What I Didn’t Say Last Week About Tariffs

Confining these columns to about 900 words is generally a good thing—it forces me to be compact and to focus my arguments (though readers may disagree on how well I do that)—but it occasionally is a drawback when it doesn’t leave room to squeeze in everything important. In addition, in today’s fast-moving environment, sometimes important things happen after the column has been published. Such is the case with the Trump tariffs, so this week I want to comment on two topics I skipped last week.

The first is the issue of taking other countries’ value-added taxes (VATs) into account when calculating the size of the rebalancing tariffs Trump wants to impose. He proposed to make U.S. tariffs reciprocal by calibrating them to the level of everyone else’s tariffs, one by one. In addition, the proposal suggests that VATs as well as other unspecified unfair trade practices will be taken into account in setting the reciprocal tariffs. Both of those additions would produce a huge increase in the level of U.S. tariffs, so it makes sense to try to understand what he is talking about.

VATs are like a sales tax, but one which is paid at each stage of the manufacturing process, reflecting the value that has been added at that stage of production. The end consumer pays the VAT, and corporations collect the tax and are responsible for remitting it. However, if the product is exported, the VAT is rebated. Trump’s complaint is that U.S. exports to the European Union pay the VAT upon entering the European Union. He views that as discriminatory because the VAT is rebated on EU exports. Europeans argue that it’s a sales tax, and products sold in the EU are subject to it, whether they are made in Europe or imported. (In fact, some 170 countries have a VAT—the United States is an outlier—but Trump’s complaints have focused on the European Union.) It’s taken me five years and a number of arguments to understand this, but I think I’ve finally got it and will attempt to explain it with an example.

Let’s start with a car that costs $50,000. If it is an American car, it would sell in the United States for $50,000 plus state sales tax—in this example, we’ll assume 5 percent—which comes out to $52,500. If that car were exported to the European Union, it would cost $50,000 plus the VAT, plus the tariff. EU VATs vary by country but are all between 15 and 27 percent. For our purposes, let’s say 20 percent, which is near the EU average. With the VAT, the car would cost $60,000. If you add the EU car tariff, which is 10 percent, that would be another $5,000 for a total of $65,000.

On the other side, if our $50,000 car is made in Europe and sold in Europe, it would cost $60,000—the base cost plus the 20 percent VAT. If the European car is exported to the United States, there it would cost $50,000 plus a 5 percent sales tax plus the 2.5 percent tariff, or $53,750. If you’ve made it this far, you can see the VAT operates as a sales tax on both cars, and any price differential is due to the difference in tariffs. If there were no tariffs on either side, the U.S. car in Europe, and the European-made car would both cost $60,000—the base cost plus VAT. In the United States, both cars would cost $52,500—the base cost plus sales tax. The price differential between the two cars in both cases is caused by the difference in tariffs, not the VAT.

Apparently, the Trump administration does not see it that way and wants to add the amount of the VAT to the U.S. reciprocal tariffs it wants to impose. In our example (and ignoring any additional charges for unfair trade practices), that would mean the $50,000 European car coming into the United States would cost $50,000 plus a 5 percent sales tax, plus a 10 percent car tariff (matching the EU level), plus the 20 percent VAT, or $67,500, which is a significant increase. Of course, Trump’s threat last Friday was a 25 percent tariff on cars, which would actually be a bit less ($65,000), assuming the VAT and existing EU tariffs were not also added.

The second issue is the scope of the steel tariffs Trump announced. The announcement initially did not include a list of the actual products covered, but it did say that they would include “downstream” products. The list has now been published, and it is exceptionally broad. Since this is a continuation of the Section 232 national security tariffs he imposed in his first term, it was surprising to see that knitting needles, crochet hooks, stoves, and a wide variety of nuts, bolts, and screws were included—all doubtless security threats to our beleaguered consumers. If you shop at Home Depot, you’re going to get a surprise once the tariffs go into effect.

Both these examples illustrate the same carelessness of facts and law that characterized Trump’s first term. The VAT issue reflects ignorance of basic economics and failure to understand how VATs actually work. The steel list shows the hypocrisy of a national security determination that has very little to do with security, as well as Trump’s willingness to distort the law to achieve his goals. Both are reminders that the rollercoaster ride continues and that the risk of the cars flying off the tracks is growing daily.

William Reinsch is senior adviser for the Economics Program and Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.