Lindsey, Lawrence B., “The Budgetary Case for Fundamental Tax Reform,” testimony before the Senate Budget Committee, 02/02/11

The third major problem with our income based system is that it encourages economic activity to go abroad. An item that is manufactured in China but purchased in America has a cost structure that involves no U.S. income or payroll taxes on its labor content and virtually no U.S. corporate tax on the capital involved in the production. Of course China does have an income tax, but it is quite low compared to ours. The Chinese Individual Income tax produces revenue equal to just 1.2 percent of GDP compared to roughly 7 percent in the United States. The largest component of the Chinese tax system is the Value Added Tax, which generates roughly one third of all Chinese tax revenue. But Value Added taxes are rebated on exports, so this tax does not apply. Conversely, an item built in America and then sold to China involves labor costs that pay both income and payroll taxes and capital costs that involve the whole panoply of U.S. taxation. When they arrive in China the import cost is subject to Chinese Value Added Tax. And this is not just the Chinese. Throughout Europe Value Added Taxation has increasingly replaced direct taxation on personal and corporate incomes over the last couple decades and under World Trade Organization rules it is perfectly legal for them to rebate the tax on exports and impose it on imports.

We complain a lot about the advantages the Chinese give themselves through
manipulation of their exchange rate. At the same time we induce this massive self inflicted wound on ourselves in the form of our income based tax system. And whenever someone advocates raising rates within our current tax regime they are implicitly calling for these distortions to be larger and therefore for Chinese goods to become even more competitive here and our goods to become even less competitive overseas.