use their VATs strategically.  It is very hard to produce a product in the U.S., pay our taxes, then pay a 17% VAT when shipping to another country.  It is basically a tariff.

And other countries rebate their VAT when their companies ship to the U.S. - or to any other country.

In the world map below, we pay an average of 17% VAT when exporting to every red country.  The only non-VAT countries (other than the U.S.) are failed states and petro states.

Over one hundred fifty countries tariff our goods via a VAT.  We have to neutralize that global distortion to be competitive in trade.  If you produce something in business, you know how devastating that 17% differential can be.  It is not theoretical.

As to China, we not only fight against the currency tariff (from a 30% or so undervalued yuan) but also the VAT tariff.

Countries use the VAT to replace tariffs that they reduced.  Mexico and Canada had no consumption tax until the NAFTA passed, then Mexico imposed a 15% VAT and Canada imposed its Goods and Services Tax (GST) to raise border charges again. Central American countries had no VAT before the Central American Free Trade Agreement, but now they have a 12% VAT.

Harvard professor Gita Gopinath advises countries, like France, how to use a VAT to accomplish trade advantages in a strategy called “fiscal devaluation.”  In an article called “Fiscal Devaluations”, Gopinath and her co-authors say:

We show that even when the exchange rate cannot be devalued, a small set of conventional fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a dynamic New Keynesian open economy environment.

Gopinath advises a payroll tax cut as the VAT offset.  But the trade impact is the price differential. This is not just an academic article, it is a plan that is implemented by various countries across the world.

Like currency devaluation, they can raise prices on imports, while keeping domestic goods less expensive, by increasing a VAT and lowering domestic taxes like the payroll tax.  The result is a price differential similar to the currency undervaluation result.  If a country increases its VAT while lowering other domestic taxes, the price for domestic goods is the same because the net tax burden in those goods is the same.  But imports are more expensive because they pay the higher VAT without getting the domestic tax cut benefit.


4 Responses to “VATs used to Accomplish Same Goals as Currency Devaluation”

  1. Mo says:

    When a VAT tax is imposed, it increases the cost of imports as well as domestic production. Exporters get the VAT tax they paid rebated because it’s an artificial cost that would put them at a severe disadvantage with foreign producers that do not have to pay taxes at every stage of production. It’s important to note that importers of US goods get to reclaim the VAT tax they paid when they sell the goods to the final consumer. So the final consumer winds up paying the tax unless the importer can’t sell the goods.

    Many countries that have VAT taxes also have trade deficits so just adding a VAT tax is not the cure all. The big problem that the US faces with some countries with VAT taxes is that they have import duties and tariffs on top of the VAT taxes that get charged on US exports.

    What’s interesting to note is that residents of some very large exporting countries travel abroad to buy the products made in their home countries. They do this because the VAT taxes all stages of production which results in a significantly higher cost at the retail level in their home country as opposed to a country with no VAT taxes.

    • China Watcher says:

      Mo, you may be missing some major points. First, no one I know or respect would support imposition of a VAT without fundamental reform of the rest of the tax system in a way that reduced taxes on incomes (including payroll taxes) and eliminated some of the more than 20 inefficient excise taxes. Done right, tax reform would leave the US as a relatively low tax country (yes, that’s what we are!) and at the same time a smartly taxed country (that’s what we’re not). Republicans want to broaden the tax base; taxing consumption is the most effective and efficient way to do that. Illegal immigrants, underground workers and businesses,and importers would finally pay their fair share, while exporters would no longer be double taxed. We’d have a powerful incentive to save, invest, produce and export — all areas of chronic deficiency in our economy. However, as an economic and a political reality, it must be accompanied by relief on income taxes. Second, your trade balance test makes no sense. It’s not possible for every country to have a trade surplus, just as it’s not possible for every country to have a cheap currency. The real point is that even those with trade deficits (all tiny by comparison to the chronic US deficits) would have larger deficits if they insisted on handing their foreign competitors a two-way trade advantage. Consumption taxes are necessary components of effective trade strategies, but they are not sufficient. The CPA message seems to be right on target: America needs a clear national objective and a coherent, comprehensive strategy for achieving it. Fundamental tax reform is an important element in that strategy, but no one has argued that it’s the whole story.

  2. Tom T says:

    Thanks, Mike. VAT has an additional benefit of capturing taxes instead of allowing them to pile up. Piling up of unpaid taxes leads to all sorts of gaming to get out of paying taxes and provides money to pay an industry whose job it is to legally avoid paying taxes. It also tends to get politicians to sell tax loopholes and not close them when they pop up to “friends” in the industry who control the money.

    Of course you are right in your analysis. The actual costs of running the government is placed on its productive ability AND the productive ability of other goods coming in.

    As Mo states, this will not solve government budget deficits due to poor governance, but it could solve the free rider effect of goods sold into the United States by competitors.

    We have been selling economic activity to trading partners way too much because our USTR has allowed apples to oranges comparisons in tax and other standards required for the production of goods in the U.S. in the “other” standards we have seen lead in jewelry trinkets from China as well as adulteration of food items to the point that the Chinese themselves don’t trust buying their own powdered milk for infants, not to mention the environmental degradation in China and unsafe slave worker environment in Bangladesh. Just because it is “good” for the consumer does not mean it is good for the world. We need to move from an extraction economy to a sustainable economy. The VAT could help do that since the USTR is sitting on his/her hands.

  3. Craig Harrington says:

    I would like to take a moment to address the idea that consumers will circumvent the VAT by purchasing goods overseas.

    First, this simply is not something that happens nearly enough to merit consideration in a tax policy. How many people can afford a $1000 return flight from New York to London just to avoid paying a 200 GBP markup on a computer? The answer is zero.

    I use the example of a computer because electronics are virtually the only goods on the market expensive enough that taxes are noticeable while also being portable enough to buy overseas and bring home. I used the London-New York flight because with 160 VAT countries around the world making up more than 90 percent of the world’s population and nearly three-quarters of the global economy virtually the only country you could possibly travel to while avoiding a VAT without seriously limiting your shopping options is the United States. Nobody is traveling from London to Paris to avoid VATs, because both countries have a VAT and the tax burden is roughly equal.

    Some people will choose to purchase high-end goods while they are on a previously scheduled vacation, but even that is a tiny number.

    Second, even for those “consumer tourists” the VAT still applies when they return home. If they fail to declare that they bought a new computer during their week-long trip to the East Coast they are committing a crime (a form of tax evasion). Do people do this on occasion? Probably, but you cannot pillory good policies on the grounds that someone might one day break the law.

    I lived in the United Kingdom for a year and I have dozens of friends and family living in Europe. Never has a single person ever mentioned the idea of traveling abroad to avoid VAT. For one thing, it’s extremely expensive to travel overseas. For another, if they get caught smuggling foreign goods above a certain value they will have to pay a criminal penalty on top of paying back the VAT anyway.

    More than 6.5 billion people live in countries with VATs. How many of them are so wealthy that they can afford to the luxury of overseas travel and consider it a cost savings? The majority of the world’s population lives below the international poverty line. How many are so wealthy that the hassle of arranging such an extravagant plan is worth more to them than simply going to their local store and taking home a brand new iMac before lunch?

    Lots of people bring up the idea that consumers might travel to countries without VATs to make purchases, thereby nullifying their domestic tax structure, but the only population group that could really benefit from that is university students or new immigrants who are moving into the United States from abroad. We are the only consumer market in the world without a VAT. For those people, yes, it is cheaper to buy that laptop Stateside, rather than at home. For everyone else the VAT is a non-issue. Lots of countries have strong consumer markets, only one consumer country lacks a VAT.


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