Countries with VATs are penalizing themselves the most, even if companies doing business there are caught in the net of this bad policy.

I have heard a growing number of commentators in President Trump’s circle arguing that we should impose tariffs on countries with a Value-Added Tax (VAT) because these countries unfairly penalize U.S. exports.

And now, “President Trump signed a memorandum on Thursday” to direct “his advisers to come up with new tariff levels that consider a range of trade barriers and other economic approaches adopted by America’s trading partners, “ the New York Times reports. “He said the measure would particularly target non-tariff barriers that other countries throw up against U.S. exports and the value-added taxes that the European Union charges, which U.S. officials see as discriminatory.”

I will focus on the VAT today. The idea, which the president had mentioned in the past, is that it is unfair that American exports to, let’s say, France are taxed with the VAT when sold in France, while French exports to the U.S. aren’t hit with a VAT when sold in the US.

This apparent disparity is presented as discriminatory by design and should be addressed with tariffs on goods Americans buy from France. We have heard this argument from those who argued we should switch to a Border Adjustment Tax back in 2017 and are once again making today.

I am unclear whether the goal is to force countries such as France to remove their VATs or if the point is to put permanent tariffs on imports from VAT-using countries. Either way, this attempted justification for tariffs, like so many others, is flawed and frustrating. I don’t see why other countries’ bad tax systems should be remedied by asking consumers to pay the (higher) price.

A VAT is a consumption tax, not a tariff. It applies equally to all goods sold in a country – domestically produced or imported. If a country has a 20 percent VAT, both a domestically made car and an imported car sold within that country pay the same VAT. There is no built-in preference for local producers; in that sense, it is not discriminatory.

It is also incorrect to call the VAT rebates on exports, an “export subsidy.” VAT systems refund any taxes previously paid on inputs to ensure that exports are taxed only in the country of final consumption. For example, if a French automaker exports a car to the U.S., France rebates the VAT to the exporter because the U.S. will tax the car at its own sales tax rate. This is much like the fact that a U.S. automaker exporting to France doesn’t pay U.S. sales tax on that export — France will impose its VAT on the car when it is sold there. The goal of these rebates is to avoid double taxation rather than give foreign exporters an advantage. The U.S. sales-tax system does the same thing. When a Texas-based company sells a product in-state, it collects Texas sales tax. If it sells the product to a buyer in Oregon (which has no sales tax), it does not collect Texas sales tax.

VAT border adjustments (exempting exports and taxing imports) are standard global practice and are accepted under World Trade Organization (WTO) rules. The fact that they are legal (there is a question of whether a Destination Border Adjustment Tax would be) doesn’t necessarily mean they are good. All of us in the U.S. benefit from the fact that the U.S. has no national VAT. That’s a clear advantage that we have over all the taxpayers in countries that have VATs, which is basically every other developed country.

The fact that VATs are legal under the WTO also doesn’t mean that they are fully neutral with respect to trade. While VATs are not protectionist/discretionary by design, their border-adjustment mechanism — where exports are exempt from VAT while imports are taxed — does affect trade flows by subtly, not intentionally, discouraging both imports and exports. Empirical research supports this idea. This suggests that higher VAT reliance correlates with a decline in trade openness. It makes sense, as a VAT often leads to higher prices, reducing overall consumption and demand for imports and making domestic production less competitive in global markets because of the tax burden on domestic firms along the supply chain due to incomplete rebates.

In short, VATs have real, if unintended and incidental, effects on economic activities, including global trade flows that should not be overlooked. The same would be true of the BAT, by the way. But they aren’t intentionally protectionist, or discretionary, just costly and distortionary.

Do I believe that foreign countries would be better off if they taxed everyone (American exporters and their own people) less and gave up their VATs? Absolutely, I do. Everyone would benefit, including American companies doing business in these countries. My biggest problem with the VAT is that it is a tool for the expansion of government. Historically, countries that have implemented VATs often start with modest rates, which escalate over time. For instance, when the United Kingdom introduced VAT in 1973, the rate was 10 percent; it has since risen to 20 percent. This upward trajectory reflects the tax’s capacity to generate significant revenue, which can embolden government expansion. That’s in part because the VAT is often embedded in the price of goods and services, making it less noticeable to consumers. This opacity can lead to less public resistance to tax increases, providing governments with a pathway to raise funds without immediate backlash. This tremendous ability to raise lots of revenue is why you hear people mention adopting a VAT or a BAT in the context of raising more revenue and making the government bigger. But as the rate grows,  they cause a bigger and bigger hit to the economy.

To conclude, yes VATs have many features that should worry those who don’t love big government. But countries with VATs are penalizing themselves the most, even if companies doing business there are caught in the net of this bad policy. But they aren’t penalized any more than domestic companies are. But we always knew we have better taxes than many other countries have. Why screw this up by imposing tariffs on ourselves, especially if these countries never remove their VATs?