VAT does favor exports, but it is nothing like what Trump claims

There is a small kernel of truth in saying that VAT motivates exports, but Trump’s broader argumentation that they are like tariffs is completely wrong.

There are times when Trump says outright lies, and while those are not completely rare, they are also not the majority of untrue things that he says. Most of the untrue things that Trump and his acolytes say can be described as complete mischaracterizations of something partially true. And so it is the whole VAT and exports debate. Since I think that it is important not to dismiss partially true claims outright, as that opens us to criticism of hypocrisy and TDS, here is a brief explanation of what is true in the claims – and what is not.

Small kernel of truth

The Trump claims about VAT are combination of “VAT favors exports” and “VAT is a tariff”. While the latter statement is clearly false, the former statement is not completely wrong. It seems to be based on the logic that when goods are exported the VAT originally levied on the produced goods is refunded, which to somebody like Trump not paying much attention to details might seem as if the exporting country is subsidizing exports. Of course, this is not the case: it is just not taxing them like domestic consumption.

But this also points to the small kernel of truth in the statement. To see that, consider the situation of a European producer who is producing goods. Is it better for such a producer to sell in the European market or the US market? That of course depends on prices in both markets, so the question is pretty much unanswerable. What is answerable is the question “Is it for them easier to sell in the European market of U.S. market?” The answer here is straightforward: given that in the European market their good is going to be taxed, then it should, ceteris paribus, be easier to sell into U.S. market. Simply, VAT is a tax, and as with every tax, it discourages the activity that is being taxed, here selling a consumption good in Europe. Since the U.S. does not discourage any such activity, then it is easier for a firm to find somebody to trade with in the U.S. than in Europe.

What I just described can be in a single sentence summarized as “VAT discourages domestic consumption”. Of course, Trump and his allies have flipped this by saying that “VAT encourages exports”, which, while not untrue per se, is exactly the mischaracterization that Trump likes to do. It does not encourage exports, it simply discourages the alternative to exports. While that is almost the same – discouraging one option is almost the same as encouraging an alternative – it is not exactly the same.

There is another perspective in which VAT encourages exports. Since VAT is a tax on consumption, then on its own, it should lead to an increase in savings. The basic international macroeconomic identity is “Saving−Investment=Net Exports”. So by (unintentionally) motivating saving, the VAT might be contributing to net export surpluses, which are the ire of the Trump administration. But even this is only one (static) part of the story. Dynamic perspective would argue that eventually, a higher savings rate will lead to the accumulation of high savings that will discourage further savings and also that net exports would lead to currency appreciation, offsetting some of this effect.

Moreover, if we say the part of the story focused on consumption taxes, we also need to talk about the other major European taxes, specifically the taxes levied on labor (not just income tax, but also social and health contributions), which are also higher in Europe than in the U.S.. And the effect of these labour taxes is to discourage work and hence production, which is probably one reason why European work much less than Americans and consume much more leisure. So, on the whole it is not clear that the overall European tax system is favorable to exports.

The (larger) false statements

Ok, now that I have talked at length about the “small kernel of truth” in Trump's statements, it is time to talk about the broader statements that are not true. Is VAT tariff or even something close to a tariff? Not in the literal sense, as it is not a tax imposed on the import of goods. But it is also not in the economic sense which focuses on favoring/disfavoring goods based on their source of origin.

To see this, notice that the VAT refund for European exporters does not make them more competitive in the U.S. relative to local companies: they both still face identical conditions in so far as when they sell at the same price they receive the same revenue (the difference between selling prices and revenue being taxes and subsidies). Indeed, levying VAT on exports would put European exporters at a disadvantage in the U.S. because the domestic firm would not pay any sales tax while the exporter would. Similarly, the VAT refund does not put the U.S. firm at a disadvantage in the European market even though it does not get any VAT refund and has to pay European VAT. The reason is that both U.S. and European companies are treated equally with respect to European VAT.

Overall, the story about VAT and tariffs is a typical example of Trumpian communication:

1. Take something that is true, in this case, the fact that VAT makes it make more appealing to sell abroad

2. Mischaracterize it, as in portraying that VAT as something akin to an export subsidy

3. And then push it from the realm of untrue to the realm of flat out lie, such as claiming that VAT is (like) tariff

The beauty of this, of course, is that the small kernel of truth in the first step creates a plausible deniability: the opponents can either say it is all nonsense, which it is not, or try to (correctly) explain that it is 95% nonsense, but that is harder to do.