Opposing a Destination-Based Tax Doesn’t Mean Opposing All Consumption Taxes

by Veronique de Rugy

Over at EconLog, David Henderson comes to my defense. He responds to a post by the Niskanen Center’s Karl Smith criticizing me for warning people about one of the many risks of implementing a border-adjustment tax (a 20 percent tax on imports that exempts exports): Once in place, the rate could easily be increased. In making that case I pointed to actual examples of people already calling for such a hike.

I wasn’t going to respond to Smith anymore than I had on Twitter when his post came out. However, Henderson’s fight for my honor prompted me to change my mind only because some of the arguments Smith makes are often made in the course of the BAT debate.

First, Smith jumps to the wrong conclusion when he implies that my opposition to BAT comes only from the risk I perceive of tax-rate hikes in the future, and that opposition to higher rates shows how little I care about the structure of the tax code. Second, he also makes the common mistake of assuming that 1) a destination-based tax is the only way to move to a consumption tax and 2) that a border-adjustment tax is a consumption tax.

He writes:

Yet, whether we should have a high or low rate on a minimally distorting tax structure is precisely the argument we want to be having. Consider what the alternative suggests: that we ought prefer a tax structure which does more economic damage to the country so that our political opponents will be less willing to use it. Even if that tactic were to in some sense “work,” it leaves us with less revenue, more debt, and greater economic distortions. We should seek policy that improves the range of outcomes rather than simply thwarting the other side from achieving their objectives.

First, as my many posts and articles on the issue demonstrate, stopping liberals from jacking up a border-tax rate in the future is hardly my only reason to oppose it. Implied here is also the idea that my opposition to higher rates, and to the BAT, is evidence that I oppose a more efficient tax structure. When I corrected him on Twitter, he responded in a way that made me better understand his point. In his mind, a move to a BAT is a move to a consumption-based tax, a tax system much less distortive and efficient than the current system. As such, an opposition to the BAT means an opposition to a consumption tax and hence, my opposition to a more efficient tax system.

Smith isn’t particularly supportive of the border-adjustment tax and is more interested in showing the weakness of my argument as per the title of his post. The problem for him is that he wrongly assumes that I don’t support a move to a consumption-tax system (even though I have been calling for such move for over a decade). That’s because he mistakenly believes, like many others, that all consumption taxes are equally desirable. It may be correct from an “efficiency” point of view but it’s incorrect from a small-government point of view. Some consumption taxes are destination-based taxes, that’s the BAT. While they are possibly less distortive (it remains to be seen in the case of a BAT), they give a lot of power to the government. But a consumption tax can be an origin-based tax. Unlike a destination-based tax, it has the merits of being less distortive without giving massive collective power to the government.

I will concede that I am biased against big government. That’s why I have always opposed destination-based taxes. As I have explained before, a destination-based tax may be a consumption tax but its design undermines tax competition by creating an environment where no matter how high the rate goes, companies and people have nowhere to go and are stuck shouldering a potentially high tax burden. In other words, my complaint about liberals using the BAT to hike future rates was actually less a criticism about the tax rate — even though I don’t like that either — than it was about the structure of a tax that gives too much power to the government and makes it easier to hike future rates.

Thankfully, destination-based taxes, like the BAT, are not the only way way to move to a consumption-based system. We could, for instance, adopt an origin-based consumption tax such as the Hall-Rabushka flat tax. So don’t be fooled by the rhetoric that we must adopt a BAT to get a consumption tax.

Finally, I inferred from our Twitter exchange that Smith wrongly assumes that the Border Adjustment Tax is indeed a consumption tax. The wage deduction that makes it a BAT and not a Value Added Tax (VAT) means that it’s not a consumption tax as economist John Cochrane explains here:

The revenue point, I think, makes it clear though just how far from a VAT or consumption tax this is. From the Tax Policy Center, Federal government revenues are $3 trillion — about 17.5 percent of GDP. Thus, a pure VAT of 17.5% with no Federal personal income tax, estate tax, excise tax, corporate tax, or anything else is revenue neutral. Current corporate taxes are 10 percent of government revenue and 1.5 percent of GDP over the past five years — tiny. So if this tax needs to have a 30 percent rate just to generate 1.5% of GDP, its base must be tiny.

If we tax corporate sales, but allow corporations to deduct wages, the cost of inputs, investments (i.e., they buy forklifts for the factory, and can deduct the cost of the forklift), interest payments, and dividend payments then . . . there is nothing left! So, I infer that the tax base is only on interest and dividend payments.

Get that? That’s another case, where pro-BAT advocates are selling the tax for what it is not. It is not a consumption tax. But again, if it was a consumption tax, free-market advocates should still be wary of a destination-based tax.

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