Tyler Cowen recently made an uncharacteristic mistake:
But there is another way to pose the question and that is “should the resources in the EU be allocated toward export, or not?” And then exports are VAT-free, and within-EU sales generally are not VAT-free. So there is an encouragement to exports here. America has sales taxes, but VAT rates usually are higher. Thus you can say that Europe does more to encourage exporters than does the United States. Of course you can say the same about many other European government interventions. Germany’s notorious Sunday closing laws also encourage more exports. Send it to the US, and let it be sold on a Sunday, bitte! (Just not in Paramus, NJ.)
From an American point of view, I don’t think anything is wrong with this kind of “export subsidy” (and that is not how I would describe it in a first-order sense, but we are steelmanning here).
Note that he did not call a VAT an export subsidy, but did suggest that “there is an encouragement to exports here”. I don’t see how that is true. If you have a 20% VAT, and export goods to another country with a 20% VAT, obviously there is no advantage. But what if you export to a country with no VAT?
Consider a $100 item that sells in Europe for $120 due to the VAT. According to PPP it would sell for $100 in countries without a VAT. So once again, there is no obvious encouragement to export. (PPP may not hold for other reasons, but that has no bearing on whether VATs encourage exports.)
I’m not suggesting that you cannot construct an argument where VATs encourage exports. Thus, if you compared a VAT to a situation with no VAT and a bigger budget deficit, the imposition of a VAT might result in a lower real exchange rate and more exports. But that’s true of any device for raising tax revenues, and I don’t see Tyler making that argument. The fact that within-EU sales are not VAT-free seems completely irrelevant, unless I’m missing something.
[The original post had a typo, omitting the word “not”]
One other point, and this is not aimed at Tyler’s post. If it were true that VATs were like export subsidies, then they would be exactly the opposite of tariffs. European tariffs discourage US firms from exporting to Europe. European export subsidies would encourage US firms to export to Europe, as export subsidies are equivalent to import subsidies. So if VATs were like export subsidies, then they would also be the exact opposite of import taxes.
READER COMMENTS
Warren Platts
Mar 28 2025 at 5:17pm
Answer: you get better terms of trade gains! I should be more clear: What if you are a non-VAT country that exports to a country with a VAT? Then you get better terms of trade gains than even tariffs. The EU knows all about this even if the Americans don’t..The other thing is there was a historical pattern in the so-called free trade era: as countries eliminated “tariffs” they instituted VATs instead. Why? What’s the difference?
Scott Sumner
Mar 28 2025 at 5:19pm
Have no idea what you are talking about.
Warren Platts
Mar 28 2025 at 6:58pm
It is simple: you impose a protective tariff, (especially if you are a big country like the USA), the foreign producers will lower their prices, accepting a smaller profit margin. Thus the tax burden is split between foreign producers and home consumers. The burden borne by foreign exporters is called the terms of trade gain. BUT if you have a VAT that ostensibly does not discriminate between foreign and home producers, the foreign exporter still faces that 20% VAT, but they don’t face the protection of home producers. So in terms of beggar-thy-neighbor policies, VATs are better (or worse considering) than tariffs.
Matthias
Mar 28 2025 at 7:52pm
I’m a bit confused. I thought protectionists are complaining that foreigners are selling things too cheap, and that this is somehow bad for the locals.
Now you are telling me the goal of protectionism is to somehow get the foreigners to sell for even cheaper?
Thomas L Hutcheson
Mar 28 2025 at 9:31pm
Yes, that is the “optimal tariff” argument. It’s like if all the importers got together and agreed not to pay so much. Nothing wrong with the theory and it actually works for export taxes if the exporting county (or group of countries like OPEC) has market power but individual exporters do not.
Warren Platts
Mar 29 2025 at 2:15am
It depends on what you want to do, I reckon. If your goal is revenue raising (and lord knows the USA gov needs more revenue: it’d take a 25% tariff on ALL imports just to pay for the U.S. Navy Department) then ideally, the foreign exporter will eat the entire cost of the tariff and the home consumer will notice no price rise whatsoever. This, technically, would not have a protective effect, but it might induce the foreign producer to start a greenfield factory within the USA, thus benefitting workers and further increasing tax revenues.
john hare
Mar 29 2025 at 6:05am
@Warren Platts,
I disagree with your second sentence. The US government is spending irresponsibly. More revenue is on the lines of giving the drunk a drink, or the spendthrift spouse more money. Without some means of getting spending under control, more revenue is likely to be more waste.
