Want to drive my Lamborghini?
Why the nature of trade with Mexico is inherently imbalanced
In a July 2016 NBC News/Wall Street Journal poll, 55 percent of Americans said they favor free trade and think it is good for America. Donald Trump regularly brings up free trade and rails on the topic, stating that we have negotiated some really lousy trade deals with other countries.
This subject hits home with average Americans, not because they are all well-versed in the nuances of what a good free trade deal should look like, but because many have felt the pressure of good-paying jobs leaving America, and New Hampshire, for some obscure overseas location or, worse yet, south of the border in Mexico.
Mr. Trump has briefly tried to describe the problem with the trade deals, alluding to different business tax systems around the world. All this did was inflame the actual and armchair economists, many stating that he does not know what he is talking about. It may, however, be that all of these experts are simply not listening.
About 140 countries around the world use a tax system called a VAT, or value-added tax. This system is like a sales tax. In the case of Mexico, the VAT is 16 percent. Countries that use a VAT generally exempt sales outside the country (export sales) and only tax sales inside the country. The United States does not use a VAT system. We tax business profits.
The way this works in practice is:
• If a U.S. company sells to a company in the U.S., there is zero VAT.
• If a U.S. company sells to a company in Mexico, there is a 16 percent VAT.
• If a Mexico company sells to a company in Mexico, there is a 16 percent VAT.
• If a Mexican company sells to a company in the U.S., there is zero VAT.
Criticism of Trump points out that there is a level playing field. All of the sales in Mexico are subject to a 16 percent VAT, whether from a Mexican company or from a U.S. company. And, none of the sales in the U.S. are subject to VAT, so again, there is a level playing field.
Paul Krugman, the Nobel Prize-winning economist, commenting on Trump’s statement said, “It [VAT] is levied on both domestic and imported goods, so that it doesn’t protect against imports — which is why it’s allowed under international trade rules, and not considered a protectionist trade policy.”
With all due respect to Mr. Krugman and the other more esteemed people motivated to criticize Mr. Trump, they are missing his point. The tax does not cause an unfair trade advantage at the transaction level, which is the criticism they are leveling. It does, however, amplify the inherently imbalanced nature of the trade deal.
The U.S. has the largest economy in the world at $19 trillion. Mexico has the 15th-largest economy at $1.1 trillion. In the NAFTA trade deal, the U.S. agreed to provide Mexico with free-trade access to the U.S. markets, and in return, the U.S. gets free-trade access to the Mexican markets. So, we “traded” access to a $19 trillion market for access to a $1.1 trillion market. Who is smarter than a 5th-grader?
If I had a manufacturing company, why would I not set up in Mexico and ship all my products back to the U.S.? In addition to the lower overall business costs, my exports from Mexico are not subject to VAT. I can manufacture goods and ship them to the U.S., and I do not have to pay into the Mexico VAT tax system. In addition, goods sold in the U.S. markets are not subject to U.S. business profits tax, because I operate in Mexico.
Think of it this way: Imagine that you want to enter into a free-trade car deal with your neighbor. He can drive your car any time he wants and you can drive his car any time you want. The only difference is that you own a Lamborghini and he drives a Toyota Corolla. Doesn’t sound like such a great deal, does it? Oh, and let’s not forget, you also agree to pay for your own gas (a system that taxes business profits) and pay to put gas in his car (a system that taxes sales, VAT.)
Donald Trump has been in business for a long time and has achieved a very high level of success. When he outlines a problem with the system, elites – who have not achieved anywhere near his level of success – should pause for a moment and make sure they understand what exactly Donald Trump is talking about before they start to pile on.
Republican Frank Edelblut is a state representative from Wilton.