The spat over VAT

Summary

Summary of "The spat over VAT" Episode of The Indicator from Planet Money

Release Date: April 15, 2025

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Introduction

In the episode titled "The Spat Over VAT", hosts Paddy Hirsch and Adrian Ma delve into the complexities surrounding the Trump administration's focus on Value Added Tax (VAT). This discussion emerges in the backdrop of President Trump's recent declaration of a national emergency concerning the trade and economic practices of America's trading partners. The episode aims to demystify VAT, explore its implications on international trade, and analyze the differing perspectives between the administration and economic experts.

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Understanding VAT vs. Sales Tax

Defining the Taxes: VAT, or Value Added Tax, is often misconstrued as a novel trade barrier. However, as economist Kimberly Klosing clarifies at [03:27], "A value added tax is a consumption tax, it's a multi-step tax, but it amounts to exactly the same thing as a sales tax. It's just administratively different."

Mechanics of VAT: Unlike the straightforward sales tax in the United States, VAT operates through multiple stages of production and distribution. For instance, creating a chair involves several transactions:

1. Wood Production: The woodmaker pays VAT on the wood purchased.
2. Chair Manufacturing: The chairmaker adds value to the wood and pays VAT on this added value.
3. Retailing: The retailer further marks up the chair's price, applying VAT again before the final sale to the consumer.

As Paddy Hirsch illustrates at [04:18], "In the US, the only one of these people... who pays the consumption tax is the person who buys the chair in the store." Conversely, in VAT systems prevalent in Europe and other countries, each stage of production and distribution incurs VAT, culminating in the consumer bearing the total tax burden.

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The Trump Administration's Stance on VAT

The Trump administration has labeled VAT as a "non-tariff barrier to trade that distorts the market" (Paddy Hirsch at [00:50]). Contrary to the consensus among economists, the administration argues that VAT discriminates against U.S. producers exporting to Europe and inadvertently favors European manufacturers in the U.S. market.

Administration's Argument:

• Rebates on VAT: When European manufacturers export to the U.S., they receive VAT rebates on their production costs. The administration contends that this gives them an unfair advantage.
• Tariff Calculations: Utilizing trade deficit data, the administration has proposed imposing tariffs based on imbalanced trade figures, a method Kimberly Klosing criticizes as nonsensical ([08:27]). For example, with a trade deficit of $80 (buying $100 of mangoes and selling $20 of goods), the proposed tariff would be 40%, derived by dividing the deficit by two.

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Economists' Perspectives

Kimberly Klosing's Analysis: At [07:19], Klosing points out flaws in the administration's logic, stating, "If you imagine trading with the island country that only sells mangoes... it's kind of a nonsense way to generate a tariff." She emphasizes that VAT is fundamentally a consumption tax and not inherently a trade barrier. Moreover, she highlights that the U.S. benefits from export subsidies, which distort trade in the opposite direction.

Michael Strain's Insights: Economist Michael Strain from the American Enterprise Institute challenges the administration's beliefs. At [07:36], he argues, "The President and some of his key advisors genuinely, though incorrectly believe that if the US runs a bilateral trade deficit with another nation, that is in itself evidence that that other nation has trade barriers against U.S. exports." Strain further asserts that the administration's focus on VAT is misinformed and fails to address the actual dynamics of international trade.

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Implications of Tariffs and Trade Barriers

Economic Consequences: Both Klosing and Strain agree that indiscriminate tariffs, such as those proposed under the guise of addressing VAT concerns, are detrimental. Strain outlines several adverse effects at [09:59], including:

• Higher Consumer Prices: American consumers would face increased costs.
• Reduced Wages and Incomes: Real wages and household incomes could decline.
• Decreased Competitiveness: U.S. manufacturing firms might struggle against international competitors.
• Employment Declines: Manufacturing jobs could diminish.
• Slowed Economic Growth: Overall economic expansion might decelerate.
• Geopolitical Tensions: Strained relationships with allies could escalate.

Trade Distortions: Klosing also points out that the U.S. has long benefited from trade systems it helped establish, fostering prosperity. Imposing tariffs as a reactionary measure not only undermines these systems but also introduces unnecessary distortions.

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Potential Consequences of the VAT Dispute

The episode underscores that the Trump administration's approach to VAT, driven by trade deficit concerns, may lead to multifaceted challenges:

1. Economic Strain: As highlighted by Strain, higher consumer prices and reduced disposable incomes could stifle economic activity.
2. Competitive Disadvantages: Tariffs might make U.S. goods less attractive abroad, harming exporters.
3. International Relations: Tariff impositions could sour diplomatic ties, weakening alliances and cooperative economic efforts.
4. Domestic Market Disruptions: Industries reliant on international supply chains might face increased costs and operational hurdles.

