TAX ADJUSTMENTS ON INTERNATIONALLY TRADED GOODS By Paul Wonnacott I. INTERNAL TAXES AND ADJUSTMENTS AT THE BORDER. II. V. SUMMARY. The tax treatment of goods entering into international trade has been a continuing source of dissatisfaction in the United States. When American goods are exported to Germany, for example, they are subjected not only to the regular customs duties, but also to a levy equivalent to the German internal tax on value added (11%). On the other hand, when goods are exported from Germany to the United States, the German Government provides tax credit or rebates for the tax on value added (TVA) already paid on these exports, while tax levies are made by the United States Government only on the relatively few products on which there are federal excise taxes. Furthermore, the United States exporter sees himself at a disadvantage in exporting to third markets, since the German exporter is granted tax credit for the TVA already paid on exports, while the U.S. exporter receives no such credit for the predominant tax which he pays, i.e., the corporation in come tax. This tax treatment is consistent with the rules of the General Agreement on Tariffs and Trade (GATT), which, broadly speaking, require the application of the origin principle of taxes for direct (income-type) taxation, while permitting the application of the destination principle for indirect (sales-type) taxation. That is, income taxes are generally imposed according to the location of the origin of the income, while sales-type taxes are imposed on goods according to the location of their consumption rather than the location of their production. While U.S. complaints have centered on the indirect taxes of the countries of the European Economic Community, similar treatment is generally applied to indirect taxes—including the federal excise taxes and the state sales taxes in the United States. These taxes are imposed on imported goods Paul Wonnacott is Professor of Economics at the School of Business and Public Administration, University of Maryland. sold in the United States, and are not levied on goods produced in the United States for export. Because the present practices are consistent with GATT provisions, U.S. dissatisfaction over the tax treatment of exports to the EEC has been expressed in the form of a recommendation that the GATT rules be changed. This recommendation gained its most conspicuous expression in the January 1, 1968 balance-of-payments message of President Johnson: American commerce is at a disadvantage because of the tax systems of some of our trading partners. Some nations give across-the-board tax rebates on exports which leave their ports and impose special border tax charges on our goods entering their country. International rules govern these special taxes under the General Agreement on Tariffs and Trade. These rules must be adjusted to expand international trade further. The questions which this raises are really two: what are the implications of the present GATT arrangements, and what are the merits and feasibility of alternative arrangements. These two questions will be the focus of the discussion below. I. INTERNAL TAXES AND ADJUSTMENTS AT THE BORDER Before attention turned to a detailed consideration of U.S. complaints regarding the GATT rules on the treatment of taxes at the border, it is appropriate to look at these arrangements in some detail. It is a useful shorthand to classify indirect or sales-type taxes as being eligible for treatment according to the destination principle; that is, exports may be exempted from taxation and rebates provided for indirect taxes already applied to exports, while levies may be made on imports equivalent to the taxes applied to domestically produced goods destined for domestic consumption. For direct or income-type taxes, the origin principle must be used, and therefore no rebates are permitted to exports on account of direct taxes paid domestically. The taxes which are generally regarded as eligible for treatment according to the destination principle, and for which, consequently, tax adjustments may be made on goods entering international trade, are: single-stage general sales taxes; cascade (multi-stage cumulative) taxes; value added taxes; and excise taxes. On the other hand, the following are generally accepted as direct taxes which are ineligible for border adjustments; that is, they are taxed according to the origin principle: personal and corporate income taxes; capital gains taxes: wealth taxes; and estate duties. There are a number of other taxes which are not normally considered eligible for border adjustment, but for which border adjustments have sometimes been made, namely: property taxes, employers' contributions to social security, payroll taxes, and stamp duties (e.g., taxes on transfers of certain documents). While these ambiguous cases have from time to time been an irritant, much of the United States resentment has centered on the Tax On Value Added. This is a multi-stage tax which is broadly equivalent to a singlestage sales tax, but is collected at each step of the productive process at which sales take place. Under the TVA as it is applied, say, in Germany, the businessman is required to apply the tax (11%) on the sales to his customers. He is then required to remit to the government the 11% tax, less any tax which he has paid to his suppliers. For example, suppose a manufacturer buys $100,000 worth of raw