Taxation and International Trade

 

     There is another aspect to the economic effects of taxation not covered adequately in the 'Economics of Taxation 101' post: the impact on international trade. With President Trump reviving tariffs as a tool of international policy, the ramifications of that and other taxes are worth examining.

    Everyone has heard from time to time that a given country – ours or others' – is blessed with an abundance of natural resources. This is obviously a good thing, but if the inhabitants of the country merely sell off the non-renewable resources, a wealthy country can quickly be reduced to ruin and destitution. A few natural resources are not expendable, such as climate, access, etc., which can be lumped into the Realtor's favorite line – location, location, location. Virtually everything else can be exhausted or decimated for short term profit. Taxation can play a major role in either facilitating or discouraging the demise of a country's natural resources.

    Development of mineral resources can contribute positively to the wealth of a country, but not in the long term if they are liquidated in international trade. On the other hand, consumable resources such as fossil fuels can be depleted internally or externally if not given the proper respect as finite non-renewable assets. In either case, the fairly obvious policy a country should pursue with all non-renewable resources is to try to conserve them for posterity.

    So what should be the proper approach to international trade? Ideally one should export renewable assets, primarily labor, and strive for at least net zero export of non-renewables. In fact, a net positive import of non-renewables is desirable, with export profits being based on value added to imported raw materials by labor and manufacturing. This strategy, in fact, been responsible in a large part for the ascent of China in recent decades.

    The role of taxation for encouraging the principles described above is to discourage or restrict export of non-renewable raw materials; to NOT tax the contribution of labor to exported products; to discourage imports to the extent that they are primarily labor intensive; and to encourage to the extent possible the import of non-renewable raw materials. Tariffs can be useful for achieving the proper balance of types of imports, but should not interfere with obtaining raw materials.

    As usual, the Income Tax is perhaps the worst offender in achieving the desired trade objectives. It taxes the labor and value added of Americans at the source and throughout the supply chain, and therefore works diametrically opposite to the strategy outlined above. It does not tax exported non-renewable raw materials, but instead taxes any American labor involved in producing and shipping them. As this blog has repeatedly emphasized, THE INCOME TAX MUST GO!

    Sales Taxes, on the other hand, tax some or all goods and services consumed by the residents of a country. In this country State sales taxes are a levy on American goods and services, but also a levy on all imported goods. Unfortunately, they usually do not tax foreign services rendered by mail, telephone or internet. A National Sales Tax would treat domestic and foreign entities equally, and would also be more or less equivalent to an across-the-board tariff of the same rate. This would then make any additional targeted tariffs more advantageous to American producers and a more flexible tool for trade negotiations.

    It is worth noting that a tariff is essentially a sales tax levied on specific imported goods or on imports from specific countries. It is levied on imports at the time and/or place of import and not at the point of sale. This differs from what Americans are accustomed to, as sales taxes in this country are levied by each State at the time of sale as an add-on. Thus the tariff sales tax is buried in the price of the affected goods and as such goes more or less undetected by the consumer. A National Sales Tax could be implemented in a similar manner.

FUNDAMENTALS OF TAXATION 101

 

This essay will examine the various taxation schemes governments have devised to fund their parasitic existence, and to fund their operations, both desirable and undesirable. In addition we will examine who pays for this largess, and show that with little exception all taxes are paid by the consumer.

To begin with it is desirable to categorize taxes into two groups, direct and visible taxes, and indirect and invisible taxes. The first group includes, among others, point of sale taxes, title taxes, excise taxes, real estate taxes, property taxes in general, and of course income and payroll taxes. The second group includes inflating the currency, tariffs, sales taxes that are embedded in the price, and oddly also all of the direct taxes, including income taxes. This latter point is little appreciated and the major impetus for this essay.

The fact that virtually all of group one taxes directly affect the price of goods and services purchased in the market leaves little doubt that these taxes are paid by the consumer. They either reduce the amount of money that the consumer has to spend in the market place, or they increase the price of the goods and services the consumer buys. The direct taxes are plainly visible and can be understood by every consumer that is affected.

On the other hand the indirect and invisible taxes require considerably more time and thinking to appreciate how much is paid and by whom. These taxes deserve a more thorough discussion.