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Conclusion

"The Spat Over VAT" episode of The Indicator from Planet Money provides a comprehensive examination of the Trump administration's contentious focus on VAT as a trade barrier. Through insightful discussions with economists like Kimberly Klosing and Michael Strain, the episode elucidates the fundamental nature of VAT, contrasts it with the U.S. sales tax system, and critiques the administration's rationale and methodology. The consensus among economic experts is clear: blanket tariffs based on flawed interpretations of VAT and trade deficits are poised to inflict significant economic harm and destabilize international trade relations. The episode serves as a crucial analysis for listeners seeking to understand the intricacies of tax policies and their broader economic implications.

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Notable Quotes

• Paddy Hirsch [03:27]: "A value added tax is a consumption tax, it's a multi-step tax, but it amounts to exactly the same thing as a sales tax. It's just administratively different."

• Kimberly Klosing [08:27]: "It's kind of a nonsense way to generate a tariff."

• Michael Strain [09:59]: "We will see higher prices for American consumers. We will see reductions in real wages and real incomes for workers and households."

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Produced by Lily Quiros, engineered by Robert Rodriguez, fact-checked by Sierra Juarez, and edited by Julia Richie Kkannon for NPR.

Transcript

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[Paddy Hirsch]

This is the indicator from Planet Money. I'm Paddy Hirsch.

[Adrian Ma]

And I'm Adrian Ma. It's been a couple weeks since President Trump declared a national emergency due to the trade and economic practices of America's trading partners. Since then, we have had some whiplash, he said again. Yeah, Trump said he'd keep some tariffs, but he'd pause others and also crank up the tariff heat on China.

[Paddy Hirsch]

Yeah, it's been a bewildering time. And there's one area that's still making economists and investors particularly puzzled. The focus of the administration on value Added Tax, vat, or VAT for short. Trump's order calls VAT a non tariff barrier to trade that distorts the market.

[Adrian Ma]

Now, this is not what most economists think. Most economists say that is simply the equivalent of a sales tax which just like in the US Everybody pays regardless of where the goods came from. But this has not stopped the Trump administration from using VAT as as a reason to slap tariffs on America's trading partners.

[Paddy Hirsch]

So on today's show, we'll examine the spat over vat. We'll explain what it is and why Trump isn't happy about it. That's coming up after the break.

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[Paddy Hirsch]

So Adrian, you're in D.C. right? Do you pay sales tax there?

[Adrian Ma]

Yeah, we have a 6% sales tax here.

[Paddy Hirsch]

Oh, 6%. A low tax environment. I'm in Los Angeles. We're getting up to 10.5% at this point.

[Adrian Ma]

Okay. Yeah.

[Paddy Hirsch]

But regardless of how high your sales tax is or if you pay sales tax at all, Oregon sales tax is pretty simple to understand, Right? It's a consumer tax, also known as a consumption tax. You buy a thing, you pay tax on it. Kimberly Closing is an economist and a professor at the UCLA School of Law. She says a value added tax or VAT is pretty much the same.

[Kimberly Klosing]

So a value added tax is a consumption tax, it's a multi step tax, but it amounts to exactly the same thing as a sales tax. It's just administratively different.

[Adrian Ma]

Now notice Kim called it a multi step tax. And one way to think about these steps is to think about a chair. So in the life of a chair, basically four people touch it, right? You've got the person producing the wood for the chair, you've got the person making it, you've got the retailer who sells it, and finally you've got the person buying it.

[Michael Strain]

Yeah.

[Paddy Hirsch]

And in the us, the only one of these people in these four steps who's actually regarded as a consumer and therefore who pays the consumption tax is the person who buys the chair in the store. The end buyer. Like me here in la, if I go to a store and I buy a chair, I pay 10.5% sales tax on that chair. And that's all the tax that's paid. It's simple.

[Adrian Ma]

But in most other countries around the world, they have a value added tax regime. So it's not that simple. With that, everyone who buys a thing, whether they're the end consumer or a manufacturer or a supplier, they all pay the consumption tax.

[Paddy Hirsch]

Yeah. Take this wood maker, right? He marks up the price of his wood, adding value, and he pays tax on that to the government. He then passes that tax cost on to the chairmaker. The chairmaker fashions the chair, marks up the price, adding value again, and paying tax on that added value, which he then passes on to the retailer, the retailer marks up the chair's price again, slaps that value added tax onto the chair, which is paid by the shopper in the store, and which in Europe amounts to about 20% on average.

[Adrian Ma]

It's like a game of hot potato, kind of is tax potato from the.

[Kimberly Klosing]

Buyer'S perspective, once they've bought the chair, it'll look like the chair costs 20% more because of those different steps in the tax. So the ultimate person who pays it is the consumer. And the same is true for sales taxes in the United States.

