Auerbach

 

"Moving to a destination-based cash-flow tax

An alternative approach has been to identify fundamental tax reforms that can deal more adequately with the new economic realities.  One such approach builds on the concept of business cash-flow taxation, first proposed in the late 1970s by the Meade Committee (Institute for Fiscal Studies 1978).  Originally conceived as a tax on the cash flows of domestic producers (an ‘origin-based’ tax), the cash-flow tax had many potential benefits, including eliminating the tax on normal returns to new investment, removing tax-based incentives for corporate borrowing, and eliminating the need to measure income of companies with complex business arrangements.  But this standard cash-flow tax leaves in place the pressure for international tax competition via incentives for companies to shift the location of profitable activities and reported profits to low-tax countries.  This shortcoming led to consideration of a destination-based cash-flow tax (DBCFT), which adds ‘border adjustment’ to cash-flow taxation and has the effect of basing the tax on the location of consumers rather than on the location of profits, production, or corporate residence.

As described in a series of papers, including Auerbach (2017), converting an origin-based cash-flow tax into a destination-based cash-flow involves relieving tax on export revenues and imposing tax on imports, in precisely the same manner as is done under existing value-added taxes (VATs).  The key difference from a VAT is that the DBCFT maintains the income tax deduction for wages and salaries, and thus amounts to a tax on domestic consumption not financed by labour income, in principal a much more progressive tax than the VAT.

The DBCFT confronts the key international problems of existing tax systems. 

First, it removes corporate residence as a determinant of tax liability, which would eliminate the incentive for corporate inversions currently being driven by the US approach of taxing the foreign-source income of its resident companies (and hence primarily a US problem). 

• Second, because transactions with related foreign parties would be ignored by the tax system (the border adjustment offsetting any domestic tax on receipts or deduction of expenses associated with cross-border transactions), there would be no incentive to manipulate internal transfer prices to shift profits from a high-tax country, either through overstating the cost of imports from related foreign parties or by understating the value of exports. 
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• Finally, because the border adjustment would have the effect of imposing a tax based on where products are sold, rather than on where they are produced, the DBCFT would eliminate any tax on business profits generated by producing in a country that adopts it. 
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Note that all of these effects of the DBCFT are independent of the tax rate adopted under the new system.  As such, it would remove the incentive to compete over tax rates.

DBCFT adoption would need to confront many technical issues, including potentially persistent tax losses on the part of exporters (whose domestic costs would be fully deductible even as their export revenues were relieved of tax), the need to deal consistently with non-corporate businesses, and constructing an appropriate tax regime for financial institutions.  While these issues are important, potential solutions exist, and it is primarily with respect to other issues that concerns have arisen, particularly after a version of the DBCFT was proposed by the Republican leadership in the US House of Representatives (Tax Reform Task Force 2016)''.

Auerbach