Inflation of the money supply is only possible in the case of fiat currencies. Unfortunately virtually all of the major currencies in the world are now fiat currencies and can be increased at will by the controlling governments. In the case of the U. S. and the dollar, this is accomplished by the Federal Reserve, which is supposed to be independent of the government but is in fact a creation of the Federal Government and therefore ultimately under its control. Thus creation of more money by the U. S. government is not only possible but has been used more and more to cover deficits between income and spending. This is a tax on everyone that uses dollars in that the extra money created and spent by the government drives up dollar prices for everyone else.

President Trump has reintroduced tariffs, i.e. taxes on imported goods, both for income for the government and as a economic weapon against foreign countries. Tariffs can increase prices of imported goods to compensate for the increased prices of domestically produced goods due to various taxes paid by domestic producers, but in that case tariffs are paid by the U. S. consumer. However, if the foreign importer has enjoyed a windfall profit by pricing his goods the same as the domestic producer, he can eat some or all of the tariff. Unfortunately the American consumer still pays the same elevated price, but in a real sense the importer is paying the tariff.

In the U. S. most sales taxes are only applied on final retail sales, so the embedded sales tax is mostly irrelevant here. However, ALL the direct taxes – real estate taxes, retail sales taxes on capital expenditures, income and payroll taxes, etc. – that are paid by every U. S. entity involved in getting the goods and services to the consumer are also embedded in the price and are therefore paid by the consumer both in and out of the country.

This last point is the main takeaway from this essay. Every American that contributes to making goods and services available to the market has to include all the taxes he pays in his price for his contribution to net a desired or necessary profit to support his existence. Thus the fundamental fact is that the consumer pays virtually all the taxes, not the worker making the product, not the corporation he works for, not the rich ;individual who owns the corporation that the socialist claims will pay, not even the trucker who delivers and the retailer who sells the product. All of these pay taxes only to the extent that each of these consumes the goods in the marketplace. The consumer pays either by sales, excise, tariffs, etc. taxes embedded in the prices of the goods and services he buys, or by losing buying power with the income, real estate, personal property, etc. direct taxes he pays. Even the parasitic welfarite that lives off of government largess has his or her consumption reduced by the price increases representing the taxes added.

The principle presented in the last paragraph is why the Income Tax is such a bad idea, and why replacing it with a National Sales Tax is greatly preferred. Even if such a tax would be at a rate to replace the Income Tax revenue to the government, the consumer would not be paying more that he does now since he pays it all anyway. In fact, by eliminating the gargantuan IRS empire and the indirect costs to business of complying with the insanity of the Income Tax code, one would expect that effectively the consumer would pay less. It is almost impossible to put a number on the indirect costs referred to here, especially since currently every business decision is made worrying about the tax considerations. No wonder Marx listed a graduated income tax as a major tool in destroying a country.

One last consideration as to why the Income Tax is a terrible idea. The contribution of the Income Tax to the price of all goods manufactured in this country makes a major contribution to why American exports are non-competitive in world markets. This burden cannot be offset with tariffs or the like, and the elimination of such would go much further than tariffs to make the U. S. a dominant economic player in the world markets.

Years ago Milton Friedman stated the principle that the total taxes that a government takes in must equal the total expenditures. The U. S. government does not really operate with a 'deficit'; it just collects that part of its income from the indirect and invisible taxes. This author would add the principle discussed above that all taxes are ultimately paid by the consumer. These two principles should allow taxes to be understood in spite of all the noise surrounding the subject.

Income Taxes, Consumption Taxes and Tariffs

Currently (April 2018) there is considerable debate raging as to the wisdom of the Trump proposed tariffs. As one more opinion on the subject, I would like to frame the argument in terms of who pays for maintaining the U. S. marketplace rather than in terms of punitive actions and retaliatory reactions in the form of tariffs.

Since the government's income in the U. S. is primarily derived from taxes, and in particular from income taxes, the government's costs of providing the infrastructure - currency, roads, courts, etc. - is paid in this country by the individuals and companies (which again boils down to the individuals) that pay the income taxes. Thus the participation in the U. S. markets by foreigners is a free ride since they do not pay U. S. income taxes. This is why U. S. made goods do not compete in both domestic and foreign markets.