materials, with $11,000 in taxes being added to the price of these materials. Suppose, also, that his costs (excluding taxed inputs) and profits are $50,000. He will now sell the product for $150,000 plus the 11% tax which he is required to charge his (domestic) purchaser. His tax liability to the government will not, however, be the total 11% collected on his sales, or $16,500. Rather, from these taxes collected he may substract the taxes of $11,000 paid on his inputs. As a result, his net tax bill will be $5,500, or 11% on the value which he has added to production. The consequences of the TVA are similar to those of a single-stage sales tax on the final product, except that part of the tax is collected at an earlier time, and there is therefore an advantage to the government and a disadvantage to the producer arising from the earlier timing of tax payments. Because of the fundamental similarity between the TVA and a single-stage sales tax, the TVA has sometimes been characterized as analogous to counting sheep by counting their legs and dividing by four. The basic advantage to the government in the. TVA-apart from the timing of tax collections-is the reduction in enforcement problems. If a seller escapes the tax collection machinery, not all the tax on his sales is lost (as would be the case with a single-stage tax); rather, the tax is lost only on the value which he has added. On the other hand, since the tax is being collected at all stages, the administrative costs tend to be high. This is particularly true where the TVA is collected at different rates on different products. (The Dutch, for example, have two rates, while the French have four.) When goods are imported, taxes are imposed on them at the domestic rate; in this example, at 11%. At following stages of production, this 11% collected on imported inputs can be subtracted from the total tax liability, just like the tax paid on domestic inputs. Because imports are thus caught up in the whole process, an exemption of imports per se would not encourage imports (except insofar as it slightly changed the timing of tax collections, or except insofar as imports going directly to the final purchaser escaped taxation altogether.) This is so because, with a tax unpaid on imports, there would be no credit available at the next round of the productive process. The exemption of imports itself is therefore a relatively minor concession, affecting the timing of collections; it was partially practiced for a time in Denmark, with a 9% levy being made on imports compared to a standard TVA rate of 12.5%. Rather, if a significant favorable change is to be made in the treatment of imports, they must either be overtly subsidized, or, what amounts to the same thing, the producer employing imported inputs must be given credit for taxes not actually paid on imports. Such a subsidization of imports (together with taxes on exports) was used by Germany from November 29, 1968, until the float of the German mark in the fall of 1969. On exports, no tax is collected; in this respect, the TVA is like ordinary single-stage taxes. There is no refund on exports as such. However, credit is granted for taxes paid on inputs used in the production of exports, just as it is granted for taxes paid on other inputs. Under the "regime suspensif" in France, the above procedures are modified, although this has little economic effect other than its effect on the timing of tax collections. Most exporters operate under this "regime," under which they obtain tax-free inputs for goods intended for export, up to the value of their exports for the previous year. In effect, the German system of tax payments on inputs, followed by rebates, is simplified in the case of most French exports. II. UNITED STATES OBJECTIONS TO THE PRESENT GATT RULES There are three different elements to United States objections to present border adjustments. In the first place, these arrangements seem unfair to the businessman engaged in international trade. Secondly, the balance-of-payments consequences of the present rules may be looked at in a more complex manner, involving the incidence of direct and indirect taxes, Thirdly, particular problems arise when changes are made in border adjustments. The Simple Case Against the GATT Arrangements: The Apparent Unfairness of the Present Border Adjustments Taxes may be viewed as a cost of carrying on business, and therefore taxes, like other costs incurred in the process of production, must be included in the final price of the products. The United States exporter pays the major business tax in the United States (the corporate income tax). Then, when he exports his goods to Europe, they are subjected to a major European tax-the TVA-when they enter at the border. Thus, if he wants to compete with the European on his home ground, he sees himself at a double disadvantage, paying both the U.S. income tax and the European TVA. In contrast, when the European businessman wants to compete with the American company in the United States market, he pays neither the TVA (since rebates are granted on the TVA already collected on exports), nor does he pay the U.S. corporation tax. In passing, it should be noted that the above simple statement leaves out a number of points which would be considered very relevant by the European businessman. In the first place, while he does not pay the U.S. corporation tax, there are corporation taxes at home, some of which |