Amid the rants, raves and tirades with which Donald Trump launched his global trade war on Wednesday night, the president identified one whipping boy we can all agree deserves the treatment. Everyone despises VAT—the tax he singled out as “exorbitant”—almost as much as the president, right?
Businesses are baffled by it, leftists insist it’s unfairly shouldered by the poor and all of us feel a bit resentful when we clock that a bill is going to cost 20 per cent more than we had thought. All agreed? Not so fast. I’m aware that it’s a way to lose friends and alienate people, but I would defend this hated tax against just about everything that’s thrown at it.
Value Added Tax arrived in Europe in the 1960s and came to Britain in and around our entry to the European Communities in the 1970s. It replaced the sorts of sales taxes still levied in many American states. It’s a huge technical improvement. By being calculated specifically on the actual worth of the specific work contributed by each company —the “value added”—it removes various damaging distortions. The (admittedly counterintuitive) business of a plumber having to pay VAT on his pipes before claiming it back helps ensure the tax system is even-handed in its treatment of a car company that manufactures its own brake systems and another that buys them from a specialist firm—which is exactly how it should be.
And at a time of straitened public finances, VAT does sterling work in plugging leaking government revenues. It does this by turning every business into a tax collector for its customers. It’s also fairer than people imagine, because even idle riches can’t avoid it forever: the only value of wealth is the knowledge that it will be spent one day. When it is, it will be taxed. The detail makes it more progressive again, with zero-rating for goods such as food and children’s clothing on which the poor pay more.
But trying to use such nerdy but good-faith defences of VAT to argue with Donald Trump is like bringing a textbook on legal procedure into a cage fight. The bone that the president picks with VAT is that it is analogous to an undeclared tariff on American imports because when the US sells in Europe, US goods are just as liable to it. This is as dishonest as everything else Trump says—but particularly easily exposed as such. For this reason, the VAT fixation is worth pausing on for what it reveals about the Trumpian logic—or lack of logic—that now threatens to drag down the world economy.
Tariffs make foreign-produced things more expensive than domestically produced things; VAT doesn’t do so because it is charged on foreign and domestically supplied wares in the same way. If US firms weren’t charged VAT there would be a distortion; as it is, consumers are shopping on a level playing field. This is such a tabloid-friendly, slam-dunk argument that, in order to somehow rationalise the presidential agenda, a more elaborate sophistry is now getting an airing, including in the Financial Times. This asserts that the playing field that we need to apply a spirit level to is not that between imported and domestic goods for customers, but rather that between import and export markets for producers. It is suggested that European car-makers, facing VAT at home but not the US, will be lured into flooding the American market. By contrast, the global ambitions of hapless American businesses will founder on VAT charged overseas, and instead they too will concentrate on the US market.
It’s hard to know where to start with this. For one thing, just as American-made cars sold in Europe attract VAT, European-made cars in the US will pay any local sales taxes, so the basic position is one of similarity rather than difference. For another, there are many, many other taxes that contribute to the total “wedge” between production cost and the final price paid by the consumer. A lot of these—particularly payroll levies—are a lot higher in Europe and the UK than the US. Europe could just as well argue that it needs a special tariff on the US to make up for this competitive disadvantage.
More fundamentally, what passes for the Trumpian analysis turns its back on 200 years of economic understanding since David Ricardo. It disregards the interests of us all as consumers and the gains from specialisation that international trade can unlock. It also considers everything from the point of view of domestic producers. Many on the right, even some in the Trump circle, understand this and worry about where the president’s trade posturing is heading. It’s easy at a Maga rally to bark that tariff is a “beautiful” word because only foreigners ever pay them, but—as has been understood in Britain since the corn laws–when you erect walls against foreign goods, prices at home rise.
Why has Wall Street been wobbling so badly? And why, in his first 10 weeks in power, has Trump so often declared tariffs and then at least temporarily backed off? It is because everyone knows they will translate into inflation, and then interest rate rises, and then slower growth.
I say all of this not as some kind of free trade absolutist. I’m completely persuaded, as per pieces we’ve run in Prospect by thinkers such as Dani Rodrik, that in recent decades hyper-globalisation got out of hand. The disruption of trade always creates losers as well as winners. For far too long, politicians liberalised and then looked away from the victims. Had America not neglected its rust belt, the world might not have been cursed with Trump.
Nor do I think everything or even most of what’s gone wrong in economic history is down to restrictions on free trade. For me, the infamous tariffs of the 1930s were far more a symptom than a cause of the Great Depression. There is always more than trade going on. In the US and many other advanced economies, growth was on average something like twice as rapid in the relatively protectionist 1950s as it has been in more recent times.
This is one area, however, where the conventional economic wisdom does contain at least some, well, wisdom. Open trade really can give consumers better products and lower prices, and also spur sleepy local businesses to raise their game by exposing them to competition. The interesting question is why Donald Trump, a lifelong marketopian in all other respects, is so determined to push against all orthodoxy on tariffs. He has been demanding a mercantilist approach to America’s trading relationships for decades.
I can see three answers, all rooted in character flaws. The first is simple chauvinism: to the extent that Trump is himself a flag-waving America First-er, it may offend his sensibilities that many consumers, Americans included, prefer products made somewhere else. The second is his penchant for bullying. The US’s share of world trade is nothing like what it once was, but it’s still the world’s biggest consumer market. Overturning multilateral trade rules in order to strong-arm mostly smaller partners over tariffs affords a glorious opportunity not just to bludgeon them into submission, but be seen to do so.
Finally, there is Trump’s dogged determination to wield power without responsibility. The American constitution makes most taxes the preserve of Congress. By contrast, commercial policy, including tariffs, is mostly a matter for the government which, in Trump’s “l’etat c’est moi” worldview, is him alone. If he is able, as he hopes, to substitute the state’s dependence on income and other taxes for tariffs, he will acquire far greater, less checked and less accountable economic power.
As ever with Trump, it’s wrong to imagine that disinterested reason has any role to play in making sense of his remarks or decisions. An economist is now less useful than a psychoanalyst in understanding the real threat to world trade. The big danger is not the design of VAT or any other tax. It is an unhinged id.
