Monday, 19 March 2012

Using taxes to correct trade imbalances

John Whalley, who has done a lot of work on tax, trade, and development, has a new paper with Chunding Li entitled Indirect Tax Initiatives and Global Rebalancing, in which the authors suggest that value added taxes can be used strategically to correct the global trade, current account, savings, debt and deficit imbalances that led to the 2008 financial crisis.  Exchange rate policies have been the main tool for rebalancing, but Whally and Li suggest that with cooperation, the US, Germany, and China could use VATs to achieve it.  From the abstract:
We suggest that if China and Germany (as major surplus countries) switch their present VAT systems from a destination principle to an origin principle, and the US (as the major deficit country) adopts a VAT on a destination principle, jointly these actions can significantly reduce the three countries’ joint imbalances and so contribute to global rebalancing.  ... VAT structures are not only good for global rebalancing but also the changes we consider are beneficial for welfare and revenue collection. 
And from the paper:
both China and Germany (and the EU more broadly) operate destination based value added taxes under which imports are taxed but exports leave the country tax free. Both have large trade surpluses of about 5% of GDP. Switching to an origin basis which taxes exports and allows imports tax free entry will, given these significant imbalances, raise taxes and effectively also tax imbalances potentially lowering their size. The long claimed neutrality of origin/destination basis switches for the VAT ... only holds for balanced trade, and not for today’s world. In the US there is no VAT, but revenue pressures given the debt and deficit situation could in the next few years potentially result in its adoption. Were this to happen, given the large US trade deficit a VAT in the US introduced on a destination basis could similarly serve to reduce the US imbalance. We also suggest that an internationally coordinated indirect tax change involving China and Germany switching to an origin based VAT, and the US introducing a destination based VAT could potentially lead to a significant change in global external sector rebalancing. 

There are plenty of formulas, charts, and jargon-filled paragraphs in the paper, but it also includes a straightforward explanation of how VAT works.   I'm not a proponent of VAT in general, but am interested in how these taxes might impact trade.  I think the political appetite for new taxes in the U.S. is too low to produce a federal VAT even if it could promise to reverse the trade imbalance, but the authors argue that "any individual country’s VAT changes will significantly reduce world total and individual country’s imbalances, improve individual country’s welfare and increase revenues."

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