March 4, 2025 marks the beginning of a new trade war that the United States has launched against Canada. The trade war that the first Trump administration started in 2018 ultimately ended with a new trade agreement, the Canada US Mexico Agreement (CUSMA). This time around, it is far from clear what the second Trump administration is trying to accomplish. The declared reason in the Executive Order invoking the US International Emergencies Economics Power Act, fentanyl and migrants crossing the US's Norther border, is a complete fabrication that does not withstand empirical scrutiny. In fact, Canada has deployed significant new resources dealing with border issues. Prime Minister Justin Trudeau concluded in a televised speech earlier today that Trump "[...] wants is to see a total collapse of the Canadian economy, because that'll make it easier to annex us." If that is what Trump has in mind, he will find out that Canadians are more resilient than he imagines. Canadians are proud to be Canadians. Canada will not join the United States through economic coercion.

On February 26, US Commerce Secretary Howard Lutnick warned Canada that our Goods and Services Tax (GST) would become subject to "retaliation". He accused Canada of "cheating around the sides" and "cheating right down the middle" of our free trade agreement [source]. Lutnick is the former chairman and CEO of Cantor Fitzgerald and BGC Group, so you would expect that he would be familiar with basic economic principles. Instead, his statements reveal either a complete lack of understanding of the economics of taxation, or a willful disregard of his knowledge in making blatantly false statements. This makes Lutnick either ignorant or mendacious; take your pick.

For the record: value-added taxes are not hidden tariffs. The sales tax applies equally to domestic goods and imported goods. Canada's GST (or Harmonized Sales Tax, HST, in some provinces) does not discriminate between domestic and foreign goods. It is simply a broad and efficient way of taxation as is found in most developed nations. The United States has sales taxes in many states, but not at the federal level. Canada's GST is different from a single-stage sales tax because it is a multi-stage "value-added tax", or VAT. It is levied along the chain of production, with producers receiving an input tax credit for VAT they have paid on their supplies, while collecting the tax on their sales to other businesses or consumers. In practice, a business ends up paying the tax only for the value they have added. That is what makes it a "value added" tax, as opposed to a sales tax that is only applied to final sales to consumers rather than to producers along the supply chain.

What happens when a Canadian manufacturer sources inputs from a US supplier rather than a Canadian supplier? The GST/HST applies to all imports. Let's say the manufacturer buys $100 worth of inputs from a Canadian supplier, who charges our manufacturer $105, which includes the 5% GST. The manufacturer processes the input and sells a final good for $160, plus 5% GST, so $168. The manufacturer collects $8 in GST, but can claim a $5 input tax credit, and in the end remits only $3 to Canada Revenue Agency. The Canadian input provider had previously remitted their $5 of GST to Canada Revenue Agency as well, adding up to $8 in total. Now the Canadian manufacturer replaces the Canadian input with an identical item produced in the United States, again worth $100. Then the manufacturer is responsible for paying the $5 of GST, but at the time of importation. The manufacturer then adds their own value, and remits the other $3. So in the end, both foreign and domestic input provider are treated equally and fairly. They are both subject to the GST.

GST is not placed on Canadian exports, because these goods are not sold in Canada. So here the economic logic works slightly differently. The Canadian manufacturer would sell their final good to the United States at $160, not $168. The manufacturer receives the $5 input tax credit, but the input provider paid the $5 GST. So these two transactions add to zero, and the Canadian government gains no revenue from exported goods. Again, the GST is a purely domestic Canadian goods on anything sold in Canada. But it doesn't discriminate against foreign producers.

Of course, each country can apply their own VAT, and most countries do. The exception here is the United States, which does not make use of this instrument at the federal level. However, forty-five states have state-wide sales taxes, and the highest rates are found in Louisiana, Tennessee, Arkansas, Washington, and Alabama [source]. Combined taxes in Canada tend to be higher, as we also have provincial taxes or harmonized sales taxes. In British Columbia, the combined rates is 12%, while in Ontario, the HST is 13%. The average VAT rate across OECD countries is 19.3% [source]. If the United States wants to be a low tax jurisdiction, that is their choice to make. But it does not amount to an unfair trade practice if other countries have higher rates. Canadian manufacturers do not receive an unfair advantage in the United States.

Furthermore, a 2021 research paper by Youssef Benzarti and Alisa Tazhitdinova found only small elasticities of trade flows with respect to VATs, even when VAT changes are large. These elasticities are substantially smaller than the elasticities of trade flows with respect to tariffs estimated in the trade literature. In essence, VATs are unlikely to distort trade flows.

So what is Mr. Lutnick talking about? His assertions are ludicrous. Value-added taxes are not tariffs.