Thomas Schinkel and Associates

In part one of this series, I described the major societal changes underway that will have a transformative effect on every major aspect of our economy. Many of these fall within the public policy realm. For example, if you look at how America will be retooled, you can quickly begin to draw a picture such as the one below:

Major changes are under way already in each of these categories. They will profoundly change the U.S. by 2015, a mere five years from now. Today I focus on a  complex, seemingly mundane issue that I believe is at the root of some of our problems. If you look at the American economy from 35,000 feet, in a simplified way, the following picture emerges:

The upshot? The structural trade imbalance suggests that our exporters are not exporting enough and our appetite for imported products is out of control. Also, the Federal government is either spending too much money or not collecting enough from taxpayers. This is a strange combination of circumstances since we have the largest economy in the world, plenty of highly talented people, and more than our share of enterprises capable of handling international markets. For the longest time, I thought this imbalance had to do with our shift to a services economy.

Then I began to investigate whether other countries that had gone the same route must have the same conditions. My first stop was Sweden, one of the most advanced economies in the world with as large a services sector as America’s. My finding was a real surprise to me.

It turns out, Sweden does not have a trade deficit. To the contrary, that seemingly “tired old socialist country in the North of Europe” is doing very well. Sweden is balancing its trade relations with the world, and makes lots of money internationally from their services sector, much more so in relative terms than we do in the U.S. Sweden is a small country and I began to wonder if perhaps I was comparing apples to oranges? Not satisfied, I went to the Japanese trade statistics and found the following picture, courtesy of JETRO:

To my astonishment, I had to conclude that Japan – which like the U.S., Sweden and Europe, also has a large services sector — does not have a trade deficit either. Their services are in deficit, but they make it up handsomely with their merchandise exports. Again, not completely satisfied that I was comparing apples to apples, I looked at the European Union which has an economy that is actually numerically larger than the U.S. but with plenty of problems in its own financial services sector, with sovereign debt, etc. I wanted to compare the EU’s international trade position with that of the U.S. as in the following chart:

What does this really mean? Then, suddenly it dawned on me what the problem is. Drawing on two previous experiences in my own career as a business consultant, I remembered several intervals that related to fiscal policy, here in America and in Europe. The Europeans during the late 1960′s and 1970′s were under tremendous pressure from American corporations to restructure their economies. One thing they did agree upon was the implementation of a Value Added Tax (VAT). As a junior executive in the late 1960′s, I actually conducted seminars on VAT for the members of the trade association I worked for, explaining how it strengthens exporters and places a consumption tax on imports.

Later, during the 1980′s when I was working with several mid-sized companies here in New England, I again ran into the subject and I noted that my clients were able to get a refund on taxes when they exported products to overseas markets. In fact, one was a manufacturer of surgical blades, Rudolph Beaver and Son, in Waltham, MA. I worked with the owner of the company on export development programs and one of the issues we had was with overseas pricing. Under a law called the Foreign Sales Corporation (FSC) Act, they were able to claim 5% of their export sales as refunds from the federal government to compensate for the fact that their competitors overseas were operating under a VAT system and we in America were not. It turned out that under the World Trade Organization rules, the Europeans and other countries were able to convince lawmakers in Washington that this was against the new rules of the game and eventually the entire FSC program went away.

But today we are still operating under an old-fashioned hodge podge of payroll taxes, income taxes, estate taxes and property taxes, while our most important competitors have adopted a VAT system. That has helped them raise revenues for their government, but much more importantly, it has strengthened their exporters’ hands in international markets and it weakened their importers’ hands. Imports are levied the VAT, while exports get the VAT money that has been built up within the country returned to the exporter.

Now, here you have it. In America, our imports are by world standards cheap, cheap, cheap. And for the last thirty years, our exporters have always been behind the eight-ball. They have a pricing disadvantage built into the system that is directly traceable to the fiscal policies (or lack thereof)  pursued by Washington during the last thirty years. No wonder our exports are in deficit year after year. No wonder our imports are always exceeding exports. And no wonder we are not collecting the right kind of taxes! We are punishing work (payroll tax), and subsidizing consumption. Maintaining the status quo on this for thirty years, we have allowed our economy to distort into a financial services Valhalla while the value-creating industries, especially the exporters, have suffered. So, here is my wish list for action:

1. Reduce or eliminate direct taxes on work (payroll tax), property (property tax) and income (income tax);

2. Introduce a broad-based, universal system of indirect taxation focused on all aspects of consumption, a Value Added Tax.

If we do this we can expect the following:

a) Reduced imports

b) Improved exports

c) Reduced government deficit

d) Strengthened domestic production (jobs in value-creating activities)

And that, my dear friends, is exactly what the doctor ordered! Sooner or later, a Value Added Tax System will be introduced and it will be an important and effective part of the Retooling of America that is already underway.

Thomas Schinkel