[Adrian Ma]

And VAT is just like sales tax in another way. Everybody pays. Michael Strain is an economist at the right leaning American Enterprise Institute, and he says no matter where a chair is made, when it's sold in the US the buyer pays sales tax. And similarly, when a chair is sold in Europe or India or Japan, no matter where it was made, the buyer, the buyer pays value added tax.

[Michael Strain]

And so the VAT doesn't tilt the playing field toward domestically produced goods and away from US Exports, and therefore it is not a trade barrier.

[Adrian Ma]

President Trump and his economic advisors, they don't agree with this. They say the current system discriminates against US Producers selling goods in Europe and gives European manufacturers an advantage when they're exporting to the US and how would.

[Paddy Hirsch]

It do that, you ask? Well, firstly, they point to the fact that when a French chairmaker exports a chair to the US she gets a rebate from the government on any VAT that she's incurred in the production process. Remember, she had to pay VAT to the government on that wood that she bought in order to make the chair, right? Well, yeah, of course she gets a rebate, says Kim.

[Kimberly Klosing]

The reason that Europe rebates the VAT when their sellers sell into our market is for the simple reason that it's a tax on European consumption. Right. And anything that's sold not in Europe is not consumed in Europe. So it doesn't make sense to tax the consumption of exports. That would be a net discouragement to exports.

[Adrian Ma]

Okay, but the Trump people would say that when an American chairmaker wants to sell his chairs in France, he has to pay not only the French value added tax, but he also has to pay taxes that are embedded in the US Production process.

[Paddy Hirsch]

But here's the thing. When it comes to consumption taxes in the U.S. companies generally don't have to pay those taxes the way that they do in Europe as part of the production process. In fact, American companies get an exemption for sales tax if they incur it, you know, depending on the state. And if anything, Kim says the US has an advantage when it comes to exporting to the eu.

[Kimberly Klosing]

We have an export subsidy that's baked into our tax code. In particular, companies who have really high profit margins are rewarded with a deduction of about 50% relative to what they would pay on domestic sales. And that actually is a trade distortion.

[Adrian Ma]

Over at the American Enterprise Institute, Michael Strain says the Trump administration appears to be aiming at VAT as part of a wider campaign aimed mainly at trade deficits, which we talked about in an episode last week.

[Michael Strain]

The President and some of his key advisors genuinely, though incorrectly believe that if the US Runs a bilateral trade deficit with another nation, that is in itself evidence that that that other nation has trade barriers against U.S. exports. And I think they're trying to figure out what those barriers might be. And one of the explanations they've kind of fumbled upon is vats.

[Paddy Hirsch]

Speaking of fumbling upon things, Kim Klosing points to the bewildering way in which the tariffs on trade partners appear to have been calculated using trade deficit data.

[Kimberly Klosing]

If you imagine trading with the island country that only sells mangoes, and you sell them $20 worth of stuff and $100 of mangoes from them, and it's completely freely traded, there's free trade in both countries.

[Adrian Ma]

According to the Trump administration's formula, the tariff with this island should be 40%. Why? Well, because of our trade deficit. We buy 100 bucks of mangoes from them, they buy 20 bucks of widgets from us, and 100 minus 20 is 80.

[Kimberly Klosing]

And then you divide by two, right? Two, you get 40%. It's kind of a nonsense way to generate a tariff.

[Paddy Hirsch]

Now, it's not that tariffs are always bad, right? Michael Strain says there were circumstances in which they could be useful, perhaps in the case of shoring up national security, I mean, maybe even as a negotiating tool.

[Michael Strain]

I think that there are circumstances under which tariffs can be useful. I think that imposing large tariffs can strengthen the President's hand.

[Adrian Ma]

But as for the notion that Trump needs to hammer America's trading partners to make up for decades of being taken advantage of, well, Kim Klozing says that just does not reflect reality.

[Kimberly Klosing]

We tend to represent our interests very well, and we've really prospered, you know, more than almost any country in the world by this trading system that we helped build and that we carefully nurtured for a period of more than 70 years.

[Paddy Hirsch]

Again, like most economists, both Kim Klausing and Michael Strain agree that these blanket indiscriminate tariffs will damage America regardless of why they're being imposed.

[Michael Strain]

We will see higher prices for American consumers. We will see reductions in real wages and real incomes for workers and households. We will see US Manufacturing companies be less competitive. We will see declines in manufacturing employment. We will see a slowdown in economic growth, and we will see substantial increases in geopolitical tension with our allies.

[Paddy Hirsch]

A lot of pain, in other words, both economic and otherwise.

[Adrian Ma]

This episode was produced by Lily Quiros and engineered by Robert Rodriguez. It was fact checked by Sierra Juarez and edited by Julia. Richie Kkannon edits the show and the indicators of production of npr.

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