Under the US Constitution, Congress is supposed to set tariff rates. But our government stopped paying attention to the Constitution long ago, so we also need to think about the implications of the president’s views on tariffs. Here’s Fortune magazine:
Still, Trump blames the VAT for the U.S. trade deficit with the European Union, which hit $236 billion in 2024, according to the Census Bureau, second only to China.
“A VAT tax is a tariff,” Trump told reporters Thursday.
That’s not true. A tariff is a tax on imports, while the VAT is simply a tax on all domestic consumption, regardless of where the good or service is produced. In the end, the only major difference between a value-added tax and a sales tax is the way in which it’s collected.
So what might have led the president to make a statement that conflicts with reality? It might be related to an equation that seems to cause all sorts of confusion:
GDP = C + I + G + (X – M)
Because imports (M) show up in this equation with a minus sign, many people wrongly assume that imports tend to reduce GDP. Not so, imports have no direct effect on GDP, as they also show up as a positive in either consumption or investment (if the imported product is a capital good.)
A VAT is a tax on all consumption, regardless of where the product is produced. There are two ways to collect a consumption tax. In America, we collect the tax at the point of purchase. In Europe, the tax is applied to both domestic production of consumer goods, and also to consumer goods imported from elsewhere. Because the VAT does not discriminate between domestic and foreign production, it is not a tariff.
The sky is not green, it’s blue. And a value added tax is not a tariff. President Trump once suggested that ‘tariff’ is the most beautiful word in the dictionary, hence you might expect him to know what a tariff actually is.
You can argue that the president should have a lot of power in order to “get things done.” You can argue that a president cannot be expected to understand basic economic principles. But you cannot argue both points at once.
In my view, tariff is one of our ugliest words, associated with ignorance, xenophobia, statism and nationalism.
READER COMMENTS
steve
Feb 18 2025 at 4:02pm
Let’s not forget that Trump believes that the US does not pay the tariff. Canada and Mexico will be paying those 25% tariffs. Since tariffs in this view are free money there is no reason to not have them.
Steve
David S
Feb 19 2025 at 2:16am
I’m not sure where Trump gets his ideas, and his attention span tends to waver unless he’s carrying out an act of personal vengeance, but he and his supporters seem to believe the following when it comes to the economy and monetary policy:
-We can lower tax rates on Americans through a tariff regime because costs will be borne by importers–as Steve notes.
-We can have low borrowing rates, zero inflation, and a surge in domestic production as a consequence of the tariffs and general MAGA spirit.
-We can lower unemployment rates and housing costs by deporting people.
-We can write off national debts–especially debt held by foreigners—and there will be no consequences for that.
This will be a long, strange trip. Or, a short and brutal one.
Alan Goldhammer
Feb 19 2025 at 8:58am
“I’m not sure where Trump gets his ideas”
Occam’s Razor answer: Peter Navarro
Scott Sumner
Feb 19 2025 at 4:57pm
I think Trump’s always believed these things, and in Peter Navarro he found the one economist (and convicted felon) who agrees with him.
Arqiduka
Feb 19 2025 at 3:08am
I think this is a bit if a simplistic interpretation of the claim.
The point is not whether VAT applies only to imports but rather that it doesn’t – and can’t- apply to EXPORTS.
A country applying a VAT relies on YOU to tax their exports, and this was the context of the claim. It is not a tariff, but rather an invitation to set one.
Dylan
Feb 19 2025 at 5:46am
But you need to tax domestic consumption at the same level. We already do this in that imports are subject to a sales tax just as domestic goods are. A tariff treats imports differently, and a VAT in the exporting country provides no justification for that.
Arqiduka
Feb 19 2025 at 7:28am
There is a significant difference.
Under a VAT regime, I import American half-finished products, recoup some of the import VAT on them, bake them into a finished product, am paid back full VAT for it, and am free to sell it to the US.
An American importer using French half-finished inputs cannot recoup his sales tax on them, neither is he paid back upon export, unless I am mistaken.
Trade between two VAT regimes is fine.
John Hawkins
Feb 19 2025 at 1:52pm
This strikes me as essentially correct. If we had consumption taxes (which would be more efficient than whatever you want to call what we’re doing), we’d be fine, but we don’t.
Scott Sumner
Feb 19 2025 at 5:00pm
“A country applying a VAT relies on YOU to tax their exports”
This is completely false. Europe doesn’t care whether we have a VAT or not.
Arqiduka
Feb 19 2025 at 7:35pm
A strong reply for such a complete misunderstanding of my point.
Scott Sumner
Feb 19 2025 at 11:31pm
Then maybe you should provide a less confusing explanation. If you didn’t mean what you said, then why say it?
Arqiduka
Feb 20 2025 at 8:00am
Because that’s obviously not what I said.
What I said was that a VAT regime goes out of its way to leave no effect of exports, as if no tax whatsoever had ever been levied. As it should.
This is not the case for any other impost you apply at the border that I’m aware of. So, stuff comes super-competitive out of a VAT regime, and it is understood that it is you the would-be importer who needs to do something about it. No one would or should bat an eye if you did.
The whole issue just doesn’t arise at all of I just put an equivalent tarif on your exports.
Or you can just get a VAT in of course, preferably one with a higher rate applied on imports than domestic value chain.