The spat over VAT

0:01NPR.

0:11This is The Indicator from Planet Money. I'm Paddy Hirsch. And I'm Adrian Ma. It's been a couple weeks since President Trump declared a national emergency due to the trade and economic practices of America's trading partners. Since then, we have had some whiplash. He's arrogant. Yeah, Trump said he'd keep some tariffs, but he'd pause others, and also crank up the tariff heat on China. Yeah, it's been a bewildering time. And there's one area that's still making economists and investors particularly puzzled. The focus of the Trump administration on value-added tax, VAT or VAT for short. Trump's order calls VAT a non-tariff barrier to trade that distorts the market.

0:54Now, this is not what most economists think. Most economists say that is simply the equivalent of a sales tax, which, just like in the U.S., everybody pays regardless of where the goods came from. But this has not stopped the Trump administration from using VAT as a reason to slap tariffs on America's trading partners. So on today's show, we'll examine the spat over VAT. We'll explain what it is and why Trump isn't happy about it. That's coming up after the break.

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2:11As a leading threat intelligence company, Recorded Future cuts through the noise with precision intelligence. That's why top banks and governments trust them. Because security leaders don't just react. They foresee spotting the signals that others miss and acting before threats become setbacks. Recorded future. Know what matters. Act first. So, Adrian, you're in D.C., right? Do you pay sales tax there? Yeah, we have a 6 % sales tax here. Oh, 6%, a low tax environment. I'm in Los Angeles. We're getting up to 10.5 % at this point. Okay. But regardless of how high your sales tax is, or if you pay sales tax at all, Oregon, sales tax is pretty simple to understand, right?

2:55It's a consumer tax, also known as a consumption tax. You buy a thing, you pay tax on it. Kimberly Klausing is an economist and a professor at the UCLA School of Law. She says a value-added tax, or VAT, is pretty much the same. So a value-added tax is a consumption tax. It's a multi-step tax, but it amounts to exactly the same thing as a sales tax. It's just administratively different. Now, notice Kim called it a multi-step tax. And one way to think about these steps is to think about a chair. So in the life of a chair, basically four people touch it, right? You've got the person producing the wood for the chair.

3:34You've got the person making it. You've got the retailer who sells it. And finally, you've got the person buying it. Yeah, and in the U.S., the only one of these people in these four steps who's actually regarded as a consumer and therefore who pays the consumption tax is the person who buys the chair in the store. the end buyer. Like me here in LA, if I go to a store and I buy a chair, I pay 10.5 % sales tax on that chair. And that's all the tax that's paid. It's simple. But in most other countries around the world, they have a value-added tax regime. So it's not that simple. With that, everyone who buys a thing, whether they're the end consumer or a manufacturer or a supplier, they all pay the consumption tax.

4:15Yeah, take this woodmaker, right? He marks up the price of his wood, adding value, and he pays tax on that to the government. He then passes that tax cost on to the chairmaker. The chairmaker fashions the chair, marks up the price, adding value again, and paying tax on that added value, which he then passes on to the retailer. The retailer marks up the chair's price again, slaps that value-added tax onto the chair, which is paid by the shopper in the store, and which in Europe amounts to about 20 % on average. It's like a game of hot potato. Kind of is. Tax potato. From the buyer's perspective, once they've bought the chair, it'll look like the chair costs 20 percent more because of those different steps in the tax.

4:55So the ultimate person who pays it is the consumer. And the same is true for sales taxes in the United States. And VAT is just like sales tax in another way. Everybody pays. Michael Strain is an economist at the right-leaning American Enterprise Institute. And he says, no matter where a chair is made, when it's sold in the U.S., the buyer pays sales tax. And similarly, when a chair is sold in Europe or India or Japan, no matter where it was made, the buyer pays value-added tax. And so the VAT doesn't tilt the playing field toward domestically produced goods and away from U.S. exports. And therefore, it is not a trade barrier.

5:36President Trump and his economic advisors, they don't agree with this. They say the current system discriminates against U.S. producers selling goods in Europe and gives European manufacturers an advantage when they're exporting to the U.S. How would it do that, you ask? Well, firstly, they point to the fact that when a French chairmaker exports a chair to the U.S., she gets a rebate from the government on any VAT that she's incurred in the production process. Remember, she had to pay VAT to the government on that wood that she bought in order to make the chair, right? Well, yeah, of course she gets a rebate, says Kim.

6:08The reason that Europe rebates the VAT when their sellers sell into our market is for the simple reason that it's a tax on European consumption, right? And anything that's sold not in Europe is not consumed in Europe. So it doesn't make sense to tax the consumption of exports. That would be a net discouragement to exports. OK, but the Trump people would say that when an American chairmaker wants to sell his chairs in France, he has to pay not only the French value-added tax, but he also has to pay taxes that are embedded in the U.S. production process. But here's the thing. When it comes to consumption taxes in the U.S., companies generally don't have to pay those taxes the way that they do in Europe as part of the production process.

6:50In fact, American companies get an exemption for sales tax if they incur it, you know, depending on the state. And if anything, Kim says, the U.S. has an advantage when it comes to exporting to the EU. We have an export subsidy that's baked into our tax code. In particular, companies who have really high profit margins are rewarded with a deduction of about 50 percent relative to what they would pay on domestic sales. And that actually is a trade distortion. Over at the American Enterprise Institute, Michael Strain says the Trump administration appears to be aiming at VAT as part of a wider campaign aimed mainly at trade deficits, which we talked about in an episode last week.

7:30the president and some of his key advisors genuinely, though incorrectly, believe that if the U.S. runs a bilateral trade deficit with another nation, that is in itself evidence that that other nation has trade barriers against U.S. exports. And I think they're trying to figure out what those barriers might be. And one of the explanations they've kind of fumbled upon is VATS. Speaking of fumbling upon things, Kim Clausing points to the bewildering way in which the tariffs on trade partners appear to have been calculated using trade deficit data. If you imagine trading with an island country that only sells mangoes, you sell them$20 worth of stuff and you buy$100 of mangoes from them and it's completely freely traded.

8:20There's free trade in both countries. According to the Trump administration's formula, the tariff with this island should be 40 percent. Why? Well, because of our trade deficit. We buy 100 bucks of mangoes from them. They buy 20 bucks of widgets from us. And 100 minus 20 is 80. And then you divide by two, right? Two, you get 40 percent. It's kind of a nonsense way to generate a tariff. No, it's not that tariffs are always bad, right? Michael Strain said there were circumstances in which they could be useful. perhaps in the case of shoring up national security. I mean, maybe even as a negotiating tool.

8:57I think that there are circumstances under which tariffs can be useful. I think that imposing large tariffs can strengthen the president's hand. But as for the notion that Trump needs to hammer America's trading partners to make up for decades of being taken advantage of, well, Kim Clausing says that just does not reflect reality. We tend to represent our interests very well, And we've really prospered, you know, more than almost any country in the world by this trading system that we helped build and that we carefully nurtured for a period of more than 70 years. Again, like most economists, both Kim Clausing and Michael Strain agree that these blanket indiscriminate tariffs will damage America, regardless of why they're being imposed.

9:40We will see higher prices for American consumers. We will see reductions in real wages and real incomes. for workers and households. We will see U.S. manufacturing companies be less competitive. We will see declines in manufacturing employment. We will see a slowdown in economic growth. And we will see substantial increases in geopolitical tension with our allies. A lot of pain, in other words, both economic and otherwise.

10:15This episode was produced by Lily Quiroz and engineered by Robert Rodriguez. It was fact-checked by Sierra Juarez and edited by Julia Ritchie. KKKN edits the show and the indicators of production of NPR.