Feeds:
Posts
Comments

Archive for the ‘Tax Reform’ Category

We have reached the 50th full day of the Trump Presidency.

In that span of time, we’ve had lots of political wrangling between Trump and the media. We’ve been introduced to the concept of the “Deep State” (yes, there is a permanent bureaucracy that acts to protect its own interests, but it’s silly to call it a conspiracy). There have been some controversial executive orders. And Trump made his big speech to Congress.

Lots of noise, though, does not mean lots of action. The President hasn’t signed any big legislation to repeal Obamacare, or even any legislation to tinker with Obamacare. There haven’t been any big changes on fiscal policy, either with regards to spending or taxes.

Heck, Trump hasn’t even told us what he really thinks on some of these issues.

In other words, the biggest takeaway after 50 days is that we still don’t know whether Trump is going to make government bigger or smaller.

I address some of these issues in two recent interviews. We’ll start with this discussion on the day of Trump’s Joint Address. I mostly focus on the need for entitlement reform and explain how Trump could do the right thing for America…if he wants to.

You’ll also notice, right at the end of the interview, that I made sure to sneak in a reference to fiscal policy’s Golden Rule. Gotta stay on message!

In this second interview, which occurred a couple of days later, I start the conversation by fretting about how the border-adjustable tax could kill the chances of getting good tax policy.

In the latter part of the interview, the discussion shifts to infrastructure and I make the rare point that we should copy Europe and get the private sector more involved (it’s generally a good idea to do the opposite of Europe, to be sure, but there are a small handful of other areas – including corporate tax rates, Social Security, and privatized postal services – where various European countries are ahead of us).

The bottom line is that we didn’t know before the election whether Trump wants to limit the burden of government, and we still don’t know today. My guess last year was that we’ll get the wrong answer, though I confess that the jury is still out.

Read Full Post »

For more than 30 years, I’ve been trying to educate my leftist friends about supply-side economics and the Laffer Curve.

Why is it so hard for them to recognize, I endlessly wonder, that when you tax something, you get less of it? And why don’t they realize that when you tax something at high rates, the effect is even larger?

And if the tax is high and the affected economic activity is sufficiently discouraged, why won’t they admit that this will have an impact on tax revenue?

Don’t they understand the basic economics of supply and demand?

But I’m not giving up, which means I’m either a fool or an optimist.

In this Skype interview with the Blaze’s Dana Loesch, I pontificate about the economy and tax policy.

I made my standard points about the benefits a lower corporate rate and “expensing,” while also warning about the dangers of the the “border adjustable tax” being pushed by some House Republicans.

But for today, I want to focus on the part of the interview where I suggested that a lower corporate tax rate might generate more revenue in the long run.

That wasn’t a throwaway line or an empty assertion. America’s 35 percent corporate tax rate (39 percent if you include the average of state corporate taxes) is destructively high compared to business tax systems in other nations.

Last decade, the experts at the American Enterprise Institute calculated that the revenue-maximizing corporate tax rate is about 25 percent.

More recently, the number crunchers at the Tax Foundation estimated the long-run revenue-maximizing rate is even lower, at about 15 percent.

You can (and should) read their studies, but all you really need to understand is that companies will have a greater incentive to both earn and report more income when the rate is reasonable.

But since the U.S. rate is very high (and we also have very punitive rules), companies are discouraged from investing and producing in America. Firms also have an incentive to seek out deductions, credits, exemptions, and other preferences when rates are high. And multinational companies understandably will seek to minimize the amount of income they report in the United States.

In other words, a big reduction in the corporate rate would be unambiguously positive for the American economy. And because there will be more investment and job creation, there also will be more taxable income. In other words, a bigger “tax base.”

Though I confess that I’m not overly fixated on whether that leads to more revenue. Remember, the goal of tax policy should be to finance the legitimate functions of government in the least-destructive manner possible, not to maximize revenue for politicians.

P.S. Economists at the Australian Treasury calculated the effect of a lower corporate rate and found both substantial revenue feedback and significant benefits for workers. The same thing would happen in the United States.

Read Full Post »

As part of an otherwise very good tax reform plan, House Republicans have proposed to modify the corporate income tax so that it becomes a “destination-based cash-flow tax.”

For those not familiar with wonky inside-the-beltway tax terminology, there are three main things to understand about this proposal.

