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The Benefits of a Business Cash Flow Tax

Posted on November 14, 2016 by Elliott, Amy S.

Top tax lawyers gathered in Chicago to discuss transfer pricing challenges, but given Donald Trump's election win, they ended up discussing the possibility that the U.S. could adopt the destination-based consumption tax proposal floated by House Republicans.

The proposal -- one of many included in the June tax reform blueprint -- would eliminate taxes on items that are produced in the United States and shipped offshore while taxing items that are produced offshore and imported to the U.S. The proposal has been described as a subtraction method VAT with a deduction for wages. 

John M. Samuels of the Blackstone Group LP warned that the proposal is no longer "academic and pie-in-the-sky stuff." He said he thinks the Trump administration will defer to House Speaker Paul D. Ryan, R-Wis., and House Ways and Means Committee Chair Kevin Brady, R-Texas. "In the next two, maybe three months" the blueprint is "likely to be front and center in the House of Representatives," Samuels added. He and others spoke November 11 at the annual Federal Tax Conference sponsored by the University of Chicago Law School.

Samuels said the proposal is interesting "because it raises a huge amount of revenue from the border adjustments. We run a trade deficit of about $500 billion a year. A 20 percent tax on those imports is -- over a 10-year period -- $1 trillion." He said a destination-based consumption tax would make irrelevant all of the transfer pricing games taxpayers play, such as moving where research is done, where intellectual property is owned, or where manufacturing is located. "We spend our lives planning by moving the factors of production, but the one thing we can't move is where our customer is," he said.

Itai Grinberg of Georgetown University Law Center agreed that given the results of the election, the chances for tax reform based on the model in the blueprint "have gone way up" and that the proposal would, among other things, "eliminate all transfer pricing problems." He explained that it does so by replacing the traditional corporate income tax, which commentators agree is inefficient and distortive.

Grinberg said that the destination-based cash flow tax (DBCFT) in the blueprint is similar to a 2005 proposal in the report authored by the President's Advisory Panel on Federal Tax Reform. He explained that a business subject to a DBCFT would subtract the value of all of its non-labor inputs purchased from other entities subject to the DBCFT from the total value of its sales and then multiply the result by the rate to determine its tax liability. Also, businesses are permitted to subtract amounts paid to employees as compensation, but only for wages paid to people subject to U.S. income tax, he said. "Effectively, what one has done is taken the wage portion of our current individual income tax and made it part of a progressive consumption tax."

Grinberg said that after the various subtractions, what's left is a tax on so-called economic rents.

The WTO Hurdle

There's an outstanding issue on whether the proposal would withstand scrutiny by the WTO, which generally prohibits countries from using their income tax regimes to help exports and hurt imports. Grinberg wrote an article back in 2006 titled "Implementing a Progressive Consumption Tax: Advantages of Adopting the VAT Credit-Method System," which addresses the issue. 

Grinberg explained that the WTO's Agreement on Subsidies and Countervailing Measures says that if a country provides "a subsidy for labor outside the tax code, that is not a WTO problem." He said if the proposal were to remove the deduction and replace it with a business-level wage subsidy, it wouldn't run afoul of the WTO.

Grinberg focused on the benefits of the proposal, which he said aren't limited to efficiency and growth. "From an intergenerational perspective, what the long-term budget outlook highlights is this national tax and spending plan that asks the next generation to pay through income taxes for fast-growing, unfunded liabilities that baby boomers are going to be the primary beneficiaries of. One would think that a just society would try . . . to spread those costs out a little bit," he said. A business cash flow tax does that "in a way that an income tax can't" by "appropriately" taxing existing wealth.

Stephen E. Shay of Harvard Law School said he thinks older Americans worried about the impact the proposal will have on their savings won't generally support the plan. "It's a radical change from where we are. The notion that we should do this in 100 days" is a dangerous one, he indicated. "I really encourage all of us to just think hard and work through the issues that are being discussed because . . . there's a lot of work to be done, and there are a lot of implications of this proposal that have not fully been thought through."

Grinberg pointed out that the proposal completely protects Social Security spending from taxation.

But Paul Oosterhuis of Skadden, Arps, Slate, Meagher & Flom LLP said that when lawmakers figure out the proposal would likely increase the prices of goods and services, "they may have second thoughts about it."