Thursday, October 16, 2008


Politicians, economists and the public were staggered by the proposed $700 billion bailout of Wall Street, a sum substantially larger than the $482 billion 2009 federal budget deficit projected before the crisis. It has been reported that retirement plans have lost $2 trillion during the last 15 months of a declining stock market.

If these numbers appear daunting, consider that the United States has already had to borrow internationally to fund trade deficits larger than the bailout each of the last three years, for a total of $2.7 trillion. And the trade deficit measures a direct impact on the real economy that has cost millions of jobs.

The issue that dominated the news prior to the financial meltdown was oil. In his ad campaign, T. Boone Pickens calls the surge in oil prices “the largest transfer of wealth in the history of mankind” and urges a policy of energy independence.

But the transfer of wealth from the United States to foreign exporters has not been mainly the result of imported oil. During the period 1997-2007, the United States ran a cumulative trade deficit of nearly $5 trillion. Just under $1.3 trillion of that was for oil (and half of that was during 2005-07). The U.S. trade deficit with China, at just more than $1.4 trillion for this period, was more than the oil deficit. The United States will have to pursue import substitution for manufactured goods as well as for oil if America is to balance its trade and pay its bills in the world economy.

Unfortunately, trade has figured only marginally in the presidential campaign. Sen. John McCain is a “free trader” whose ideological blinders keep him from seeing the same financial dangers that he saw threatening Fannie Mae and Freddie Mac when he co-sponsored reform legislation in 2005. The Republican Party platform adopted in St. Paul did, however, pledge “to enforce trade laws and safeguard our workers, businesses and farmers from unfair trade.” Sen. Barack Obama has talked about adding labor and environmental standards to trade agreements. He co-sponsored S. 796, The Fair Currency Act of 2007, that would define the currency manipulation used by China as an illegal subsidy against which countervailing duties could be levied. The idea of renegotiating the 1993 North American Free Trade Agreement has come up, but America’s main trade rivals are in Asia and Europe.

There is an anomaly in the international tax system which, if corrected, would reduce both the budget and trade deficits. Most of America’s major trading partners raise a substantial amount of their tax revenues from what is called a Value Added Tax (VAT). This is a tax levied at each step of the production process and ultimately incorporated into the final price of the product to the consumer. However, if the product is exported, the VAT is rebated. On imports, the VAT is imposed like a tariff. Indeed, as tariffs have come down under international agreements, VAT rates have gone up to replace them, and now average about 16 percent. The U.S. does not use the VAT. Its imports face these overseas border taxes, while its exporters do not receive any rebates on the U.S. taxes they had to pay. American firms thus face rivals whose tax rebates lower their costs, and whose exports then come into America tax-free.

The total disadvantage to American business amounted to some $428 billion in 2006, the latest year for which data are available. Congress tried to offset this disadvantage with the Foreign Sales Corp. tax break, but the European Union had the World Trade Organization declare the U.S. law to be illegal. The VAT is explicitly allowed under the WTO. Congress called for a revision of the WTO rules in regard to border tax adjustments in the Trade Act of 2002, but no progress has been made on this negotiating objective in the current Doha Round of talks.

To have any diplomatic leverage, the United States must stake out a strong position by its own actions. Bipartisan legislation has been introduced in the House (H.R. 2600) that would authorize the imposition of a tax on imports from any country that employs indirect taxes like the VAT and then grants rebates to its exporters. The revenue would be used to fund compensatory payments to eligible U.S. exporters to neutralize the discriminatory VAT tariff effect. These border adjustment measures would be implemented if talks at the WTO fail to remedy the problem.

Congress has been consumed by the current financial crisis, but the trade deficit will continue to impose costs on the national economy until addressed. Whoever wins the White House will have to look at the VAT border problem and other unfair foreign practices that put American firms at a disadvantage, if the fundamentals of the real economy are to recover.

William R. Hawkins is a consultant specializing in defense and trade issues.

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