Beware of Geeks bearing VATs

(1:00PM EST – promoted by Nightprowlkitty)

Burning the Midnight Oil for a Brawny Recovery, cross-posted from My Left Wing.

If you wander around the fringes of economic discussion on these Interwebs, you may encounter sites extolling the wondrous virtues of the VAT. “If only we would adopt a massive VAT, our two decade long decline in manufacturing output would be gone, and we would be an exporting powerhouse once again.” … well, no, that would be a stereotyping of the argument. A real sample of the claims sound more like this, from tradereform.org:

I Squared R Element Company is in Akron, New York. It makes industrial heating elements which are used for many processes to make other things, including glass and computer chips. The company was the low bidder on a contract to export to China.

However, the company lost the bid. Why?

I squared R was told it did not include, in its bid, China’s 10% customs duty or the 17% value added tax(VAT) that must be paid at the border.

All our goods pay a 17% VAT at the Chinese border. And the uninformed say we are a high cost producer. Chinese exporters also get a 17% VAT rebate, i.e. they get paid to export.

And, yes, I have picked out this quote to pick on VAT-uber-alles advocates, precisely because it focuses on the part of the argument that is simply wrong.

More below…

The protection against imports is the tariff, not the VAT. The Chinese company that beat out the producer in that other Akron also has to pay 17% VAT on its production. If omitting the 17% VAT alone was what made the Akron, NY producer the “low bidder”, its simply lying to call them the low bidder … its like two different companies in the same state competing for a contract, and one claiming to be the low bidder because they left sales tax off their bid, which the other company included.

That element of VAT advocacy is nothing but hypocritical posturing at some stage along the line … though not necessarily on the part of a particular VAT advocate, since it may well be that a particular VAT advocate has been misinformed by hypocritical posturing polluting their sources of information.

VAT and Trade

The other part of VAT that is raised is the export rebate (again from tradereform.org:

Companies are put out of business because of VAT subsidies. Foreign exporters are paid to export, in the form of VAT rebates. The products are relieved of tax burden.

This is the real effect of VAT on trade. A natural side effect of heavy, regressive, indirect taxes is that it increases the costs of exports. That is true of VAT, over-taxing for Social Security or other payroll taxes, retail sales taxes, (hidden) wholesale sales taxes, stamp duties … its a general effect of heavy indirect taxes.

Now, from the perspective of the wealthy, a massive benefit of heavy indirect taxes is that those with freely disposable income can normally duck out on paying the indirect taxes if they direct their income to wealth accumulation instead of consumption. So if the poor, who spend all of their income, are paying 20% of their income in indirect taxes, the very wealthy, who devote much of their income to perpetuating their status as a member of a stable aristocracy of wealth, would only pay 10% if they only consume half of their income, and the more of their income they devote to accumulating wealth and economic power, the less of their income is subject to tax.

Further impoverishing the working poor, and pushing the shrinking middle class toward poverty … well, them’s the hazards. However, from the perspective of the wealthy, there is a downside … that nasty trade effect.

However, the WTO permits indirect taxes to be rebated on exports. We do this in the US for some of our indirect tax burden … indeed, we do it on a state by state basis, with sales taxes assessed in one state one payable by residents of that state. But if a particular municipality in Ohio has a total of 7% of state, county and city sales taxes, any exports from Ohio to China have a 7% “export rebate”.

VAT is as easy to rebate as retail sales taxes, because of the way it works. Each business pays VAT on its inputs, and collects VAT on its sales, and hands over to government the difference between what it collected and what it paid. In other words, the government receives the VAT on every step in the production chain on the increase in the value of sales over the value of outlays.

Since each step of the way, the VAT that is owed is a simple percentage of the sale price, computing the amount to rebate at the border is straightforward.

By contrast to China and most of Europe, in the US our biggest indirect taxes are payroll taxes, and we do not have a mechanism in place to rebate the payroll taxes.

The rebate of indirect taxes on exports … that’s the trade effect of a VAT. Claiming that there is an impact on the import side is as silly as if a Chinese firm claimed we had unfair protection against Chinese products because “The Wal-Mart between Kent and Ravenna in Ohio charges sales tax on imports!!!”.

Pushing Progressive Options Out of the Frame

Now, if the US wishes to pursue the neo-mercantalist policies of China, most of Southeast Asia, and etcetera … what would that policy package be?

• Peg our currency at a steep discount, for exchange rate stability and competitive advantage
  
• Levy steep indirect taxes on domestic consumption, and rebate those taxes on exports
  
• Maintain protective imports and discriminatory trade practices for those industries that we are trying to develop

Some of the people pushing for the VAT would happily accept that full package. Others, however, might criticize it.

