Paul Ryan and Donald Trump have, let’s say, a complicated relationship. Ryan has told the congressional Republicans he leads that he will no longer defend Trump — not that he ever really did — and told them to feel free to disavow him. Trump fired off an angry tweet in response, taking Ryan to task on immigration, jobs and the budget.
But even their policy disagreements are more complicated than you might think. Ryan would never say, as Trump repeatedly has, that the North American Free Trade Agreement has been a disaster. Yet they are not quite as far apart on trade as they appear to be. Both of them think that the way other countries tax imports and exports gives them a competitive advantage over the U.S., and that we can reduce the trade deficit by addressing the difference between our tax systems. Both of them are wrong.
During the first presidential debate, Trump complained that our exports to Mexico are subject to the country’s value-added tax, which is a kind of consumption tax. But: “When they sell into us there’s no tax.” That’s one reason he considers Nafta “a defective agreement.” His economic adviser Peter Navarro has written about the subject in a paper for the Trump campaign. According to the paper, countries that put VATs on imports but exempt their exporters are engaged in “exploitation” and “backdoor tariffs.”
The fact that the World Trade Organization allows this “unequal treatment,” Navarro says, is “a prime example of how U.S. trade representatives often fail to recognize the consequences of the bad deals they negotiate.” Trump, he promises, will pressure the WTO to change.
House Speaker Ryan agrees with Trump’s description but would solve the problem in a different way: by having the U.S. replace the corporate income tax with a business consumption tax that is “border adjusted” — meaning that the tax applies to imports and exempts exports. When the House Republicans released their tax plan, they promised: “For the first time ever, the United States will be able to counter the border adjustments that our trading partners apply in their VATs.”
Other Republicans have touted border adjustability as an advantage of consumption taxes. So has Bill Clinton. You can see the appeal for free traders like Ryan and Clinton: They seem to have found a way to respond to voter anxieties about trade without protectionism. But they’re wrong about this issue, for three reasons.
First, it’s not unfair for countries to apply their VATs to our exporters. They apply the VAT to their own companies, too. A tariff, which applies to imports but not to domestically produced goods, is different: It pushes consumers to buy the homemade rather than imported product. If your tax system is based on domestic consumption, it makes perfect sense to apply it to products that are consumed at home — whether they came from home or from foreign countries — but not to products that will be consumed in those foreign countries. The WTO allows countries to border-adjust their VATs because it grasps this point.
Second, most economists believe that making taxes border-adjusted causes the currency to appreciate, negating any effect on the value of imports and exports. That means other countries’ VATs don’t affect our trade balance. It also means that adopting a similar tax system wouldn’t, in the long run, increase our exports and reduce our imports. And it would, perversely, transfer wealth from Americans who hold foreign assets to foreigners who hold American ones.
Third, the argument rests on the enduring mercantilist fallacy that exports benefit a country and imports harm it — the same fallacy that leads many people to embrace full-blown protectionism. The goal of raising exports and cutting imports is actually a deliberate objective of lowering Americans’ standard of living.
A consumption tax could boost economic growth by ending the current tax code’s bias against saving and investment. But it would not reduce the long-run trade deficit. —Bloomberg