This article appeared on Inside Sources on January 30, 2017.
Republicans appear committed to reforming the corporate tax code — an act that is long overdue. The current system, with its high marginal rates on businesses and global reach, makes it extremely difficult for American companies to compete internationally. Unfortunately, Republicans also seem determined to finance part of that reform effort with a new tax on consumers that is, to say the least, a very bad idea.
House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady, R-Texas, want to replace the current corporate income tax with a “border adjustable” system, also called a destination-based cash flow tax (DBCFT). They believe the estimated $1 trillion in revenue this will bring over 10 years is needed to pay for the rest of the tax reform plan. In reality, the true costs are likely to be much higher than they anticipate.
The DBCFT exempts export-generated income from taxation and doesn’t allow any deduction for the cost of imported inputs, which is the same as taxing them. On the surface, this means shifting the tax burden more heavily onto importers, which tend to be retailers. These costs will be passed on to consumers in the form of higher prices.
Not to worry, supporters tell us, because the dollar will strengthen as a result of this new trade dynamic and offset the higher prices.
A recent analysis published by the Center for Freedom and Prosperity, titled “Political and Economic Risks of a Destination-Based Cash Flow Tax,” identifies three primary problems with the argument for a border adjustable system. One is the reliance on the silver bullet of quick and perfect dollar appreciation. The second is the opportunities that will likely be afforded to future politicians to raise tax rates easily and grow government. And third is that destination-based systems undermine the ability of tax competition to serve as a check on political greed.
The hope that the dollar will rise enough to offset completely consumer price hikes is a speculative basis on which to hang the welfare of millions of Americans. There’s evidence enough to question whether the dollar will jump the full amount needed to offset the tax. Even if it does, the result will be huge losses in value for American holders of foreign assets. This is probably why President Trump recently commented that the idea was “too complicated.”
Significant risk also comes from the plan’s similarities with a VAT, or value-added tax. VATs are pernicious because they have a large tax base and are hidden from consumers. Increasing the VAT rate often thus becomes too alluring a prospect for politicians to pass up and undermines any chance for fiscal discipline. The imposition of VATs goes a long way toward explaining the more explosive growth of European governments compared to that of the United States over the last half-century.
The DBCFT isn’t precisely a VAT, but it comes very closely to being one. It just exempts labor compensation from the tax base while VATs do not. But even that difference might not last.
It’s debatable whether the tax would pass muster at the World Trade Organization. If the WTO does rule against it, then the easiest and thus most likely political response will be for whoever is in charge at the time to turn it into a full VAT.
Even if that concern proves unfounded, the DBCFT may be doing enough already to contribute to the future growth of government.
Tax competition helps protect taxpayers from excessive taxation because politicians who attempt to impose onerous burdens will see their base flee for better jurisdictions. That can’t happen with a destination-based system, which is why the tax has been championed by a prominent academic on the left like Alan Auerbach. He touts that the DBCFT “alleviates the pressure to reduce the corporate tax rate,” and celebrates that the new system will be “more progressive.”
A recent survey from the U.S. Consumer Coalition reports that voters would prefer tax cuts be offset by spending reductions instead of new taxes in other areas. So if Republicans insist on starting from the erroneous assumption that pro-growth tax cuts need to be “offset,” then they should move the tax cut alongside some or all of the $10.5 trillion in cuts reportedly desired by the administration. Else, they risk enabling the left to achieve something they have thus far only dreamed of: a European tax system capable of fueling European levels of government spending.