  • First, the tax rate on business would drop from 35 percent to 20 percent. This is unambiguously positive.
  • Second, it would replace depreciation with expensing, which is a very desirable change that would eliminate a very counter-productive tax on new investment outlays. This is basically what makes the plan a “cash-flow” tax.
  • Third, any income generated by exports would be exempt from tax but the 20-percent tax would be imposed on all imports. These “border-adjustable” provisions are what makes the plan a “destination-based” tax.

I’m a big fan of the first two provisions, but I’m very hostile to the third item.

I don’t like it because I worry it sets the stage for a value-added tax. I don’t like it because it is designed to undermine tax competition. I don’t like it because it has a protectionist stench and presumably violates America’s trade commitments. I don’t like it because that part of the plan only exists because politicians aren’t willing to engage in more spending restraint. And I don’t like it because politicians should try to reinvent the wheel when we already know the right way to do tax reform.

Heck, I feel like the Dr. Seuss character who lists all the ways he would not like green eggs and ham. Except I can state with complete certainty I wouldn’t change my mind if I was suddenly forced to take a bite of this new tax.

Today, I’m going to augment my economic arguments by noting that the plan also is turning into a political liability. Here are some excerpts from a news report in the Wall Street Journal about opposition in the business community.

A linchpin of the House Republicans’ tax plan, an approach called “border adjustment,” has split Republicans and fractured the business world into competing coalitions before a bill has even been drafted. …There is also global uncertainty: Other countries may retaliate, either by border-adjusting their corporate taxes or by challenging the U.S. plan at the World Trade Organization as too tilted toward American producers.

And The Hill reports that grassroots organizations also are up in arms.

Americans for Prosperity is stepping up its efforts to advocate against a proposal from House Republicans to tax imports and exempt exports, as lawmakers are increasingly raising concerns about the proposal. …AFP has hundreds of volunteers and staff who are making phone calls about the proposal. The group has about 100 meetings set up with Congress members and their staff for next week, while Congress is in recess.

Meanwhile, the Economist reports that the plan is causing uncertainty around the world.

To offset a border-adjusted tax of 20%—the rate favoured by House Republicans—the greenback would need to rise fully 25%, enough to destabilise emerging markets burdened with dollar-denominated debts. If the dollar stayed put and wages and prices rose 25% instead, the Federal Reserve would have to decide how to respond to an unprecedented surge in inflation. Why tolerate such disruption?

Holman Jenkins of the Wall Street Journal has a devastating take on the issue.

Like a European value-added tax, its cost would be deeply hidden in the price of goods, thus easily jacked up over time. Also, compared with the current tax structure, businesses would see less incentive to move abroad in search of lower taxes, eroding a useful pressure on politicians to be fiscally sane. And because the tax would alter the terms of trade, it would be expected to lead to a sharp increase in the dollar. U.S. holders of foreign assets would suffer large paper losses. Since many foreigners borrow in dollars too, a global debt crisis might follow. The tax might also violate World Trade Organization rules, inviting other countries to impose punitive taxes on U.S. exports.

Last but not least, John Tamny outlines some of the political downsides at Real Clear Markets.

…the House of Representatives…is aggressively promoting a…tax on imports. …When we get up and go to work each day, our work is what we exchange for what we don’t have, including voluminous goods and services produced for us around the world.  …Party members are proudly seeking a tax on our work. …Only the “stupid” Party could come up with something so injurious to every American, to the American economy, and to its growth-focused brand.  But that’s where we are at the moment.  The Party that attained majorities with its tax cutting reputation is aggressively seeking to shed its growth brand through the introduction of tax hikes meant to give politicians even more of what we the people produce.  If so, the majority Party can kiss its majority goodbye.  It will have earned its minority status.

For what it’s worth, I think John overstates the case against the plan. The additional revenue from border-adjustable tax provision would be used to cut taxes elsewhere. Heck, the plan is actually a significant net tax cut.

But John is right when you look at the issue through a political lens. If the DBCFT actually began to move through the legislative process, opponents would start running commercials about the “GOP scheme to impose new consumption tax on Americans.” Journalists (most of whom dislike Republicans) would have a field day publicizing reports about the “GOP plan to raise average family tax bill by hundreds of dollars.”

Such charges would be ignoring the other side of the equation, of course, but that’s how politics works.

