- WND - http://www.wnd.com -

The VAT: Menace to free trade

The impact of the Value Added Tax, or VAT, on international trade is a complicated aspect of global commerce that is generally only comprehended by experts. Yet, the impact of the VAT may be the single most important variable in explaining U.S. balance of trade deficits that are spiraling out of control – to the detriment of both U.S. manufacturing and the continuing validity of the U.S. dollar itself.

The 2006 U.S. trade deficit is estimated to exceed $760 billion, while last year China also came to hold an historically high $1 trillion in foreign exchange reserves, $700 billion of which was held in U.S. dollar assets.

Simply put, the average United States citizen can no longer afford not to understand the VAT, especially now, in an era where the World Trade Organization dominates our international trade agenda and where NAFTA has morphed into NAFTA-plus, as demonstrated by the Security and Prosperity Partnership of North America, which President Bush declared with Mexico and Canada at the Waco, Texas, summit of March 23, 2005.

The modern VAT was created by French economist Maurice Laur? in the 1950s. The basic concept is that a “value added” tax is imposed at each stage in the chain of production of a good or service.

The goal is for the VAT to be charged to the consumer at the point of sale, such that the amount of the VAT ends up being calculated as a percentage of the final value of the good or service. The VAT charged the consumer is not reimbursed to the consumer, so at the final point of retail purchase the government gets to keep the VAT once and for all.

A VAT and a sales tax are both considered “indirect” taxes that ultimately are shifted to the consumer. Income taxes, in contrast, are considered “direct” taxes in that the tax cannot be shifted to someone else other that the person earning the income. The main difference between a VAT and a sales tax is that the VAT is applied at each stage of production, whereas sales taxes are usually only imposed once, at the final point of sale.

For our discussion, we do not need to master all the intricacies of exactly how the VAT works in practice. What we are concerned about is that in international trade there is a differential between how indirect taxes and direct taxes are treated, and that differential puts the U.S. at a decided disadvantage.

The United States does not use a VAT system. Some 137 countries, including every major U.S. trading partner such as the EU countries, China, Canada and Mexico, have VAT systems.

Here are the crucial points we need to understand:

A simplified example (which excludes movement expenses and customs duties) helps understand the reason U.S. goods are disadvantaged by VAT systems.

A U.S. car that sells for $23,000 in the U.S. includes profit and covers various tax obligations of the producer, as well as pension costs for workers. When that car arrives in Germany, a 16 percent VAT will be added on to the $23,000 price, meaning that the car will be sold in Germany for $26,680.

Yet, no tax comparable to a VAT is imposed on a German car imported into the United States. Consider the example of a German car that is sold in Germany for $23,000 after the 16 percent VAT is imposed. The example is constructed to compare a U.S. car manufactured in the U.S. and sold in the U.S. that is roughly price competitive with a German car manufactured in Germany and sold in Germany.

The differential VAT taxation issue becomes a problem when the U.S. manufacturer suffers price disadvantages when the U.S. car is exported to Germany to be sold in Germany, compared to the price advantages the German manufacturer receives when the German car is exported to the U.S. to be sold in the U.S.

When the German car is imported to the U.S., Germany rebates the 16 percent VAT to the manufacturer, allowing the export value of the car to be $19,827.59. Moreover, when the German car is imported to the U.S. no U.S. tax comparable to the VAT is assessed, so the car is allowed to enter the U.S. market at a price under $20,000.

In this example, U.S. producers are disadvantaged two ways. On export, U.S. product that otherwise sells for the same price in domestic markets starts off with a disadvantage of $3,680 because of the VAT. At the same time, the German car, which sells at home for the same price as the U.S. car in America, is sold to the U.S. for a price which is $3,172.41 less than the U.S. car. When you add these disadvantages, U.S. car companies face disadvantages at home and abroad that can be measured as $6,852.41.