The progressive critique is that neo-mercantalism is an effort to export our unemployment overseas by pursuing trade surpluses, at the expense of the standard of living of the majority of the our population. Some few at the top will benefit from successful neo-mercantalist policy, while for the majority of the population, its a policy of taxing domestic consumers to finance infrastructure used for domestic production and export production alike.

And just like old-fashioned mercantalism, neo-mercantalism only works if there are countries that are in a position to run sustained trade deficits. After all, one country’s exports is another country’s imports – so the whole world cannot run a global trade surplus with itself. If everyone pursues a trade surplus, then on average half must fail.

Back in the days of “paleo-mercantalism”, that country running the perpetual trade deficits was Imperial Spain, possessor of two mountains of silver in Mexico and Peru, which could be acquired by merchants in other European nations by selling things to wealth Spaniards, and then used to buy into the lucrative Asian carrying trade. More recently, it has been trade deficits by the United States as we have progressively hollowed out our industrial capacity while maintaining consumption on the back of credit extended to us … as a side effect of the cheap currency policy.

But one reason the world experienced a financial crisis is that the US was in a financially fragile position, where our financial sector did not have the resilience to withstand a nasty shock … which came in the form of an oil price shock. And if the US is the country chasing trade surpluses … who then plays the trade deficit role we used to play?

While balanced trade can be sustainable over the long term, trade surpluses for all is strictly impossible, They are more than unsustainable, they cannot happen in the first place. So a policy regime in which economic success requires trade surpluses is a policy regime that, by definition, dooms at least half of the economies in the world to failure.

The corporatist critique of that policy package is different. Pegging the currency at a steep discount undermines the economic strength of corporations earning income in that currency. Further, it makes the maintenance of a 700+ strong foreign base network more difficult, and so undermines the coercive force that can be deployed in support of corporate economic power. And protective tariffs in high income nations undermines the ability of large transnational corporations to benefit from their relative advantage in operating cross-border production systems.

So the only element from the neo-mercantalist policy package that seems appealing to the corporatist is the VAT itself.

Of course, when we read David Brooks extolling the virtues of the VAT in the NYT … we can be confident that it is not in a policy package including an exporters exchange rate for the US$, nor one that includes a general revenue tariff on all imports.

Naive populism deployed against the interests of the populace

This is not to say that a VAT is an unambiguously bad thing. Any tax is an element of a tax structure, and what matters is the shape of the entire tax structure. This is, of course, itself a critique of much VAT advocacy, which treats the VAT as a good thing in and of itself, no matter what the context.

Consider two different scenarios:

• (1) A VAT is put into place in order to avoid restoring capital gains taxes to a two-tier structure, placing a SSI levy on incomes in excess of $250,000 and simplification of the personal income tax structure to close loopholes used primarily by those earning over $250,000
  
• (2) A VAT is put into place that is large enough to eliminate the 12%+ payroll income tax that funds Social Security and Medicare

These two VAT’s have quite different impacts, both in terms of trade and in terms of impact on the working poor and the middle class.

In the first scenario, the relative tax burden is shifted onto the working poor and middle class. A VAT of, say, 10%, taken on top of the 12%+ payroll income tax, would mean that the working poor would be paying 22%+ of their income in taxes. And the rebate of the VAT is primarily a way to increase indirect taxation without making the trade impact worse … there is no substantial trade loss from a two-tiered capital gains tax or from closing income tax loopholes, and a payroll tax on incomes over $250,000 is not going to affect the decision whether production facilities should be located in the US or some other country. So putting a VAT in place rather than those taxes, there is no employment gain from that … not even the neo-mercantalist variety.

In the second scenario, the relative tax burden is shifted away from the working poor and the middle class. VAT is levied on all “Value Added”, and not on wage and salary “Value Added” alone. This is a net progressive impact, and its stronger then the regressive impact of shifting the tax burden off of production for export … so over-all, its a net progressive change.

Now, which of the two do you think David Brooks is really arguing for … using VAT to shift more of the tax burden onto the working poor and shrinking middle class, or using VAT to shift the tax burden off the working poor and shrinking middle class?

Naive VAT advocacy which overstates the trade benefits of the VAT and is, underneath that, founded on the impossibility of all countries replicating the trade surpluses of China …

… that form of VAT advocacy plays into the hands of the corporatist version of VAT, where VAT is used because we have started to reach the limits of sales tax and payroll tax, and some other mechanism is needed to drive regressive indirect  taxes up still further.

There is no way to achieve a progressive use of VAT if the political alliance that is formed in support of VAT includes the paymasters of the David Brook’s of the world … because under that political alliance, VAT will be use as a regressive tool. And once the machinery of VAT collection is put into place, and people become accustomed to it, it becomes entrenched … it is far easier to defend against VAT used in a regressive way than it will be to restructure the system once it is in place.

So Beware of Geeks Bearing VATs.