All of which brings me back to one of my original points. We already know that the flat tax is the gold standard of tax reform. And we already know the various ways of moving the tax code in that direction.

My advice is that Republicans abandon the border-adjustable provision and focus on lowering tax rates, reducing double taxation, and cutting back on loopholes. Such ideas are economically sounder and politically safer.

Read Full Post »

February 5 Addendum: For my left-wing friends and others who are bending over backwards to misread this column, saying nice things about Russia’s flat tax doesn’t mean (as noted below) that Russia’s overall economic policy is admirable. And it obviously doesn’t imply anything favorable about Russia’s dismal political system or Putin himself. I like the Russia flat tax for the same reason that I like trade liberalization in China and Social Security reform in Chile. Every so often, bad governments stumble upon a good policy and I think that’s laudable because I want people to have better lives. Sadly, I don’t think the Putin-Trump “bromance” will lead to a flat tax in the US, but that would be an unexpected and nice silver lining to that dark cloud.

=======================================

I’m obviously a big fan of a simple and fair flat tax.

In part, my support for fundamental reform is driven by my desire for a low rate, for no double taxation, and for the elimination of loopholes. Those are the economic reasons for reform.

But I also am very much motivated by the moral case for tax reform. It offends me that we have 70,000-plus pages of special favors for the friends and contributors of politicians. I value the rule of law, so I want everyone in America to play by the same rules.

And I confess that I’m jealous that other nations have adopted this common-sense reform while we’re still stuck with a punitive and unfair internal revenue code.

But the silver lining to this dark cloud is that we can learn from the experiences of other nations.

A recent report looks at what’s happened in Russia following the introduction of the flat tax.

On December 23, 2016, in his annual end-of-year press conference, Russian President Vladimir Putin said that despite his “many doubts” at the initial stage of introducing a flat 13-percent personal income tax in 2001, tax reform in Russia has been a major success. …Putin claimed that in 2001, when the tax reform was introduced, he was “concerned that the budget would lose revenue, because those who earn more would have to pay less.” He said he was also concerned “whether social justice would be ensured and so on.” However, as the reform gained traction, “personal-income tax collection has increased – pay attention – seven times,” Putin said. …Daniel Mitchell, a senior fellow at the Cato Institute, told Polygraph.info that two factors contributed to a significant increase in personal income tax revenue: “the low rate made tax evasion and avoidance much less attractive, and increased incentives to earn income.”

I appreciated the chance to talk to the reporter and get quoted in the story, but I am naturally suspicious about the claims of government officials. So I wondered about Putin’s claim about a seven-fold increase in income tax receipts.

I know there were good results in the first few years after reform. I authored a study for the Center for Freedom and Prosperity last decade, and there was data at the time showing an impressive increase in revenues from the personal income tax. That data certainly bolstered the argument for tax reform.

But we now have almost another full decade of data. Has the Russian flat tax continued to produce good results? Is the low tax rate continuing to encourage both the earning of income and reporting of income?

To answer these questions, I had my intern cull through various IMF Article IV consultation reports on Russia to get up-to-date data on personal income tax receipts in Russia. And what did I learn? Was Putin wrong?

Yes, Putin’s claim of a seven-fold increase in tax receipts was completely misleading. There was actually a 10-fold jump in personal income tax revenue.

In other words, the flat tax is a success. In today’s Washington, you would say the Russian government is winning bigly.

But there are caveats.

  • Russia has experienced significant inflation, at least compared to the United States. So if you factor out increases in the price level, personal income tax revenues are “only” about three times higher today than they were before the flat tax was implemented.
  • Moreover, a flat tax is not a panacea. Notwithstanding the good results it has delivered, Russia has an unimpressive ranking of #102 from Economic Freedom of the World. In other words, there’s still a long way to go if Russia wants to become a rich nation.

But these caveats don’t change the main conclusion, which is that the Russian flat tax works. Just as it works in Hong Kong. And just as it works in Jersey. It works wherever it is tried.

Let’s look at another example. Writing for Forbes, Fahim Mostafa explains that the Hungarian flat tax also has been a big success.

