The U.S. current account deficit, the broadest measure of the nation's balance sheet with the world, was down 43 percent in the first quarter of this year compared with the same period in 2008, thanks to the Great Recession and the contraction in consumer spending it caused. But a declining economy is not a viable, long-term solution for the nation's chronic trade imbalance. Creating a more sustainable commercial relationship with the global economy requires creative thinking. And the place to start might be the U.S. tax code.
American taxation largely involves levies on personal and corporate income. Most nations in the world derive the bulk of their tax revenue from value-added taxes akin to sales taxes. Both approaches have practical and philosophical merits and demerits that tax lawyers can debate ad nauseam. But one thing is clear: The United States is out of step with the world, not only on its tax rates -- the government taxes less and is proud of it -- but, more fundamentally, on how America structures it taxes.
The failure to raise revenue through a VAT imposes a $350 billion trade disadvantage on American companies, according to estimates by Terence P. Stewart, managing partner of the law firm Stewart and Stewart, an amount equivalent to half the U.S. current account deficit last year.
How did the country get into this mess? In the aftermath of World War II, the United States was trying to speed Europe's economic recovery. As part of those efforts, Washington agreed to allow other governments to rebate to producers any indirect taxes paid on their exported goods and to impose an equal tax on any imports, including those from the United States.
At the same time, Washington agreed that any rebate of a direct tax on exports, such as the U.S. corporate income tax, would be treated as a trade subsidy and thus not permitted. Decades later, long after U.S. allies needed this implicit subsidy, this tax loophole remains. And, not surprisingly, 153 countries now rely on the VAT or similar indirect taxes.
In practice, this means a German manufacturer of a car exported to the United States gets a rebate from Berlin equal to the indirect taxes paid on production of the vehicle. For Mercedes Benz, for example, if the vehicle it is shipping to the United States is priced at $70,000, the German government pays Mercedes Benz a $13,300 VAT rebate, to offset the 19 percent German VAT. By any standard, this is a big export subsidy.
Conversely, any U.S. carmaker, or any other producer, exporting to Germany must pay Berlin a VAT equivalent tax of 19 percent on the price of the product it is trying to sell in Germany. Worse, the American company gets no credit in Germany for the corporate taxes it pays in the United States. This VAT tax is a de facto German tariff on U.S. imports. As a result, it should come as no surprise that many American manufacturers choose to supply European markets from production in Europe rather than through U.S. exports.
No wonder economist Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics, once called the VAT rebate concession "one of the biggest trade heists in history."
Congress has long instructed American trade negotiators to find some way to do away with this tax loophole. Foreign governments have repeatedly refused. Thus, says economist Pat Choate, author of the forthcoming book "Saving Capitalism: Keeping America Strong," "even as the United States negotiates the lowering of tariffs with other nations, the VAT acts as a residual import duty that can be raised at any time, unlike a tariff rate that is bound by international agreement."
Washington could eliminate this disadvantage by shifting from a direct to a VAT tax system. But an American VAT is unlikely given the state-based nature of the U.S. sales tax and current widespread opposition to any real or perceived tax increases.
Choate proposes another approach: provide American service exporters a payment equal to the amount of the VAT other governments impose on the import of those U.S. services, such as accounting or engineering. Services were not included in the original international tax deal. So such a subsidy would not violate any U.S. obligations at the World Trade Organization.
By such a tactical move, Washington could attempt to force an opening of real negotiations with other nations on what is now one of the principal trade and tax disadvantages imposed on U.S. producers and workers. "The goal would not be to increase taxes," said Choate, "but to negotiate away a major economic disadvantage that the United States now faces."
None of this would be easy. But negotiations to remove foreign trade barriers in the Doha Round of multilateral talks or to gain appreciation of the Chinese renminbi are not going that well, either. And the U.S. trade deficit might well begin to rise again once the economy recovers. So what is there to lose?
This article appears in the Aug. 8, 2009, edition of National Journal Daily.