Krugman loses a debate on trade to ... DONALD TRUMP ?
Say what?! I laughed my ass off for several days after reading this Krugman blog post so decided to explain it to everyone else.
Have to start here, for all my Republican friends out there, this is highly ironic because, contrary to what you may believe, Donald Trump is wrong on almost every single point he makes relating to trade:
- No foreigners aren't stealing our jobs.
- No higher tariffs will not protect American jobs.
- No imports are not bad.
- No GDP will not increase if we reduce/eliminate the trade deficit
The reason this all gets super-duper ironic is that Paul Krugman's area of specialty is trade. Before Krugman (stupidly) pointed this out I would have told you Trump was wrong on everything relating to trade. Now I realize one of his points is correct and Krugman's attempt to rebut it is a failure.
VAT - Value Added Taxes
This is the topic of discussion. Specifically a provision within VAT called "zero-rating rules." Krugman attempts to rebut an economic point from a white paper prepared by Trump's advisers on VAT as an implicit tariff against American exporters. The Krugman article is VAT of Deplorables and the Trump white paper is Scoring the Trump Economic Plan.
I’ve been writing about Donald Trump’s claim that Mexico’s value-added tax is an unfair trade policy, which is just really bad economics. Here’s Joel Slemrod explaining that a VAT has the same effects as a sales tax. Now, nobody thinks that sales taxes are an unfair trade practice. New York has fairly high sales taxes; Delaware has no such tax. Does anyone think that this gives New York an unfair advantage in interstate competition?
Here is the key unequal tax treatment issue: While the US operates primarily on an income tax system, all of America’s major trading partners depend heavily on a “value added tax” or VAT system. Under current rules, the WTO allows America’s trading partners to effectively create backdoor tariffs to block American exports and backdoor subsidies to penetrate US markets. Here’s how this exploitation works:
VAT rates are typically between 15% and 25%. For example, the VAT rate is 25% in Denmark, 19% in Germany, 17% in China and 16% in Mexico. Under WTO rules, any foreign company that manufactures domestically and exports goods to America (or elsewhere) receives a rebate on the VAT it has paid. This turns the VAT into an implicit export subsidy. At the same time, the VAT is imposed on all goods that are imported and consumed domestically so that a product exported by the US to a VAT country is subject to the VAT. This turns the VAT into an implicit tariff on US exporters over and above the US corporate income taxes they must pay.
Thus, under the WTO system, American corporations suffer a “triple whammy”: foreign exports into the US market get VAT relief, US exports into foreign markets must pay the VAT, and US exporters get no relief on any US income taxes paid.
Where Krugman's Wrong
Firstly, Krugman doesn't refute the fundamental point: that VAT is paid by US exporters and not paid by foreign importers. Secondly though, his analogy of interstate trade isn't a relevant example because even if we look at the sales tax in Delaware and NY, both states have relatively high state income taxes.
Even at that though I almost stopped reading after the last Krugman sentence I quoted because I felt Krugman had the argument in the bag. It is common in economics courses to teach comparative advantage using Krugman's same analogy:
"you wouldn't think Idaho is creating unemployment in its state's orange-growing industry by importing Florida oranges and focusing on producing crops where Idaho has an advantage, like potatoes, right?"
So I almost stopped listening and gave the argument to Krugman at that point, but for one thing. In economics it is also a common saying that tariffs are just a sales tax levied at an earlier stage of production. So I was suspicious of Krugman's argument that a higher VAT was in essence a sales tax and that couldn't be equated to a tariff. So I went in for further inspection and decided to hear out the claims of Trump's economist. Upon reviewing the VAT argument in Trump's white paper it is very apparent that Trump's adviser is right and Krugman is wrong. All their statements are true and Krugman refutes none of them.
Where Trump's Both Right and Wrong
Correct: Refunding the VAT on a foreign firm that exports to America, while making American imports into that foreign country pay the VAT, gives an advantage in tax treatment to the foreign-based producer.
Incorrect: There's room to dispute Trump's claim it penalizes the American exporter who sends goods into a country with a VAT. All the goods produced domestically in that country also pay the VAT. So it isn't the case that the American goods are disadvantaged. This is where Trump's economist makes his argument more nuanced in order for it to hold up to the criticism I just laid out. His nuanced point is:
and above the US corporate income taxes
He doesn't say it directly at this point in the white paper, but implied is that American firms pay a much higher corporate tax rate than firms in other countries. So the whammy is the higher tax rate plus the VAT makes them less competitive than the foreign company paying the VAT and a lower foreign tax rate.