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Wednesday, April 25, 2012

VAT vs Corporate Income Tax, Part 2

Between Part 1 and Part 2 I have been considering Wayne's set up and how we can glean anything useful from it in terms of meaningful real life analysis.  It is one of the down sides to stripped down examples.  The devil is always in the details.  I don't believe that things are as disproportionate as they appear at first glance when we add the realities that the countries with VATs actually do levy a corporate income tax in addition.  And the company in the VAT country will not only pay income taxes in their country but in the Unites States as well. 

Whereas the US company would pay income taxes in the foreign country as well as the VAT tax.  But, the foreign income tax paid can be used to offset the US tax so the foreign tax may not be a factor in the total tax cost for the US business. 

So here is what we have:

VAT company...income tax, maybe income tax for both their country and the US, depending on that country's tax laws. 

US company...US income tax + foreign country's VAT

This analysis leaves us with the impression that, due to the VAT the US company gets the worst of it and that IS highly likely, but due to the nature of the United States tax laws it is by no means guaranteed.  To be conservative let's assume that the US company gets the worst of it and therefore is at a competitive disadvantage.  What change or changes could we make to create a more level playing field?

When a VAT country sells goods to a foreign country, they pay the VAT and then get a rebate for it from the government.  Wouldn't it be similar if the US tax law allowed the US companies a VAT credit for VAT paid.  Then, we would be looking at income tax laws vs. income tax laws.  That is the solution that jumps out at me.


  1. In a previous discussion on this blog we discussed tax code expenditures which is what a credit to US companies for VAT paid (when selling to a foreign country) would be. Something of a “Catch 22”

    While potentially enhancing foreign sales (the good) it would result in fewer taxes being collected (the bad?). And then we have to consider what other countries would change in response to our change. The search for a level playing field is elusive indeed.

  2. Tom, that is a very good point (I'm sure you already knew that). If government assists businesses in being more competitive, one of the expectations would be an increase in profits subject to income tax. Also, VATs are deductible for income purposes now. That deduction would no longer be available if businesses were allowed to take a credit. So between the loss of the deduction and the hope of higher profits subject to income taxes, the net change to tax revenues resulting from allowing the VAT credit could be negative, but there is a chance it could be positive.

  3. We do not have a Federal VAT tax because the Democrats focus on the fact that it is regressive and the Republicans focus on the fact that it would be a cash cow to the Federal Government.

    We will get a VAT tax as soon as the Republicans focus on the fact that it is regressive and the Democrats focus on the fact that it would be a cash cow to the Federal Government.

    I don't remember who said that first. I wish it had been me.