Does a VAT promote exports?

Joel Slemrod goes through the details (pdf), including a discussion of a co-authored 1990 paper by Feldstein and Krugman, and also the Lerner theorem.  As you might expect, there is much wisdom, and microeconomics, in that six-page piece.  His answer on the tax side is basically “no,” a VAT does not favor exports, consistent with what Krugman argued a few days ago.  I should note this is not such an easy question, and I don’t think one economist in twenty, if asked on the spot, would come up with exactly the right answer and why (not an excuse for those who get it wrong with prep and Google at their disposal, though I should add this is one of the most esoteric economic errors I have seen a candidate/advisor make).

Here is a summary passage from Slemrod:

First step, understand why a uniform VAT is equivalent to a uniform RST [retail sales tax]; both levy tax on domestic consumption regardless of where goods or services were produced. Second step, calmly reassure oneself that, as is intuitive, an RST does not favor domestic over foreign production and neither encourages nor discourages exports or imports. This implies step three: that a VAT (like an RST) neither encourages nor discourages exports or imports. If step three fails, return to steps one and two until fully convinced.

Quick: say a country taxes imports and subsidizes exports, how quickly can you see that in a first-order model this ought to be neutral?

That all said, it turns out that Trump and Navarro are (partly) right after all, although probably not for the reasons they might have thought.

In fact it is Feldstein and Krugman (p.12) who best explain why, and this has to do with how a VAT boosts savings (and thus trade surpluses), relative to the USA system of taxation:

The best case for arguing that a VAT enhances competitiveness is not what it does but what it doesn’t do: a VAT, unlike an income tax, does not place a tax on saving. Thus, to the extent that a VAT substitutes for an income tax, it will tend to reduce the current propensity to consume. As many economists have pointed out (see, in particular, Frenkel and Rain 1988), to the extent that a value-added tax that substitutes for an income tax reduces current consumption, it will in turn will tend to lead to a trade surplus in the short run. A trade surplus, other things equal, tends to increase the size of the traded goods sector.

Now I am fine with “going all Don Boudreaux” and believing that more Mexican imports are no problem whatsoever.  If Mexico, because of its tax system, saves more and ends up investing more in the United States, great, even if the measured U.S. trade deficit goes up.  I am happy with that situation, whether or not I believe the correct model is one where all trade accounts fall into balance in some super-long run.

But if you banish I from C + I + G, condemn trade surpluses, and believe that single country moves toward a higher trade surplus drain aggregate demand from the global economy, then actually Trump and Navarro have a point. Fortunately, none of that is my view, so we are back to them being wrong.  Perhaps this is a case of “Aggregate Demand Drain for Me but not For Thee.”


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