The following is a guest article by George L. Salis, Chief Economist and Senior Director of Tax Policy at Vertex. The views expressed are solely those of the author.

As global trade and tax policies become increasingly intertwined, value-added tax (VAT) and tariffs are often mistakenly used interchangeably in recent public discourse. When this misunderstanding is put into practice, it often leads to distortions and spillover effects, creating uncertainty and risk for U.S. domestic businesses operating globally.

Although the U.S. economy remains resilient, a fundamental understanding of these cross-border tax principles is more critical than ever amid slowing economic output. Global businesses need to understand how the VAT system operates and its policy intent, how it differs from tariffs, and the practical implications when dealing with countries that have adopted VAT systems.

VAT and Tariffs: Fundamental Differences

VAT and tariffs behave fundamentally differently because they have distinct fiscal policy objectives and serve different revenue purposes. VAT is a multi-stage taxation process in which producers at each stage of the production chain pay tax proportional to their value added. Businesses receive tax credits for the VAT they bear, and ultimately consumers bear the tax burden.

Retail sales tax and VAT both target overall consumption, while tariffs are designed to regulate and balance trade by directly taxing imported goods at the border, making them more expensive than domestic products. Consequently, domestic prices typically rise to remain competitive with foreign prices. VAT also differs significantly from the U.S. sales and use tax (SUT), which is ultimately paid by consumers at the point of sale.

VAT is the standard revenue tool for most economies worldwide. More than 175 countries, including all major EU nations, levy VAT. Since the EU operates as a single market, it maintains a unified VAT system, although rates vary across European countries, ranging from 17% in Luxembourg to 27% in Hungary.

VAT Is Not Specifically Targeted at U.S. Exporters

VAT is a neutral tax imposed on both domestic and foreign goods, and therefore is not inherently discriminatory and is generally not considered a trade barrier. As a neutral tax, it treats domestic and foreign goods equally.

Although some countries may include VAT in the landed cost of broader trade or non-trade barriers, this does not mean VAT becomes a tariff, although it often leads people to mistakenly believe VAT has tariff-like properties. Consequently, governments measuring trade deficits may exploit this confusion in complex calculations, mixing tariffs with non-tariff barriers, thereby creating distortions.

VAT is also considered a "border-adjustable" tax, meaning a country's exports are exempt from VAT, while imports (e.g., goods from the United States) are subject to tax. The World Trade Organization (whose influence in international trade policy has declined) does not view this as a trade barrier because, as long as imports and domestic goods are subject to the same VAT rate, trade flows are not distorted (a view shared by most economists and countries). Tariffs may place U.S. goods at a relative disadvantage by imposing import taxes if domestic goods are not subject to a corresponding tax. In contrast, VAT does not differentiate based on the origin of the product.

To some extent, it could be said that tariffs are somewhat economically similar to a "national VAT." Although this is not their primary trade policy objective, if a fixed baseline rate exists (e.g., 10% or 20%), tariffs could indeed appear similar to a national VAT because they also raise prices for final consumers. It resembles a consumption tax because importers source goods from other countries and then (ultimately) pass the cost on to buyers. Although it behaves somewhat like VAT, tariffs are levied only once (at the transaction point)—although their impact may be "lagged," with consumers feeling it later.

Tariffs may also exert upward pressure on indirect tax rates over time. When prices rise due to any external factor, consumers and businesses respond by cutting spending. Tariffs can particularly dampen consumer demand and reduce corporate profitability, thereby affecting the income tax bases on which states rely.

In response to these revenue declines, state and local tax authorities often raise sales and use tax rates and/or broaden the tax base to include more goods and services. Recently, in early August, the Pew Charitable Trusts reported that at least 20 of the 25 largest U.S. cities are experiencing "fiscal stress... and credit rating downgrades." Although most state budgets remain stable, according to estimates from the National Conference of State Legislatures, "the federal funding landscape continues to shift," Pew Research noted.

The Unique Position of the United States

The United States occupies a unique position as one of the few developed economies without a national consumption tax. The average state and local sales tax rate in the U.S. is approximately 7.52%, with some states exceeding 10%. Taxing authority in the U.S. is shared among states, which firmly defend their prerogative to levy state and local sales and use taxes. This unique structure makes international operations more complex for U.S. businesses operating globally, as they must understand the implications of direct and indirect taxes across different jurisdictions.

Meanwhile, VAT systems are typically "unitary systems," such as in the EU. At the consumption VAT level, there is no dichotomy or separation between provincial, regional, state, and national policies.

VAT maintains trade neutrality by imposing taxes on imports while providing rebates on exports. U.S. exporters do not pay sales tax when selling goods abroad, but U.S. consumers pay sales tax when purchasing imported goods. Maintaining this balance ensures all products receive equivalent tax treatment.

Navigating the Complexity

Distinguishing between VAT and tariffs is essential for understanding network-dependent trade in the modern supply chain world. VAT is a consumption tax that is generally trade-neutral and border-adjustable, while tariffs are direct import taxes designed to influence and shape trade flows.

Amid political rhetoric and unpredictable economic changes, a clear understanding of these principles is crucial for U.S. companies. Businesses must adapt to evolving trade policies and inherent uncertainties to plan effectively and thrive in the global marketplace.