Tariffs were bad, but VAT taxes? They’re just another way to make you pay more. Here’s the real math behind it.
KEY TAKEAWAYS
MY HOT TAKE
A rose, by any other name… Alas, you will be treated to—yes, another treatise on trade-related taxes. Before we begin, I have to get two things out there. First, remember my rule: policy not politics! This is a quick reminder that I have no horse in this race, I simply want to provide an objective view on policies that will affect YOUR MONEY—regardless of whose policy. Second, I want it to be clear that I understand the intent of these policies, which I believe to be noble, but we must still be judicious in our unbiased analysis of policies—it is, after all, our hard-earned money on the line. Now let’s get into it.
We will start with a quick refresher, because inflation is a complicated thing, and either politicians don’t understand it, or they are using its ambiguity to conceal private agendas. I don’t know, I will let you decide that. Inflation, my friends, is a rate of change. At a high level, it simply is a measure of the change in prices of goods and services over a defined period of time. Here is the formula:
Inflation rate = ((Current price level – Previous price level) / Previous price level) * 100
So, if eggs are now $4.95 per dozen, and they were $2.50 per dozen last January, we can calculate their rate of inflation.
98% = (( 4.95 – 2.5 ) / 2.5 ) * 100
These are actual numbers, and egg prices have, indeed, increased by 98% in the past year. It’s just math, stupid. Now, when you go to the grocery store and pick up a carton of eggs, you may mentally attempt to calculate the increase, but ultimately it is THE ACTUAL PRICE that concerns you. Why? Because it comes out of your budget; you have to pay it! Got it? Good, now let’s move on.
We have been talking a lot about how tariffs are inflationary. A lot. I am pretty sure that the general consensus is that tariffs are inflationary. Import tariffs are paid by US importers to US Customs. US importers, not foreign governments, or exporters. Those importers pass all or some of the additional cost on to consumers. You will pay more for any good that has originated, in part or whole, from a tariffed country. If you want, you can plug the numbers into the equation above ☝️🙃. The first number in the numerator gets bigger, and it is diminished by a constant, so inflation goes up. It’s just math, stupid. Keep that thought.
Yesterday the stage was set for a big announcement. Social media posts from POTUS hinted that some massive counter-tariffs would be announced yesterday. The President, amidst many other pronouncements, did ultimately announce that he would levy VAT taxes on any foreign trade partner that currently tariffs US exports. The good news is that there are no taxes yet, as that Howard Lutnick, Secretary of Commerce, was tasked with studying the current trade environment and ultimately providing recommendations by April 1st. The markets celebrated the delay by rallying—proof that the markets, too, believe tariffs to be inflationary. The real proof of this came from the bond markets where 10-year Treasury Note yields declined by 9 basis points on a day when we got a hot PPI print.
Yesterday’s revelation was that the President’s advisors had come up with VAT Taxes as an alternative to traditional tariffs, and that, somehow, they would not be inflationary. When pressed whether these new VATs would be inflationary, the President, did offer a “maybe.” Thank you, but YES, they are inflationary!
VATs, or Value-Added Taxes are levied against all goods that arrive on shore. The importer pays the tax to US Customs! The key difference between VATs and tariffs is that the importing company can deduct the tax, but only if it is not the end consumer. So, for example if an importer imports a car from the EU for $30,000, the importer pays US Customs a 20% VAT ($6,000). When the importer sells the car to a consumer at retail for $40,000 (you and me), it will charge a 20% ($8,000) VAT to the consumer, so the consumer will ultimately pay $48,000. The $8,000 VAT is collected by the importer. Because the importer already paid $6,000 when it imported the vehicle, it will pay the difference of $2,000 to the government. I know it’s complicated, but stay with me, we are almost there. SO, the government collects $8,000, the importer is reimbursed for its original tax, and the consumer pays $8,000 in VAT. You got it? CONSUMER PAYS FULL VAT! This same concept works with multiple levels, where all parties in the supply chain are made whole from the next node down, but ultimately the customer always pays. Always.
Now let’s go back to the inflation equation back at the top, using our car example. If you purchased a car prior to a VAT tax being imposed, you would pay $40,000 (forget sales tax for a moment). Once the VAT is implemented, you will pay $48,000. Cars will have inflated by 20%. It’s just math, stupid. Now, here is the twist. VAT is simply a way of charging sales tax, so when VAT is used, sales taxes are typically not. The government, in our scenario would collect a nice 20% tax on sales, BUT the consumer is still paying more. It is also important to note that VATs are typically charged on all goods, domestic and imported, which enables tax parity. In other words, the consumer pays the VAT regardless of where it comes from.
Now, there is actually some sort of silver lining, albeit it is a stretch. Going back to inflation and how it is calculated. We typically compare prices today versus prices from a year ago. If, as in our example, prices go up due to VATs by 20%, there will be an instant increase of 20%. Yes, that it is a 20% inflation rate. It will be calculated that way for the next 12 months, but on the 13th month it will go back to 0%, assuming the underlying prices of the car remain constant. That is why some smarter politicians will tell you that the inflation would only be temporary. Temporary, as in for the next year. And finally, the price of the car will still be $48,000 in month 13, and just like your $4.95 eggs, it is the price that actually upsets you, not some silly rate of change calculated by some nerd at the Bureau of Economic Analysis. No math necessary. 🤓 Class is dismissed.
YESTERDAY’S MARKETS
Stocks gained yesterday on news that new tariffs would not be launched—until at least April—investors were expecting yesterday. Bonds also gained in a relief rally, proof that markets believe that tariffs are inflationary. Producer Prices climbed more than expected which can be a bad omen for consumer inflation, and those hoping for lower interest rates sooner.
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