There is a debate going on about the destination-based cash-flow tax with border adjustment (DBCFT) included in the otherwise pro-growth House Republican Tax Reform Blueprint. As I have mentioned before, while the tax has a few very desirable features, such as taxing consumption and being a territorial system, they are by no means unique to a DBCFT. In fact, there are many reasons to be extremely concerned about it.
First, the Republicans can say until they are red in the face that we need this new source of revenue — which will bring in a trillion dollars in taxes (or possibly more) — because it helps us pay for the good features in the tax-reform plan (such as lower rates and full depreciation), but that won’t make it okay. They are preemptively capitulating to the Left’s premise that pro-growth tax cuts are something that must “paid for” through increases in other taxes instead of with spending cuts or by simply letting the economy grow and bring overall tax revenue up along with it. In addition, if history is our guide, they are likely to see the tax increase implemented (since both they and Democrats want it) — but the features Republicans like will end up being watered down through the negotiations or over the years. Steve Forbes correctly explained this in a recent open-letter:
So cut away, but please do not attempt to pay for one set of tax cuts with a massive new set of costly tax increases on consumers, namely the trillion dollar border adjustment tax that is currently part of the GOP Tax Reform Blueprint. Rather than imposing a costly new national sales tax on imports, one that will dramatically raise prices of everyday goods and services, Congress would be wise to focus their attention on spending cuts.
Second, the repeated assumption presented as fact that trade flows won’t be affected at all by the new tax on imports because nominal exchange rates will adjust immediately and fully at the moment of implementation without any prior behavior adjustments in anticipation of the change should be taken with a grain of salt. It will be a rocky process and trade flows will likely be affected. While there are many concerns about penalizing imports and consumers, depending on the design of the tax it might actually end up penalizing exports and it will certainly encourage mergers. Oh and by the way, it is also incorrect to say that this new tax treatment will put us on a level playing field with VAT-countries since VATs aren’t promoting exports.
Fourth, yes there are potential issues with the World Trade Organization, especially since the plan allows wages to be deducted, unlike Value Added Taxes (VAT).
Finally, how can Republicans ignore the long-term consequences of putting in place such a system? I know they want the revenue to pay for the rest of the tax reform but are they really incapable of imagining what will happen when Democrats are again in power and such a tax is in place? Let me give you an idea. First, as Dan Mitchell has explained, destination-based tax systems undermine tax competition, which gives tremendous powers to future Democratic administrations when they want to raise taxes. Under that regime, consumers and companies will be like the alien race in Star Trek who the Borg want to assimilate into their collective: Resistance will be futile.
While Chairman Brady dismisses a potential WTO challenge (saying it will take years to adjudicate so we shouldn’t worry about it), if the power is in the hands of a future President Elizabeth Warren and her Democratic Congress, nothing will stop them from for resolving the WTO challenge by ending the wage deduction and turning the border-adjusted tax into a VAT. A VAT on top of our current individual income tax is a development that the Left and those dreaming of more revenue for the government have long fantasized about in order to finalize our transformation into a big-government European-like nation. When that happens we will have the Republicans to thank for it.
But then again, even if they don’t turn the DBCFT into a VAT, how long do you think Democrats will wait until they raise the 20 percent rate of the Blueprint to a much higher rate? Some at the Brookings Institution are already calling for it:
Precisely because the DBCFT does not have the negative incentive effects of the corporate income tax, there is no good reason to reduce the tax rate to 25/20 percent. Indeed, the tax rate should be equal to the top rate on individual income, so as to reduce incentives to reclassify wage income as business income. . . .
A final concern is that the corporate reform proposals described above, even when coupled with some specified corporate tax revenue-raisers, would reduce federal tax revenue by about $900 billion over the next 10 years on a static basis. Revenues would fall by somewhat less if the changes were dynamically scored, but the proposals would still represent a very large tax cut and would raise the public debt.
Rough estimates suggest that setting the DBCFT rate at around 30 percent for all businesses would eliminate the revenue shortfall. This would still leave it lower than the current corporate rate or the top individual tax rate, and suggests that an even higher DBFCT rate, coupled with a reduction in the top individual income tax rate, could equate the top individual and business rates and still be revenue-neutral and probably fairly close to distributionally-neutral.
This is why, once again, I urge Republicans in Congress to think about this carefully. Yes, corporate tax reforms, such as cutting the rate and moving to a territorial system, is key to our economy. But this border-adjustment tax is a poison pill lawmakers should be reluctant to swallow.