Donald Trump peddled an economic fallacy in last week's Presidential debate by suggesting that Mexico’s value added tax, or VAT, gives its producers an advantage over American companies. He said, “When we sell into Mexico, there’s a tax – automatic, 16 percent, approximately. When they sell to us, there is no tax.”
Yes, Mexico has a VAT and the United States does not. And VATs around the world are border adjustable – exports are exempt and imports are taxable. But that does not give Mexican producers a leg up over their US competitors.
There is a simple reason for border adjustability. A VAT is meant to be a tax on consumption. Mexicans pay the same Mexican VAT on taxable goods and services they buy in Mexico no matter where they are produced. At the same time, no Mexican VAT is imposed on goods or services consumed outside of Mexico, regardless of where they are produced.
Of course, the United States has no national sales tax. We do, however, impose federal excise taxes on goods such as tobacco products, alcoholic beverages, and motor fuels. And those taxes treat traded goods the same way as other countries’ VATs. The cigarette excise tax, for example, applies to imported cigarettes, but not those exported by U.S. tobacco companies. State retail sales taxes in the United States work the same way: They apply to domestic consumption of taxed products from all sources, but not to exports.
The World Trade Organization rightly does not view these rules as trade barriers. They are simply ways for a country to tax its own residents, without discriminating based on where goods are produced. In contrast, the WTO would appropriately view a tariff that is imposed only on imported goods and services but exempts domestically produced products as a trade barrier.
A VAT does not favor one country’s producers over another’s. Trump’s claim that Mexico’s VAT gives its producers an advantage over American competitors is simply wrong.
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This article first appeared in TaxVox.