Scott Sumner
Mar 28 2025 at 8:46pm
I agree that VATs don’t have the terms of trade effects of tariffs.
Thomas L Hutcheson
Mar 28 2025 at 9:33pm
the terms of trade effect works off of market power in certain commodifies a tariff on all woud not have ToT effects
Jon Murphy
Mar 28 2025 at 6:09pm
By the way, Brian Albrecht has a great post on why the VAT is not an export subsidy, too. He gets a little more into the weeds than you, but it’s well worth a read.
Warren Platts
Mar 30 2025 at 4:05am
If you tax something, you get less of it. If untax something, you get more of it.
Matthias
Mar 28 2025 at 7:55pm
You mis-quite him there. He said that within EU-export ain’t VAT free.
I think his argument is that this discourages internal exports to other EU countries, and encourages exports to outside the EU?
Scott Sumner
Mar 28 2025 at 8:49pm
But within EU sales must pay a VAT if it’s a consumption good. The EU is basically a single domestic market. If one EU member doesn’t have a VAT, then their real exchange rate adjusts appropriately.
Again, I don’t see any way that VATs encourage exports.
Don Geddis
Mar 29 2025 at 8:11pm
Yes, but regardless of the impact of VATs on trade (and you’re probably right, they have no effect) … your post misquotes Tyler. Tyler said (as you quoted): “within-EU sales generally are not VAT-free”. But then you later summarized this (in the post) as: “The fact that within-EU sales are VAT-free seems completely irrelevant”.
Within-EU sales are not (in fact) VAT-free … and also, Tyler didn’t say they were VAT-free (and instead said the opposite). This contradiction isn’t about the economics of VATs and trade; it’s just about what Tyler said, as opposed to your paraphrase of what he said.
Scott Sumner
Mar 30 2025 at 12:02am
Sorry, that was a typo, I meant to say not VAT-free
Market Fiscalist
Mar 28 2025 at 8:53pm
If there two markets where I can sell my product – one with 0% VAT and one with 20% VAT then I am more likely to find buyers in the lower VAT area where my product is cheaper and so I will at the margin focus my sales efforts there. If the 0% zone is an export market for me then a domestic VAT is indeed encouraging exports. I
Thomas L Hutcheson
Mar 28 2025 at 9:43pm
Nope. That does not work either.
If your product was equally competitive in two zero VAT countries and one introduces a vat it changes nothing except the exchange rate. No relative prices change so your competitiveness cannot have changed either.
Tariffs/export taxes change relative prices and do affect trade, although not the trade balance oo total output. A VAT does not.
Rob Rawlings
Mar 28 2025 at 10:58pm
Assume there are 2 equally competitive firms in 2 different regions producing a good.
Start with both regions at 0% VAT and assume each initially sell 50% of their produce domestically and export the other 50% to the other region. One region then introduces VAT of 20%. Lets say this reduces sales of the product in that region. The firm based in the high VAT region loses some domestic sales but maintains its exports. The other firms keeps its domestic sales but loses exports.
Hasn’t the region who introduced the VAT harmed the exporters of the other region while leaving its own unaffected ?
Scott Sumner
Mar 28 2025 at 11:22pm
You want to think about this in a revenue neutral way. Thus consider replacing a 20% wage tax with a 20% VAT. That change should not affect the proportion of output that is exported.
If you go from no tax to a 20% VAT, this reduces employment and both domestic consumption and exports decline.
Warren Platts
Mar 29 2025 at 2:34am
Now we are talking some turkey! But if we want to reduce income taxes, why not just resort to tariffs instead of VATs?
Rob Rawlings
Mar 29 2025 at 11:36am
The consumption tax (even if replacing an income tax) will still reduce consumption, Won’t this have the effect of reducing imports of consumption goods while leaving exports unchanged?
Scott Sumner
Mar 29 2025 at 3:34pm
If you replace a wage tax with a VAT, it should not affect employment in the long run. If you go from no tax to a VAT it will reduce employment. With lower employment and real GDP, you have less domestic consumption and less exports.
Richard A.