In effect, the rebate of the VAT to German exports serves as a German subsidy for exports, while the imposition of a VAT on the U.S. car imported to Germany serves as a German tariff imposed on U.S. imports. Still, the VAT is not defined in our free trade agreements either as a subsidy or a tariff, even though U.S. manufacturers are demonstrably disadvantaged both in exporting to VAT countries and in competing with VAT-country exports in the U.S. market.

None of this disadvantage applies to one VAT country importing into another VAT country, because typically the VAT is rebated in all countries when the good exported for sale in the foreign market.

Being the only major international trade country without a VAT, the U.S. is uniquely disadvantaged by the VAT system differential. The U.S. simply has no border-adjustable mechanism that can rectify the disadvantage that is imposed by VAT rebating to VAT country exporters and VAT cost imposition to non-VAT country exporters such as the U.S.

The VAT differential can end up disadvantaging U.S. exports by imposing what amounts to a considerable penalty (with VAT rates ranging up to 25 percent depending on the country) on the U.S. manufacturer, while advantaging the foreign exporter into the U.S. by a comparable price subsidy. In effect, VAT systems function as trade subsidies for exporters and as trade tariffs for importers, although VAT preferences are defined as neither “subsidies” nor as “tariffs” under the terms of international trade agreements, including both NAFTA and the WTO.

On May 17, 2005, testifying to the Subcommittee on Trade of the House Committee on Ways and Means, attorney Terence Stewart of the Washington firm Stewart and Stewart estimated the impact of differential taxation as follows:

On the issue of differential treatment of tax systems, the U.S. is seriously disadvantaged by the application of WTO rules on taxes. With 137 countries applying a VAT tax and a worldwide VAT tax advantage of 15 percent, the U.S. faces up to $450 billion total disadvantage to U.S. exports ($180 billion) and export subsidies to import competition ($270 billion).

Simply put, the VAT differential puts U.S. exporters in a huge hole from which it is almost impossible to dig out. At the same time, the VAT differential gives those who import into the U.S. such a huge edge that their dominance of our domestic market is virtually assured from the start.

Within NAFTA, Stewart estimates that in 2005, we had a $40.6 billion VAT disadvantage with Mexico and a $33 billion VAT disadvantage with Canada. Our largest VAT disadvantage in 2005 was $47.9 billion with China.

“Every major trading country in the world economy except for the U.S. has a VAT system,” notes Auggie Tantillo, executive director at the American Manufacturing Trade Action Coalition, in an interview with this writer. As Mr. Tantillo explained:

The important thing to understand is that the VAT disadvantage is a structural impediment or distortion, just like the currency manipulation China currently exploits by refusing to allow the value of their currency to freely float on world currency exchanges. The VAT differential is not simply a tangential, frivolous or superficial thing that a few countries do here or there, just a minor irritant. The VAT differential is a core, driving aspect as to why U.S. companies find themselves continuously at a disadvantage. If you extrapolate to the next step, the VAT differential is a core reason for why we see this escalating growth in the U.S. trade deficit on an annual basis.

Ironically, Mr. Tantillo argues that the VAT differential is a key reason many U.S. companies decide to move their manufacturing offshore, preferring to export into the U.S. market rather than to operate as U.S. domestic producers.

Mr. Tantillo elaborated these points in our interview:

When you add everything up and start to look at the cumulative effect, the board of a U.S. company sitting around a table has to say, “We can cut our labor costs by ‘x’ percent, we can get rid of our health care, we don’t have to produce a pension plan, and then we have this VAT situation where our taxes are rebated to us when we ship to the U.S., the market we want to impact anyway, so why do we stay here in the United States? Why not move our manufacturing to Asia?” The economic analysis just becomes compelling for many U.S. companies.

In other words, the VAT differential functions as an additional international trade structural incentive for U.S. companies to move manufacturing to foreign countries where they can participate in the VAT advantages as importers into the U.S. market. The point is not simply that wages are less in countries such as Mexico and Canada; both countries additionally possess structural advantages in international trade, including importantly the differential on how VAT systems work.

As explained by Tantillo, “It’s time for the U.S. to confront the WTO and NAFTA and say that we can no longer abide by a structural distortion that is massively and adversely impacting our manufacturing base.”