How could Trump tax Mexican imports?
The new US administration has advanced the idea of taxing the Mexican imports as a way to pay for the US Great Wall. How could they possibly succeed with this proposal?
If they don’t want simply to scrap their membership in the World Trade Organization (WTO), the new US administration has only limited ways of doing this: it cannot be directed against Mexican imports only, it cannot be neither something directed against all products nor a customs duty of that size. What are the available avenues to do this?
The US is one of the few countries in the world which has not yet adopted the Value Added Tax mechanism (VAT), and this is the reason why the proposal is not as crazy as it appeared when reading the first news about it. It might be realistic, even within the WTO rules. These rules permit the exemption of exports and the taxation of imports under indirect taxes like VAT (indirect taxes modify the products prices).
In this first section we will see what happens when there is a change of the whole tax regime, and in the second part we will show some alternative scenarios avoiding this full change.
As a mechanism of taxation, VAT is relatively new. It was created in France in the fifties and has since expanded to 135 out of 172 countries1. History shows that once implemented, countries are happy applying increased levels of VAT over the years, making progressively more use of the advantages of this tax regime.
In its simplest form, each enterprise adds a uniform rate of VAT over its sales and discounts the VAT paid in its inputs. It is simple, easy to control, has disincentives to evasion, and produces a lot of useful information for the tax administrations. Although the real world is a lot more complex, with exemptions, differential rates and convoluted relations to the income tax, we will stick to the simple version, for the sake of having a clear exposition.
Compared to a sales tax, and talking only about the domestic market, for the final consumer there is no difference: in both cases the consumer pays a rate of, say, 20% and has no means of distinguishing one regime from the other. For enterprises, even if the taxation level is kept unchanged, the information given to the tax administration will make the difference: it shows who has received the VAT discounted in the tax declaration in each step in the production chain. If some link goes undisclosed, it simply can’t discount the taxes paid, like a final consumer.
There are real differences, however, for subnational states, which will see curtailed their ability to modify taxes at their will. This has been a big problem for India while establishing VAT. The European Union has a VAT system with different rates by state. Simplicity, off course, is not one of its advantages.
Another important difference can be found in the foreign operations. Imports should be taxed at the border in order to equalize the conditions of imported and domestic products. This is the right thing to do if exports have been exempted in its country of origin. As we mentioned already, this is the normal case today; therefore, we may say that in general, exports are exempted from VAT.
What if the other country is not taxing through VAT? In such a case, the exported product is taxed in the country of origin, as any other income from the producer firm; here we can see a kind of double-taxation when the product of the already taxed enterprise enters the foreign market and pays VAT. WTO rules, however, don’t allow any deduction on direct taxes for exporters, as it would be identical to an export subsidy, prohibited by WTO rules.
This design instituted in WTO rules has theoretic support. For the enterprises in the country taxing the income the cost of imports is cheaper, and should be -globally- equivalent to the extra-cost on the exported products.
In theory, there is not any difference: If one country changes from a regime like the US’s, which taxes the income, towards one of a value added tax, which taxes the consumption, we should expect its currency to appreciate, to bear the burden of this change. Initially there would be a push for exports and a disincentive to imports, requiring an appreciation in the exchange rate to re-establish the balance.
A first conclusion, under the scenario of a whole change from taxing enterprises on net sales to a regime of Value Added Tax: big nominal changes would be expected, but they (theoretically) counter-balance against others.
Second conclusion: in case of a whole change of regime, it is clear that it will be thoroughly compatible with WTO rules. And last conclusion, derived from here: a regime change do cover more than Mexican imports; it shall apply to all countries; at least, all WTO countries.