Correcting the Record on Tax Reform, Part II

by Veronique de Rugy

A coalition of special interests attempting to lower their tax bill at the expense of other groups is upset with me again. They are sending e-mails to Congress complaining about my opposition to the House Republicans’ Border-Adjustment Tax (BAT). You see these guys, Boeing, GE, Caterpillar (my friends from the Export-Import Bank fight), Big Pharma, and others would love the tax to be implemented because their exports would be removed entirely from the tax base while importers (including U.S. companies relying on imports to produce their goods) and consumers could get hammered.

Last Wednesday, they were upset about my free-market/conservative argument that we could pay for tax reform by cutting spending instead of implementing a risky and distortive BAT. In the process of responding, I reminded people that the tax isn’t the feature in the overall tax plan that creates economic growth. The Tax Foundation’s estimate shows that almost the entirety of the growth comes from the other parts of the reform, such as lower rates, a move to a territorial system, and full expensing. Last week, Doug Holtz-Eakin, a supporter of the BAT, told CNBC that “tax reform is a route to better economic growth. It can produce better investment, cement the U.S. as a low tax jurisdiction in the globe. And all of those things can happen with or without the adjustment at the border.” That’s because, once again, the border tax is not where the growth in the plan comes from.

This time, the coalition complains that I don’t buy their misleading claim that we need the BAT because other countries’ tax codes (rather than our own) create a disadvantage for our exporting companies. To make the case, they enroll Larry Lindsey, the former director of the National Economic Council under President George W. Bush. They quote him saying:

Germany taxes based on where a good is going to be sold — its destination — instead of where it was produced. We currently tax based on where goods are produced and not on where they are sold. So, a Mercedes leaving Hamburg actually gets a rebate from the German government on its taxes (a so-called value-added tax) because it is destined for America, not Germany. And because we tax by where goods are produced, the Mercedes avoids taxation here as well. Alternatively, a Cadillac destined for Germany pays U.S. taxes because it was manufactured here and is then taxed again in Germany because that’s where it’s sold. So the Cadillac is taxed at two points in the chain, and the Mercedes is not taxed at all. Seem fair to you?

Disappointingly, like many others before him, Lindsey is conflating income taxes with consumption taxes and switching from one to the other without telling you that he is doing so. I have edited his quote so you can get the full information. My edits are the bold-underlined text.

“Germany’s consumption taxes are based on where a good is going to be sold — its destination — instead of where it was produced. Their corporate income tax is an origin-based territorial system. We currently tax income based on where goods are produced and not on where they are sold, and luckily for U.S. companies only selling in the U.S., unlike German companies selling in Germany, we do not have a consumption tax such as a VAT. So, a Mercedes leaving Hamburg actually gets a rebate from the German government on some of its taxes (a so-called value-added tax) because it is destined for America, not Germany. That Mercedes is also subjected to Germany’s corporate income tax because it was manufactured Germany, which starts at 15 percent but can be as high as 33 percent — i.e., it doesn’t arrive tax free in the U.S. Because we only tax corporate income by where goods are produced and we don’t have a VAT, the Mercedes avoids additional taxation here.

Alternatively, a Cadillac destined for Germany pays U.S. corporate income taxes because it was manufactured here and is then taxed again in Germany under its VAT because that’s where it’s sold. A Cadillac sold in the United States, on the other hand, is subject to only the corporate income tax. So the Cadillac destined for Germany is taxed at two points in the chain (U.S. corporate income tax and German VAT), and the Mercedes sold in Germany (which competes with the Cadillac sold in Germany) is also taxed at two points in the chain (German corporate income tax and German VAT). Likewise, the Mercedes destined for the United States is subject to only one tax (the German corporate income tax), while the directly competitive Cadillac sold in the United States is also subject to one tax (the U.S. corporate income tax). Seem fair to you? (Yes.)

Notice how Lindsey switches back and forth between the German consumption VAT and our corporate income tax — while also omitting any mention that the Germans also have a corporate income tax. He then fails to mention that there is tax parity between the German good sold in the U.S. and the U.S. good sold in the U.S. Identically, there is tax parity between the U.S. good sold in Germany and the German good sold in Germany. That’s why the World Trade Organization is fine with the current system.

I am surprised that Lindsey would make such a mistake or omit such important information.

Now, I agree that our companies are at a serious disadvantage — but it’s not because of other countries’ tax codes. It is because the U.S. corporate tax rate imposed by our government on a Cadillac is higher than the German corporate income tax imposed by the German government on the Mercedes. In addition, income of U.S. multinational companies earned abroad are still subjected to the U.S. corporate tax unless the company keeps the income overseas through one of its subsidiaries. The good news is that Congress has the power to remove these disadvantages by lowering the rate and moving to a territorial tax system like most of our competitors have in the past without resorting to a BAT.

On the other hand, imposing a new tax on imports while exempting exports (no matter what interest groups who stand to benefit from the move might claim) is a terrible way to address our self-infected disadvantage. It would also open the United States to a costly challenge before the WTO, which carries its own set of risks for our country.

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