On Thursday, President Trump tasked his advisers with coming up with new tariffs on America’s trading partners, aiming to address what he describes as long-standing trade imbalances.
Central to his strategy is targeting the value-added tax (VAT), a system prevalent in Europe and other regions that taxes goods and services. Trump and his team contend that this tax framework gives other countries an edge over the U.S. in trade.
Let’s dive into the details.
### Understanding the Value-Added Tax
The VAT is essentially a consumption tax applied at each production step of a product or service. Unlike America’s sales tax, which is levied at the final purchase, VAT accumulates throughout the supply chain. Across European nations, VAT rates hover around 20%, significantly higher than the average 6.6% sales tax in the U.S. as of 2023, according to the Tax Foundation.
VAT is incorporated during each production phase, passing the final burden to the consumer rather than the business. When products are exported, most of the VAT is reimbursed to the exporter, creating an incentive to sell abroad rather than domestically.
Starting in the 1950s, many nations, spurred by France, began adopting VATs, with the European Union countries leading the charge but with notable implementations in places like China as well. This VAT rebate for exporters has been a boon for these countries, boosting their competitiveness on the global stage.
### The U.S. Take on VAT
The United States stands out among developed economies by not employing a VAT system. Back in 1993, President Bill Clinton considered an energy tax, and in response, Senator John Danforth from Missouri suggested a VAT to bolster American exports. Clinton, however, indicated that the U.S. would need ten years to ready itself for such a shift.
Over time, the Republican Party has opposed any introduction of new taxes. On Thursday, Trump presented a fresh tactic: raising U.S. tariffs on European imports to balance out the benefits European exporters gain from VAT.
While Trump argues that VAT unfairly favors international exporters, American companies similarly aren’t charged sales tax on exports, paralleling VAT functions, as noted by Alan Cole, a senior economist at the Tax Foundation.
At times, the U.S. has also capitalized on foreign VAT relief. For instance, when Trump previously upped tariffs on Chinese products, China increased its VAT relief to its exporters, allowing them to maintain competitive prices for American consumers despite the tariffs.
Still, it’s uncertain if China would repeat this relief amid new tariff threats, particularly given past sentiments where Chinese taxpayers felt burdened by the costs of American tariffs.
### Significance for European Economies
In Europe, VAT is a substantial revenue source for government budgets. Among the 37 members of the Organization for Economic Cooperation and Development, 21 countries rely on VAT for around 20% of total tax revenue.
An increase in U.S. tariffs could have significant repercussions for European businesses. “Europe’s main threat is the potential fragmentation from Trump negotiating tariffs with individual countries, which could divide the EU politically,” warned Simone Tagliapietra from the Bruegel Institute.
### Europe’s Reaction
European leaders have acknowledged the situation but await more specifics on Trump’s plans before responding. Fabian Zuleeg from the European Policy Center noted Trump’s move is likely strategic. “It’s early to predict which threats may materialize,” he said, adding that Europe is grappling with avoiding a trade spat while ensuring existing agreements are respected.