A fair number of Eastern European nations have…chosen this system of taxation over its progressive counterpart. Among the latest to join this club is Hungary, replacing progressive rates from 17% to 32% with a flat tax of 16% on income effective from 2012 onward… There is reason to believe that the implementation of this system has largely benefited the Eastern European nation. …The results from the following years have been remarkable. Total government revenue in 2015 (the last year for which OECD data is available at this time) stood at 23.8% higher than the maximum prior to the flat tax reform… According to the OECD, public debt in Hungary has been decreasing steadily since 2011. Increased revenues allow for this debt to be paid. …The flat tax has boosted consumption in Hungary, greatly increasing taxes collected from sales. Total tax revenue has shot up despite the massive cuts made to income tax. Politicians seeking to implement this policy in their own nation would do well to point out the example of Hungary.

I’ll add two comments.

First, the same caveats I applied to Russia apply to Hungary. The country is ranked #57 from Economic Freedom of the World, so it’s great that there’s a successful flat tax, but a lot more reform is needed for Hungary to become a role model for overall market-friendly reform.

Second, the author should probably make a change to the column. Instead of writing that “tax revenue has shot up despite the massive cuts,” it might be more accurate to write that “tax revenue has shot up because of the massive cuts.”

Yes, every so often you can find examples of nations being on the downward-sloping portion of the Laffer Curve, either because tax rates are ridiculously high (the U.S. before Reagan) or because a nation is developing or transitioning and needs low tax burdens to boost growth and encourage compliance.

It’s never my goal to boost revenue for governments, of course, but there’s surely a lesson to be learned about the benefits of low tax rates when both taxpayers and the government wind up with more money.

P.S. If we really want to learn from other places about the ideal tax system, we should check out Bermuda, Monaco, and the Cayman Islands.

Read Full Post »

House Republicans, as part of a generally laudable tax reform plan, want to replace the corporate income tax with a “destination-based cash-flow tax.”

I’ve addressed that topic a couple of times.

  • Left-leaning advocates like “destination-based” tax systems such as the DBCFT because such systems undermine tax competition and give politicians more ability to increase tax rates.
  • The “border adjustability” in the plan is contrary to the rules of the World Trade Organization (WTO) and there’s a significant risk that politicians might try to “fix” the plan by turning it into a value-added tax.
  • In theory, the import tax in the DBCFT is not necessarily protectionist, but the machinations of to justify that assertion, combined with the conflict it creates in the business community, undermine the consensus for reform.

I had a chance to speak about the DBCFT to a gathering put on by the Washington International Trade Association. I hit on all my main reasons for being worried about the border adjustable provisions.

For those who want additional information, I was preceded on the panel by Gordon Gray of the American Action Forum and followed by John Veroneau of Covington and Burling (and formerly with the Office of U.S. Trade Representative). You can watch the entire event by clicking here.

Regarding my remarks, I think the most relevant thing I said was when I shared new data from the Congressional Budget Office and pointed out that we can simultaneously balance the budget within 10 years and have a $3 trillion tax cut if politicians simply exercise a modest bit of spending restraint and limit annual budget increases to 1.96 per year.

And the most important thing that I said was when I warned that proponents of good policy should never do anything that might create the conditions for a value-added tax in the United States. Some people say the most important rule to remember is to never feed gremlins after midnight, but I think it’s even more important not to give politicians a new source of revenue.

Unless, of course, you want bigger government and more red ink.

Read Full Post »

In the world of tax policy, there’s an intense debate about the “border-adjustable” provision that is part of the tax plan put forth by House Republicans, which basically would tax imports and exempt revenues generated by exports.

It’s a bit wonky, but the simplest explanation is that GOPers want to replace the current corporate income tax with a “destination-based cash flow tax” (DBCFT) that would – for all intents and purposes – tax what is consumed in the United States rather than what is produced in the United States.

I’m very sympathetic to what Republicans are trying to accomplish, particularly their desire to eliminate the tax bias against income that is saved and invested. But I greatly prefer the version of consumption-base taxation found in the flat tax.

My previous columns on the plan have highlighted the following concerns.

  • Left-leaning advocates like “destination-based” tax systems such as the DBCFT because such systems undermine tax competition and give politicians more ability to increase tax rates.
  • The “border adjustability” in the plan is contrary to the rules of the World Trade Organization (WTO) and there’s a significant risk that politicians might try to “fix” the plan by turning it into a value-added tax.

Here’s what I said about the proposal in a recent interview for CNBC.

This provision is not in Trump’s plan, but I’ve been acting on the assumption that the soon-to-be President eventually would embrace the Better Way Plan simply because it presumably would appeal to his protectionist sentiments.