Mar 28 2025 at 10:56pm
A VAT of 20% will cause the currency exchange rate to be about 20% higher if the imports are hit with the VAT and the exports are rebated when compared to imports not being taxed and exports not being rebated. The VAT is trade neutral.
Scott Sumner
Mar 28 2025 at 11:25pm
Yes, the real exchange rate would be 20% higher. The nominal exchange rate depends on monetary policy.
Travis Allison
Mar 29 2025 at 3:20pm
@Richard or @Scott: If it’s not too much trouble, could you provide a causal explanation why a VAT would affect real exchange rates?
Scott Sumner
Mar 29 2025 at 3:36pm
The real exchange rate is the ratio of domestic prices to foreign prices. If you have a VAT and your trading partner does not, you will tend to have a higher price level, because arbitrage equalizes pre-tax prices. (This is all ceteris paribus)
Richard A.
Mar 28 2025 at 11:33pm
Here is a list of the tariffs on autos along with the sales tax for most countries of the world. The new tariff rate on autos imported into the US from outside North America is now 25% in addition to the existing 2.5% tariff for a total of 27.5%. For light trucks this will be 25% plus 25% for a total of 50%.
Arqiduka
Mar 29 2025 at 5:33am
VAT is the only tax that is refunded to an exporter.
You have made a widget in a VAT jurisdiction and now face the choice between selling internally or exporting to a VAT-free country. You can sell that latter at a lower price for the same profit.
What will you do? Verily, a mystery.
Scott Sumner
Mar 29 2025 at 4:09pm
In economics, a little bit of knowledge is a dangerous thing.
Warren Platts
Mar 29 2025 at 4:26pm
The geologist agrees! 🙂
Arqiduka
Mar 29 2025 at 4:40pm
I will have to take your word for it.
Jon Murphy
Mar 29 2025 at 6:33pm
In your example, the firm would be indifferent between selling domestically and abroad.
Arqiduka
Mar 30 2025 at 12:23am
I fail to see this, could you please expand?
Warren Platts
Mar 30 2025 at 3:11am
You were right when you said, “VAT is the only tax that is refunded to an exporter.” Even if you’re just an American tourist & buy a fancy Italian handbag or whatever, if you got the receipts, they will give you a VAT refund. This is of course an encouragement for exports.
Jon Murphy
Mar 30 2025 at 6:16am
Firms are profit seeking entities. If two options return the same profit (as in your scenario), then the firm will be indifferent between the two options.
Arqiduka
Mar 30 2025 at 7:09am
It goes without saying that being able to sell for less without sacrificing per-unit margins implies stronger demand, and greater total margins.
Jon Murphy
Mar 30 2025 at 7:45am
I think you mean “greater profits” in your last clause? “Total margins” is a contradiction. Also, of they’re getting the same profit, they’re not selling for less in the foreign market. They’re just paying different costs.
But regardless, you change the scenario from your original proposition, which was that profit was equal between the two.
Again, firms are profit seeking entities. They are not cost-minimizing but rather cost economizing. If they get the same profit, they’re indifferent between the two.
Ivan
Mar 29 2025 at 6:51pm
Hi Scott, I agree with your take on this and Tyler’s argument seems a bit engineered to me. Still for the sake of the argument you say: “Consider a $100 item that sells in Europe for $120 due to the VAT. According to PPP it would sell for $100 in countries without a VAT. So once again, there is no obvious encouragement to export. ”
But what if the VAT incidence is shared between the domestic consumers and the producers so the former pay only 110$, isn’t it then from profit maximizing perspective better for the producer to try to sell more abroad?
Scott H.
Mar 31 2025 at 10:32am
So, you’re saying that despite the obvious first order effects of the VAT tax, an equally sized income tax would also be working in the background discouraging work and savings, and would ultimately reduce the potential demand for your product just as much if not more than the VAT.
Knut P. Heen
Apr 1 2025 at 8:27am
I think Tyler is correct. The alcohol taxes in Norway have encouraged a lot of alcohol consumption in other European countries. Whether you call it VAT or alcohol taxes does not matter. Domestic taxes eats up your budget if spent domestically. The consequence is not that we export domestically produced alcohol, but rather that the resources are spent on producing goods the foreigners want in exchange for the foreign alcohol consumption (fish and oil in Norway’s case). Taxes on domestic consumption encourage consumption in a foreign country which encourage exports.
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