VAT is a neutral tax for businesses and cross-border trade; but does it offer discriminatory boost via fiscal devaluation?
President Trump has Value Added Tax in his sights. On 13th February 2025, he signed a memo, “Fair and Reciprocal Plan”, initiating a review of trading partners’ unfair, discriminatory, or extraterritorial taxes, “including a value-added tax“. Later, Digital Services Taxes, applied in UK, France, Italy and other states, were included in potentially discriminatory measures. He then doubled down on VAT on 17 February:
Foul, cries the rest of the world – VAT is neutral for business irrespective of domestic or imported source. It is levied on the final consumer. But, like all indirect taxes, it is collected by others (the clue is in the name, ‘indirect’). As when companies collect income tax from their employees. It’s not a tax on the company; they are just unpaid tax collectors.
BTW – US importers need never actually pay import VAT. If they use deferred VAT accounts, which many countries offer, they avoid actual import VAT cash payments.
VAT – the angle the White House missed
But did the Trump White House miss a subtler economic argument that the US is at a disadvantage since it’s the only major country without VAT? (It does have a state sales tax, but its rules and revenues are outside of the control of the federal government).
A shift in taxation from labour taxes or corporate income tax to VAT has been found to be growth enhancing (see, e.g., OECD, 2008), with positive effects more pronounced over a longer time frame (see, e.g., Baiardi et al., 2017). This is perhaps what the US fears since it doesn’t have a state VAT to mirror the same tax subsidy. The table below shows this rebalance in the EU where average corporate income taxes have been dropping, largely funded by VAT rate increases. (Sources: OECD; EC).
This 30-year pivot can today be seen in how the EU member states so heavily reply on VAT (over 33% of fiscal revenues) compared to the US’s sales tax (17% of revenues).
175 countries operate a VAT regime today. And they are quick to point out VAT is a tax on the final consumer, and meant to be neutral for businesses who may recover in input VAT suffered. So only the final VAT bill lands with the individual. Import VAT, which President Trump’s team highlight as type of tariff on imported US goods, is in fact just to equalise the taxes with locally produced goods that are also subject to VAT. So all sellers of goods are on an equal footing for tax.
However, there is a second view that VAT enables countries to shift the tax burden onto exports – particularly onto countries which don’t operate a VAT regime. The US is pretty much the only country of significant trade value to not have VAT so is vulnerable.
Perhaps this understanding got lost when the policy was being worked-up, and the Trump camp is highlighting the wrong motivation.
Shifting the tax burden from labour income and corporate profits to consumption or property taxes could support long-term economic growth while also potentially improving net exports. This approach reduces the tax disincentive for saving and encourages workforce participation. Several European countries have implemented such reforms by increasing VAT to offset reductions in employer tax burdens.
- Germany raised its VAT from 16% to 19% in 2007 while using part of the additional revenue to lower employer social security contributions. Also, the German company tax rate on retained earnings was cut to just under 30%, down from 38.6%.
- France introduced a “social VAT” reform in 2014, increasing VAT rates to help finance reductions in payroll taxes, making labor costs more competitive.
- Japan: In 2014, Japan increased its consumption tax from 5% to 8% and later to 10% in 2019. A portion of the revenue was used to fund social security programs, helping to ease the tax burden on businesses and employers.
- Canada: In the early 1990s, Canada introduced the Goods and Services Tax (GST) to replace a hidden manufacturer’s tax, shifting more of the tax burden toward consumption and away from labor and business profits.
- Australia: In 2000, Australia introduced a 10% GST while simultaneously reducing personal income taxes and employer payroll taxes, aiming to create a more efficient and growth-friendly tax system.
- China: In 2016, China completed a VAT reform that replaced the business tax system, reducing the tax burden on companies, especially in the manufacturing and service sectors, while relying more on consumption-based taxation.
Whether right or not, the real challenge, as our map shows, is that the new White House administration may struggle to impose such a tariff on effectively the rest of the world without some significant retaliation.
VAT-led Internal fiscal devaluation to give external trade boost
Fiscal devaluation is a way for governments to adjust the economy using VAT instead of or simultaneously to changing the exchange rate. It’s worth reading this paper Fiscal devaluation and economic activity in the EU Piotr Ciżkowicz, Bartosz Radzikowski, Andrzej Rzońca, Wiktor Wojciechowski,
It works by making imports more expensive and exports cheaper. This can be done by lowering taxes that raise production costs, like payroll or corporate income taxes, and increasing taxes like VAT or property taxes. Since exports are not taxed under VAT, this helps make them more competitive.
Many economists have studied the this tax pivot in Euro countries during the 2012 currency crisis. Including Greece and Portugal, which raised VAT rates to help fund payroll and corporate income tax rate cuts.
However, there are challenges. Even if the reform balances out in the long run, there might be short-term revenue losses, which can be difficult for countries with tight budgets. Also, fiscal devaluation is not the same as adjusting the exchange rate because it doesn’t involve increasing the money supply.
Economists believe that fiscal devaluation can help a country regain competitiveness. Switching from taxes on production (like corporate or payroll taxes) to taxes on consumption (like VAT) can act like an exchange rate adjustment. In the long run, the economy will adjust—either through currency appreciation in flexible exchange rate systems or inflation in fixed exchange rate systems. For some eurozone countries, where the exchange rate is too high, fiscal devaluation could help speed up necessary adjustments in the economy.
