Of course VAT is a barrier to trade | Chris Bayliss

The Trump Administration has been doing some homework, and the results are alarming. The effective tariff rate each and every nation on earth applies to imports from the United States has been meticulously calculated. On Wednesday, the President exposed its grisly contents to the world, then announced that retaliatory tariffs would be imposed on those nations’ exports to America, effective immediately.

In Britain, there was almost a feeling of relief that our own barriers to US imports were deemed worthy of reciprocal tariffs of only 10 per cent. Normally, news of a ten per cent tariff on our exports to the USA would cause panic and turmoil in the markets. As it happened, the FTSE 100 was down by a mere 1.53 per cent by noon on Thursday, and sterling was rallying.

This relative calm was a result of far worse being imposed on our neighbours, as well as to most of the rest of the world; a 20 per cent tariff on the EU’s exports to the US might even see some European operations shifting to the UK. A tariff of 54 per cent would be applied to imports from China, and some Southeast Asian countries would face rates only a little lower. No nation was too small to face eye-watering rates: the tiny Australian territory of Norfolk Island, with a population little more than 2,000 people, had been specifically carved out from the rest of Australia for a far higher punitive tariff of 29 per cent. Lesotho would face a rate of 50 per cent.

There appeared to be little rhyme or reason as to how these rates had been arrived at. Officially, a robust assessment had been carried out of both tariff- and non-tariff barriers to trade that those places imposed on imports from the US — however, Norfolk Island has the same external trade policies as the rest of Australia. The American journalist James Surowiecki noted that the calculations produced by the White House appeared to correspond to the US trade deficit of each nation, divided by that country’s total exports to the US. The only exceptions were the 11 countries, including the UK and Australia, that were not to be subjected to anything more than the blanket 10 per cent rate being applied globally; coincidentally, these countries’ barriers to US imports all happened to amount to 10 per cent.

If there were no VAT, consumers would buy more things

This would appear to demolish any factual credibility for the administration’s claims that it had undertaken a rigorous analysis of costs to American exporters of the rest of the world’s non-tariff barriers. Countries are being punished simply for selling more to the Americans than they bought from them. In any case, a number of the non-tariff barriers that had been identified (if not quantified) by the White House number-crunchers, were nothing of the sort, or so many commentators reckoned.

The most glaring example was VAT, which the US President considers to be almost equivalent to tariffs in their detrimental impact on US exports. To most Europeans, and indeed to many American commentators, this is hysterical. VAT is applied evenly across the board, it does not discriminate between domestic and foreign suppliers, and it is certainly not targeted at exporters from any particular country. Such is the ubiquity of the value added tax that the European Union regards non-application of VAT on particular products within the common market as an impediment to market harmonisation, and it punishes member states who make certain goods exempt that had previously been payable.

Nowadays, the outliers are those countries such as the US that do not impose a uniform VAT on most goods and services. Other than the US, countries that do not impose VAT tend to be either major petroleum producers, tax havens or very poor countries with largely informal economies. However, this was not always the case; the explosion of VAT as the international norm rather than the exception did not take place until the latter half of the 20th century. When it was proposed in the earlier part of the century, the objections included vociferous opposition from those who extolled the benefits of international free trade as a means of reducing costs to consumers. When VAT was first rolled out by various states decades later, it created a number of diplomatic headaches as exporter nations worried about the markets for their goods and claimed they were being treated unfairly.

The objection to the idea that VAT can be considered as a barrier to trade rests on the fact that it does not discriminate between local and foreign suppliers, so in itself it does not make a cross-border transaction more difficult than a local one. But this discriminatory aspect alone is not what makes a barrier to trade. Many of the market access barriers abroad that the Department for Business to Trade, and its predecessor agencies, have spent time researching and trying to solve apply just as equally to domestic businesses as they do to imports. These include things such as lack of protection for intellectual property, corruption, banking sector vulnerabilities and bureaucratism. These are all things that make up a country’s business environment, and they will impact whether a transaction can happen at all — be it domestic or international.

The primary impact of VAT, other than raising revenue for the government, is to reduce the overall aggregate demand within that jurisdiction. To put it simply; if there were no VAT, consumers would buy more things. British consumers would buy more British goods, and they would buy more foreign goods, including American goods. If transactions do not happen that would otherwise have happened were it not for that tax, then it is a barrier to trade. That there are many more domestic transactions that are also inhibited as a result is neither here nor there.

As with all taxes, there is a need to balance what is best for the economy overall with the need for the government to raise revenues. Most economists agree that VAT places a lesser deadweight cost on productivity than other forms of taxation, especially income taxes.

There will be ill effects and job losses, but these will be minimal

But whereas higher income and corporation taxes can reduce a country’s competitiveness as a producer and also act as a disincentive to economic activity in general, VAT has a far more limited impact on a country’s ability to produce. Any effect is certainly far less than that which it has on the nation’s capacity to consume. In a world in which every country imposed similar levels of VAT this would be inconsequential, but if you take a crude “imports bad; exports good” approach, as Trump surely does, then those countries that do not impose VAT are disadvantaged.

The official calculations of barriers to trade are clearly nonsense, and people on the British Right who are otherwise favourable to Trump’s agenda should not demean themselves by playing along with them. However, defenders of international free trade have fallen over themselves in recent weeks to deny that VAT has any impact at all on trade, which is equally dishonest. It is not a coincidence that the categories of goods that dominate US exports to Britain are zero-rated for VAT.

Trump is implementing import tariffs on the whole world because he wants to and because he can and because that’s what he told the American electorate he was going to do when he ran for office. Despite claiming that running a trade surplus is equivalent to theft, he has not exempted countries that the US runs a trade surplus with from the punishment (although in Britain’s case, this has not been helped by our own statistics contradicting the American ones, reversing the imbalance in Britain’s favour). Yet the ultimate target of Trump’s trade policy is China, and it is in our capacity as China’s customers that we are doomed to suffer his wrath.

For Britain, these tariffs will be a blow, but one that will be cushioned by the fact that we are in a better position than many of our competitor nations. Many of our exports to the United States are Veblen goods, such as luxury vehicles, for which consumers are far less price sensitive, along with extremely high value-add components in defence and aerospace where there is less choice in terms of suppliers. There will be ill effects and job losses, but these will be minimal compared to those that will be lost as a result of policies that successive governments have imposed on the British economy entirely voluntarily. That we are likely to be half way through a second “lost decade” will be the result of high taxes, inflexible land use and planning policies, an unpredictable regulatory environment and especially because of Net Zero — not because of Donald Trump.

The new American tariffs should make us reconsider many of the ways we deliberately make ourselves internationally uncompetitive. For what it’s worth, I don’t think this means scrapping VAT; out of all the ways the government can raise revenue, it’s amongst the least worst. But it could probably do with coming back down a bit — and we should at least try to assess its impact honestly.