Edwin Way, a graduate student at Indiana University, is a CPA research intern.  He is proficient in Mandarin Chinese, giving him the ability to read and interpret Chinese government data.

His article below shows how China finances its government through taxes on imports.  Indeed 20% of the Chinese government’s tax revenue comes from charging their value added tax on imports.  The tables at the end of the article show the tax breakdown comparison between China and the U.S.

(The opinions expressed are not necessarily those of CPA.)

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Matching Chinese border taxes would raise $2 trillion: How the US can avoid savage cuts to social security and steep income tax increases while paying for new infrastructure and leveling the playing field for US manufacturers

by Edwin Way

As Washington debates how to cut trillions of dollars from the US budget deficit, it would be wise to consider looking to China for insight. The Chinese government is not only sitting on three-trillion dollars worth of foreign currency — making it the richest entity on the planet — but the central government has enjoyed large surpluses even as it invests hundreds of billions of dollars in new schools, high-speed rail, military modernization and advanced high-tech industries.

There is much the US can learn from China given striking difference in the way the US and Chinese government raise revenue. Fortunately, while these differences are rarely mentioned, information on China’s system of taxation can be easily found on the website of the Ministry of Finance.

The biggest difference in the way the Chinese and American governments raise revenue is that Beijing relies much more heavily on import taxes. More than 20% of Chinese central government revenue in 2009 was generated from import taxes, while the comparable figure for the US was just 1.4%.

The Chinese impose three major taxes on most imported products: a value-added tax of 17% on imported goods destined for domestic consumption, a variety of consumption taxes and also tariffs which vary by import category and are generally higher on manufactured goods. For example, there is a 45% tariff on motorcycle imports, which is particularly damaging for the US given that the US consistently enjoys a large trade surplus in motorcycles.  Chinese value added tax and consumption taxes are typically waived for imported raw materials and inputs destined for goods to be exported.

China’s import taxes generate a tremendous amount of revenue for Beijing, almost 825 billion RMB in 2009 (US $126 billion at current exchange rates). This was the equivalent of about 13.5% of the value of Chinese imports in 2009. If the US had imposed a comparable level of taxes on its $1.6 trillion worth of imports in 2009, the federal government would have raised $216 billion in customs revenue rather than the paltry $29.1 billion it did raise. For Washington to have depended on border taxes for 22% of its revenue in 2009, it would have had to raise $463 billion in import taxes, which could have reduced payroll and income taxes by almost a quarter.

The difference in border taxation between the US and China is a major reason why American companies have difficulty competing. Chinese border taxes make it more difficult for American manufacturers to export to the Chinese market, even as Chinese companies enter into the US market essentially tax-free.

Neo-classical economists in particular should champion reforming the US system of border taxes to match those of our trading partners, especially China. From the perspective of orthodox economics, the lack of US border taxes significantly distorts private sector incentives. A long-standing principle of public finance holds that differing tax rates on close substitutes, say different sales taxes on varieties of beer, introduce efficiency-damaging distortions to the free market. If one brand of beer is taxed at twice the rate of another variety, consumers may switch to the cheaper, more lightly taxed beer — conceivably, even if they thought the heavily taxed alternative tasted somewhat better. This difference in taxation creates major market inefficiencies. In this context, efficiency can be improved by equalizing the tax rates applied to both kinds of beer.

The same principle applies to domestically produced goods and imported products. American manufacturers are in a position similar to the tasty but highly taxed beer variety. Currently, domestic American manufacturers must pay the government a number of taxes, including business taxes and payroll taxes, which are passed on at least in part to consumers. What about these companies’ foreign competitors? Manufacturers in China, Germany and in more than 140 countries pay primarily value-added taxes to their national governments, and these taxes are rebated to the companies when they export their goods to the United States. Because the US does not impose a value-added tax on imports and has extraordinarily low tariffs (averaging 1.4% of the value of imports in 2010), these imported products enjoy a considerable tax advantage versus their American competitors.

Just as with the example of differing sales taxes on beer, orthodox neo-classical economics suggests that economic efficiency can be improved if the US imposed border taxes on imports that equalized the tax rates on domestic and foreign products. Of course, a neo-classical economist might argue that these market-damaging distortions could also be reduced by having China and Germany eliminate their export-tax rebates. Realistically, the United States is not in a position to lecture the Chinese or Germans on how to improve their economic system. Moreover, US attempts to strong-arm the Chinese would recall the worst humiliations of the 19th century, when the British forced a defeated Qing empire to lower its tariffs to 5%, allowing in a flood of cheap European imports that helped destroy the Chinese economy.

Given that the US has virtually no influence over German or Chinese economic policies, the only reasonable way to eliminate the government distortions caused by differing border taxes is for the US to increase its levels to match those of its key competitors.

If American border taxes were increased from the current 1.6% of the value of imports to the Chinese level of 13.5%, the federal government could raise $2 trillion over the next ten years. This represents a conservative estimate that assumes that the level of imports will remain constant over the next ten years at their depressed 2009 levels. Remember, between 2001 and 2010 imports grew from $1.1 trillion to $1.9 trillion. If imports grow at just half that rate, equalizing Chinese-American border taxes could raise significantly more than $2 trillion over the next decade, helping the US avoid savage cuts to medicare and social security or steep increases in income and payroll taxes.

China’s stunning economic success suggests that raising border taxes to Chinese levels would not damage the US economy, but instead could simultaneously help resolve our current budget problems and encourage US manufacturing by leveling the international playing field. Moreover, even from the perspective of neo-classical economics as championed by Republican economists, this move would help improve market efficiency by reducing a major distortion to private sector incentives. Finally, if the US raised border taxes to Chinese levels, Beijing would hardly have cause to complain. After all, is imitation not the sincerest form of flattery?