VATs Are Weapons in the Trade War
The free trade consensus is quick to denounce tariffs. We’re told tariffs are bad because they raise consumer prices. They are a tax on consumers. They cause an inflationary supply shock. This orthodoxy insists that tariffs are damaging by their very nature, and that their primary effect is to harm the very consumers they purport to protect.
But here’s where things get interesting: introduce a Value-Added Tax (VAT) into the mix, and the entire calculus changes. VATs are not just tolerated by the free trade crowd; they are often praised. But what exactly is a VAT? It’s a tax applied to domestic consumption that raises prices on a much broader array of goods than any tariff ever could. It’s a tax that hits everything from bread and milk to automobiles and appliances.
Foreign VATs are particularly harmful to U.S. exports, imposing additional costs that make American goods less competitive in international markets. In the European Union (EU), member countries apply standard VAT rates to imported goods, including those from the United States. These rates vary across the EU, with Hungary imposing the highest standard rate at 27 percent, followed by countries like Denmark, Sweden, and Croatia at 25 percent. Germany, a key trading partner for the U.S., maintains a standard VAT rate of 19 percent.
China, another major destination for U.S. exports, employs a tiered VAT system. The standard VAT rate is 13 percent, applicable to most goods, while reduced rates of nine percent and six percent apply to specific categories of products and services. For instance, the nine percent rate covers sectors such as transportation and construction, whereas the six percent rate pertains to financial and consulting services.
These VATs are levied on the final sale of goods within these countries, meaning U.S. products are subject to these taxes upon entry, effectively increasing their retail prices. This taxation structure can disadvantage American exporters, as their products become more expensive compared to local goods, potentially leading to decreased demand and contributing to trade imbalances.
Worse, the VAT is designed in a way that explicitly favors exports over domestic consumption. Countries that rely heavily on VATs, like those in Europe and increasingly China, rebate the tax on goods that are exported while imposing it on imports. The result is a system that encourages exports and discourages imports, fueling trade imbalances.
By reimbursing domestic producers for VATs paid on exported goods while taxing foreign goods entering the market, VATs act as a tool of industrial policy. They incentivize production for export markets, providing a structural advantage to foreign producers at the expense of American manufacturers. This is not free trade; it is state-sponsored protectionism masquerading as market efficiency.
VATs are Worse For Consumers Than Tariffs
Yet when Trump and his supporters propose to counter VATs with tariffs, the free traders act as if a trade war is being launched. But a VAT is nothing more than a tariff with an additional tax on sales of domestically produced goods.
It’s also important to note that the inflationary effects of VATs are far more widespread than those of tariffs. A tariff on specific imports may raise prices on a narrow selection of goods. A VAT, however, is levied on virtually every step of the production process, contributing to price increases at multiple stages.
So, why do free trade advocates find tariffs abhorrent while celebrating VATs as efficient? Because they’ve accepted the global norm where foreign mercantilism is repackaged as sound policy. The hypocrisy is blatant.
If tariffs are to be condemned for raising consumer prices and creating inflationary supply shocks, then VATs deserve the same treatment. Instead, we see a deliberate blind spot — one that serves the interests of export-driven economies at the expense of American workers and producers.
Free traders should recognize that a tariff is nothing more than a VAT with an exemption for domestic producers. In this sense, a tariff is a tax cut when compared to the alternative of a VAT.
Trump’s approach, which acknowledges the role of tariffs in countering this mercantilism, is at least rooted in reality. It understands that trade policy isn’t about purity but about achieving fairness. And as long as our trading partners continue to use VATs to their advantage, the United States must be willing to respond in kind.
