President Trump’s proposed “border adjustment tax” highlights an important and fundamentally unfair aspect of foreign trade, but the solution he proposes is wrong.
{mosads}The border adjustment tax, or “BAT”, as proposed by the Trump White House, would be a new tax (a rate as high as 20 percent has been mentioned) on imported goods. It is meant as retorsion against trading partners who impose value-added tax (“VAT”) on American goods we ship to foreign countries. Goods sold in the producers’ own markets bear the VAT, but goods exported to the U.S. come without VAT, often at a substantial price advantage.
This inequity results from two different tax schemes:
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In the U.S., producers pay property, payroll, and income taxes to fund municipal, county, state and federal government that serves them. They pay sales tax if they are the final consumers of goods, although most jurisdictions exempt equipment and supplies used in manufacturing.
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Countries with VAT regimes may also pay property, payroll and income taxes, but often at significantly lower rates than their U.S. counterparts because their governments rely more heavily on the VAT.
Let’s assume a pair of sneakers produced in Massachusetts has an overhead, labor and materials cost of $100. Assume, too, that the manufacturer has paid another $20, or 20 percent of his costs in making the sneakers, in income, payroll, property, and other taxes to produce the shoe which he then sells in the domestic market for $200. His profit is $80.
Now, assume that a foreign manufacturer subject to VAT produces the identical shoe. His overhead, labor, and material costs are the same $100. But his country charges VAT in lieu of the kind of taxes the American manufacturer pays so that his final producer cost is $120, the same as the American. The foreign manufacturer sells his sneaker in his own country for $200, the same as the American, and his profit, too, is $80.
But when the American exports his shoes to the foreign country, he is charged VAT of 20 percent on their cost of $120, or $24 in VAT, so the American manufacturer’s “all in” costs to consumers overseas is $144.
The American can either sell his shoes at the same cost as his foreign competitor ($200) and take a lower profit of $56 versus the $80 profit he earns in the U.S. Alternatively, the American manufacturer can make the same $80 profit as in the U.S. by charging foreign consumers $224 (after adding the VAT expense). But the American manufacturer would lose customers because he’s charging a higher price for the same sneaker that his foreign competitor sells for $200.
The advantage to the foreign competitor doesn’t end overseas, though.
When the foreign manufacturer sells his goods to the U.S. his VAT is refunded by his government. So, they enter the U.S. marketplace at just their cost with no VAT; that is, the foreign manufacturer’s cost of his exported merchandise in the USA is just $100! The foreign manufacturer can either cut his price in the U.S. to $180 and earn the same profit as at home (and earn greater market share at a lower $180 price than his U.S. competitor), or he can charge the same $200 price as the American manufacturer and earn higher profit!
This unconscionable game of “heads we win; tails you lose” has been going on for decades, since VAT regimes were first introduced in France over 60 years ago.
American goods, already having borne the cost of the U.S. tax regime, cross foreign borders and have the foreign VAT imposed on their full value (including the additional costs of taxes borne during production) while goods from countries that impose VAT have the cost of VAT refunded to them when they are exported!
Nevertheless, President Trump’s proposal for a BAT merely exacerbates an already bad situation. Putting the onus of additional consumer taxes on the imports of Americans would only reflect a continuation of U.S. trade diplomacy that, first, ignored the VAT issue (when it was at a modest rate comparable to U.S. sales taxes); then, failed to address it when VAT rates skyrocketed over the years.
Instead of imposing a VAT, the president should pursue policy that encourages our foreign trading partners with VAT to not return it to manufacturers who export to the U.S.
Thus, in the sneaker example, the American-made sneakers would enter the foreign marketplace at their cost of $120 (including U.S. tax costs) and the foreign manufactured sneaker would enter the U.S. marketplace at the same price: $120, including the VAT. The tax imposed on the equal costs would be a decided by the respective jurisdiction where the sneakers are sold: $120 times the VAT rate overseas; or, alternatively, $120 times the sales tax in the USA.
Trade diplomacy that recognizes the difference between America’s domestic tax regime and foreign VAT regimes, and attempts to equalize it — not additional taxes — are the answer to America’s long-standing VAT disadvantage.
Demanding such a change of our trading partners shouldn’t be a heavy lift for the largest consumer marketplace — and the biggest importer — in the world.
J.G. Collins is the managing director of the Stuyvesant Square Consultancy, a business, political, policy and public relations advisory firm. His writings on these issues have appeared in Forbes, the Daily Caller, The Hill, the American Conservative and elsewhere.
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