The use of tariffs to level the playing field does provide a mechanism to make foreign sellers contribute to the costs of maintaining the marketplace they are enjoying, but it requires much legislation and regulation to target which goods and who's selling them. This in turn engenders hostility in those targeted and invites the 'trade wars' that are the current concern of the chattering classes. A flat tariff might be preferred in that it would be less 'in your face' to the trading partners otherwise targeted, but it still reeks of hostility to 'free trade'. It also does nothing to make U. S. goods more competitive in foreign markets.

To this author, a better solution is to replace the income tax with a National Sales Tax on all new goods. With respect to incoming foreign goods this serves the same purpose as a tariff - it makes the foreign producer pay his fair share of the support of the U. S. market. It relieves the exported goods from the income tax burden that makes U. S. goods non-competitive internationally. It allows U. S. workers to compete with foreigners as well as non-taxpaying illegals. It invites less hostility since it applies to domestic as well as all foreign goods equally. It requires no additional infrastructure to assess and collect tariffs. And as a huge added incentive, getting rid of the income tax would do more to restore health to the U. S. economy than any other single action.

Replace the income tax AND potential tariffs with a National Sales Tax. A win-win-win solution.

Sales Taxes vs Tariffs

With the President pushing tariffs to level the international playing field for American producers, he and his administration should seriously consider a National Sales Tax (NST) as an alternative or at least in concert with targeted tariffs. By getting rid of the Income Tax (IT) and replacing it with a NST, the burden of maintaining the U.S. market is shared by all who participate in it.

Let's first look at the current situation with the cost of the U.S. Government being primarily carried by U.S. citizens under the IT. Even with the new 'tax reform', a dollar earned by a typical citizen is first reduced by 25 cents with federal IT and a nickel for payroll tax. Then in most states, at least another nickel is appropriated by state IT, and a further nickel in state sales tax on the products bought with the 65 cents remaining. Thus the American consumer loses a third of his buying power regardless of where the products originate.

The labor cost for the U.S. producer is the full dollar cited above plus the employer's share of the payroll tax, plus of course any additional overhead for health benefits, etc. If the employee then buys his company's product, he is in effect paying, say, $1.10 (just for the labor costs) for which he netted about 60 cents. His own labor is costing him twice what he received for it.

The additional cost of a tariff on the imports used in making a given product could vary widely, but even for an equivalent product (a TV or an auto) subject to a tariff, the consumer ultimately pays the extra amount with the reduced buying power of his taxed income.

If the income taxes (and payroll taxes) are replaced by a NST of 30% (the rate proposed by the Fair Tax), the consumer will pay $1.30 for the labor share of a domestic product for which he received $1.00, or about 30% more. He will still bear the extra amount of a tariff, but with a net income of the full dollar rather than 60 cents. The tariff will still penalize the foreign producer relative to the domestic producer, but the impact to the U.S. consumer is a third less.

Even without a tariff, a NST taxes the foreign product at the same rate as the domestic product. This not only levels the tax burden between the foreign and domestic producers, but considerably enhances the competitive position of the domestic producer in the foreign markets since there is no taxation on labor for exported products. And, since the product rather than the labor involved in producing it is taxed in the U.S. market, automation and foreign labor (or even undocumented labor) hold no advantage for the domestic producer.

As we see, in many respects the NST achieves the same result as an import tariff, with considerable benefit to domestic production and consumption as well. Since all imports are equally affected, a retaliation in the form of a 'trade war' is unlikely. If, alternately, a penalty is intended for a given country's products, selective tariffs can still be imposed for political reasons.

The use of a National Sales Tax instead of the fatally flawed Income Tax is a no-brainer, but implementation in the short run begs caution based on system engineering considerations. Step functions - a sudden major change in inputs or characteristics in a dynamic system - can produce wild deviations before ultimately settling out to the long term behavior. Thus, although the NST in the long run is to be preferred, ramping it up as the IT is ramped down (say over 5 years) may be necessary. However, in no way must the IT be allowed to exist past the phase-out period. Ultimately the 16th Amendment must be repealed, and ITs forever banished in the U.S.