In plotting reciprocal tariffs, President Donald Trump has said his administration plans to penalize trading partners, including allies, that have value-added taxes. Here is what to know about Trump’s plan and VATs.
After imposing tariffs on China, Mexico, and Canada, Trump plans to levy reciprocal tariffs on other countries starting on April 2.
The idea is that the United States should impose tariffs on trading partners equivalent to the tariffs imposed by those countries. So if one country has a 10% tariff on U.S. goods, Trump will simply match that and apply a 10% tariff against that country so the two are at parity.
But the Trump administration plans to go beyond just existing tariffs in calculating reciprocal rates — it has said non-trade barriers would also be included in the calculation.
Treasury Secretary Scott Bessent, for example, said Tuesday on Fox Business that the administration would impose tariffs where foreign governments manipulate their currencies or engage in labor suppressions.
“If you will stop this, we will not put up the tariff wall,” he said. “If you do[n’t], then we will put up the tariff wall to protect our economy, protect our workers, and protect our industries.”
However, the administration has indicated that it will also consider whether the country has a VAT and border tax adjustment.
Economists do not typically consider VAT systems to be trade barriers.
What is VAT?
VATs are widely used worldwide. The U.S. is an outlier in that it does not have a VAT. Notably, VATs are a major source of revenue for the European Union.
A VAT is essentially a consumption tax applied to goods at each stage of production or distribution. It differs from a sales tax in that it is assessed at multiple points in a product’s supply chain and not merely charged at the final sale to consumers.
Take candy. A sales tax would be paid at the point of sale from the retailer to the person who buys the candy and takes it home.
In comparison, the way it generally works with a VAT is that the sugar producer would pay VAT on sales to the candymaker. The candymaker would then pay VAT on its sales to the retailer, subtracting out VAT already paid by the sugar producer. The retailer would then pay VAT on the sale to the consumer, subtracting out VAT already paid by the candymaker.
The VAT rate varies around the world, but it typically hovers around 20% in the EU. In Germany, it is 19%, and in the Netherlands, it is 21%. Some European countries have higher VAT rates, like Hungary, which clocks in at 27%, while Switzerland has a VAT of only 8.1%. For the United Kingdom, the VAT rate is 20%.
Why would Trump claim that VATs are a barrier to trade?
Last month, Trump blasted VATs on Truth Social and asserted they would be included in the tariff math.
“For purposes of this United States Policy, we will consider Countries that use the VAT System, which is far more punitive than a Tariff, to be similar to that of a Tariff,” he said. “Sending merchandise, product, or anything by any other name through another Country, for purposes of unfairly harming America, will not be accepted.”
VATs have border adjustments, which look much like tariffs, even though economists say they are not.
Many countries adjust VAT at the border by removing VAT on exports yet applying VAT on imports — something that might initially seem unfair.
For example, candy exported from the U.K. to the U.S. would not be subject to the U.K. VAT. However, sales of U.S. candy into the U.K. would be subject to a 20% border adjustment.
On the surface, it seems that the U.K. imposes a special tax on U.S. candy imported into the country — in other words, a tariff.
Still, tax experts generally say that such border adjustments are not tariffs but neutral tax policies for businesses.
Bill Reinsch, an expert in trade policy with the Center for Strategic and International Studies who served for 15 years as president of the National Foreign Trade Council, used the example of a car to explain VAT during an interview with the Washington Examiner.
Imagine a car made in the U.K. that sells domestically for the equivalent of $50,000. If it is sold in the domestic market, the final cost will be $50,000 plus the 20% VAT, so $60,000.
If the exact same car were made for the same price in the U.S. and shipped to the U.K., it would be subject to a 20% border adjustment, and the final cost would be $60,000. So, the car is treated the same, whether made in the U.S. or the U.K.
Currency movements
But there’s more reason to think that border adjustments are not a barrier to trade. That’s because they also cause movements in the currency that offset any economic effect they might have, economists say.
Border adjustments, like taxes applied to imports and exemptions for exports, affect the supply and demand of a country’s currency, which in turn affects the value of the currency.
If a VAT border adjustment is applied to U.S. goods sold in a foreign country, it makes those goods more expensive in the country using that adjustment. This reduces demand for those goods, lessening demand for and weakening U.S. dollars. However, a weaker dollar makes U.S. goods cheaper and more attractive to foreign buyers.
Research from the Peterson Institute for International Economics has found that the exchange rates offset.
“Overall, the results suggest that real exchange rate movements eventually fully offset border-adjusted consumption taxes,” the researchers found. “In particular, increases in consumption tax rates raise the prices of domestic and imported products equally.”
That’s why tax experts don’t see VAT border adjustments as trade barriers.
Alex Durante, senior economist at the Tax Foundation, told the Washington Examiner that Trump’s view of VAT and his desire to apply reciprocal tariffs represent a “fundamental misunderstanding” of how the system actually works.
He said what is missing is an understanding of how the exchange rate adjustments mitigate any discriminatory effects.
“When you account for those currency appreciation effects, the border adjustment does not discriminate against Americans or any other importing country,” Durante said.
How would all this look in practice
The details about how the reciprocal tariffs will be imposed on April 2 are still unclear. Calculating new tariff rates for all of the U.S.’s trading partners is a daunting task.
Administration officials have considered simplifying the process by sorting every trading partner into one of three tariff tiers with low, medium, or high rates, according to the Wall Street Journal. But that was ruled out, and the high-level talks are still ongoing.
“Many plans have been discussed, and when the president is ready to announce a plan, the American people will hear from him directly,” White House press secretary Karoline Leavitt said.
Reinsch initially interpreted Trump’s reciprocal tariff plan to mean there would be a different duty for every item in every country.
“They’re going to have a single number for each country,” he said. “So that number will probably be the average tariff plus the VAT — and 170 countries have a VAT, so that’s most of them — plus an unspecified amount for unspecified unfair trade practices that the administration is presumably figuring out how to identify.”
However, countries that rely on VATs cannot simply nix those taxes or lower the rates because they represent a major source of revenue.
“There’s no way they can get rid of the VAT,” Desmond Lachman, a senior fellow at the American Enterprise Institute, told the Washington Examiner. “You know, the VAT is a very important revenue source for them.”
Durante said there isn’t a way for Europeans to just say they will no longer have the border adjustment. He said it wouldn’t work in the context of their system and would create a huge carveout for foreign goods relative to domestic goods.
“There’s no way for them to lower their border adjustment without also lowering the VAT rate,” Durante said. “Otherwise, if they did that, then that means that it would actually be favoring imports relative to domestic consumption, where the idea of their system is to maintain neutrality as best they can.”
CARRIED INTEREST: WHAT TO KNOW ABOUT THE TAX ‘LOOPHOLE’ TRUMP AIMS TO END
Lachman warned that the market reaction to Trump instituting wholesale reciprocal tariffs worldwide on April 2 would be bad. He said there is a chance this plan is being used to get countries to the bargaining table.
“But if he actually does it, I think that the markets just tank,” Lachman remarked.
