On 9 February, White House Deputy Chief of Staff Stephen Miller warned European countries to expect stern tariff treatment from the second Trump administration, in return for having VAT systems. Speaking on Fox News, Miller complained that nations “all around the world” use VAT to gain “an unfair trade advantage” over the US.

According to Miller, when the US ships a car to Europe, that vehicle is taxed at 30%, while a European car dispatched to America is taxed at “basically zero” (in fact, 2.5%). For Miller, that is a “major reason” why the US auto industry is underperforming and haemorrhaging jobs. As such, President Trump would pursue “a policy of reciprocity” on VAT.

Sure enough, on 13 February the White House formally announced plans to punish “unfair, discriminatory, or extraterritorial taxes,” including VATs.

The decision to earmark VAT as a target for reciprocal treatment led commentators to infer that Trump himself construes VAT as some form of tariff. But an expert well known to ICAEW members was happy to step in and correct him.

Tricky concept

In a 2 April X thread, tax campaigner Dan Neidle highlighted serious flaws in equating VAT with tariffs. First, US sales tax applies just once, to the final transaction with the consumer. For example, a business selling a car to a New York resident must charge sales tax. But the rest of the supply chain, from raw-material suppliers to the vehicle’s manufacturer, is unaffected. By contrast, VAT applies at every level of the supply chain.

For Neidle, who gave ICAEW’s 2023 Hardman Lecture, there is one key reason why VAT works that way: to limit the scope for tax evasion. He noted that in the US system, ‘final sale’ can be a tricky concept to pin down. 

A consumer who is buying a car can easily claim that they are a business, which is hard for a seller to check. That provides a route for illegally escaping sales tax. In the UK, though, if most of the players in the supply chain are filing VAT returns, it is easier for HMRC to spot those who are not.

In Neidle’s assessment, President Trump may be construing VAT as a tariff because of a misunderstanding about how VAT is credited when UK businesses export. On the surface, that credit may look like a subsidy for exporting. In reality, it is not.

Foundational element

Neidle then turned to a more sophisticated argument: that VAT is distortive because it encourages UK companies to export to non-VAT jurisdictions, effectively functioning as a ‘reverse-export subsidy’. However, he dismissed that view, citing the thoughts of economist Paul Krugman, outlined in this Forbes piece.

“Major areas of expenditure aren’t subject to VAT – that means Jaffa Cakes and (somewhat more significantly) housing,” Neidle wrote. “So, people will tend to spend more on housing and Jaffa Cakes (and other exempt and zero-rated items) and less on VAT-able goods and services.” As neither housing nor Jaffa Cakes are imported, he argued, VAT tends to reduce imports, as we buy more domestically produced goods.

However, there is a parallel effect that non-economists find “deeply counterintuitive”, but is a foundational element of trade theory. According to a 1936 paper by AP Lerner, if imports are reduced, then so too are exports. 

The thinking goes that if we purchase fewer foreign products, foreign businesses receive less GBP from UK importers. That is also the case if UK importers buy goods in foreign currency because they will often exchange it for GBP. Again, the upshot is that there is less GBP available.

As there is less GBP, the currency’s value will rise. So, the world buys fewer UK products – and UK exports fall. Indeed, Krugman concludes that the exports-reducing effect is actually stronger than the imports-reducing one. So, VAT discourages imports and exports alike. “VAT, once more, behaves nothing like a tariff,” Neidle wrote.

Rare company

Expanding on his thread in a 2 April blog for his nonprofit campaigning body Tax Policy Associates, Neidle stressed that on VAT, the US is an outlier. Every major, developed country has adopted a VAT system, along with a majority of others. 

The most recent convert is Brazil which, in Neidle’s words, had a “mess” of national and local sales taxes until it adopted VAT in 2023. That leaves the US in the rare company of Hong Kong and Pakistan, plus a few small islands and tax havens.

According to Neidle, much of the US’s reputation as a country with lower tax than the UK comes down to VAT – and there are two consequences. “First, no major economy could abandon VAT, as Trump seems to wish, and maintain its current level of spending,” he wrote. “Income taxes would rise to unsustainable levels (in the UK, we’d pay, on average, about 60% more income tax).”

For Neidle, though, the second consequence is more entertaining. If the US kept its overall tax level exactly the same, but swapped in VAT for some personal and corporation tax and applied it absolutely everywhere else, that would not just enhance the competitiveness of US exports, but tend to increase them. “I’m sure Mr Trump is working on this proposal as we speak,” he added.

ICAEW Technical Manager, VAT and Customs, Ed Saltmarsh, says it is crucial to understand the difference between VAT and tariffs. “Misinterpreting VAT as a tariff could lead to misguided policy decisions that may not address the real issues,” he stresses.

He adds: “As demonstrated by last year’s launch of our How to Fix VAT campaign, ICAEW is committed to improving understanding in tax policy discussions. Our aims are to foster a firmer grasp of VAT’s role in building a sustainable economy and to support informed policymaking for lasting economic growth.”