So I’m quite surprised that he’s just poured cold water on the plan. Here are some excerpts from a report in the Wall Street Journal.

President-elect Donald Trump criticized a cornerstone of House Republicans’ corporate-tax plan… The measure, known as border adjustment, would tax imports and exempt exports as part of a broader plan to encourage companies to locate jobs and production in the U.S. But Mr. Trump, in his first comments on the subject, called it “too complicated.” “Anytime I hear border adjustment, I don’t love it,” Mr. Trump said in an interview with The Wall Street Journal on Friday. …Retailers and oil refiners have lined up against the measure, warning it would drive up their tax bills and force them to raise prices because they rely so heavily on imported goods.

If we read between the lines, it appears that Trump may be more knowledgeable about policy than people think.

Proponents of the Better Way Plan sometimes use protectionist-sounding rhetoric to sell the plan (e.g., taxing imports, exempting exports), but they argue that it’s not really protectionist because the dollar will become more valuable.

But Trump apparently understands this nuance and doesn’t like that outcome.

Independent analyses of the Republican tax plan say it would lead the dollar to appreciate further—which would lower the cost of imported goods, offsetting the effects of the tax on retailers and others. In his interview with the Journal on Friday, Mr. Trump said the U.S. dollar was already “too strong” in part because China holds down its currency, the yuan. “Our companies can’t compete with them now because our currency is too strong. And it’s killing us.”

I don’t agree with Trump about trade deficits (which, after all, are mostly the result of foreigners wanting to invest in the American economy), but that’s a separate issue.

When I talk to policy makers and journalists about this issue, one of the most common questions is why the DBCFT would cause the dollar to rise.

In a column for the Wall Street Journal, Martin Feldstein addresses that topic.

…as every student of economics learns, a country’s trade deficit depends only on the difference between total investment in the country and the saving done by its households, businesses and government. This textbook rule that “imports minus exports equals investment minus savings” is not a theory or a statistical regularity but a basic national income accounting identity that holds for every country in every year. That holds because a rise in a country’s investment without an equal rise in saving means that it must import more or export less. Since a border tax adjustment wouldn’t change U.S. national saving or investment, it cannot change the size of the trade deficit. To preserve that original trade balance, the exchange rate of the dollar must adjust to bring the prices of U.S. imports and exports back to the values that would prevail without the border tax adjustment. With a 20% corporate tax rate, that means that the value of the dollar must rise by 25%.

This is a reasonable description, though keep in mind that there are lots of factors that drive exchange rates, so I understand why importers are very nervous about the proposal.

By the way, Feldstein makes one point that rubs me the wrong way.

The tax plan developed by the House Republicans is similar in many ways to President-elect Trump’s plan but has one additional favorable feature—a border tax adjustment that exempts exports and taxes imports. This would give the U.S. the benefit that other countries obtain from a value-added tax (VAT) but without imposing that extra levy on domestic transactions.

The first sentence of the excerpt is correct, but not the second one. A value-added tax does not give nations any sort of trade benefit. Yes, that kind of tax generally is “border adjustable” under WTO rules, but as I’ve previously noted, that doesn’t give foreign production an advantage over American production.

Here’s some of what I wrote about this issue last year.

For mercantilists worried about trade deficits, “border adjustability” is seen as a positive feature. But not only are they wrong on trade, they do not understand how a VAT works. …Under current law, American goods sold in America do not pay a VAT, but neither do German-produced goods that are sold in America. Likewise, any American-produced goods sold in Germany are hit be a VAT, but so are German-produced goods. In other words, there is a level playing field. The only difference is that German politicians seize a greater share of people’s income. So what happens if America adopts a VAT? The German government continues to tax American-produced goods in Germany, just as it taxes German-produced goods sold in Germany. …In the United States, there is a similar story. There is now a tax on imports, including imports from Germany. But there is an identical tax on domestically-produced goods. And since the playing field remains level, protectionists will be disappointed. The only winners will be politicians since they have more money to spend.

If you want more information, I also discuss the trade impact of a VAT in this video.

For what it’s worth, even Paul Krugman agrees with me on this point.

P.S. It is a good idea to have a “consumption-base” tax (which is a public finance term for a system that doesn’t disproportionately penalize income that is saved and invested). But it’s important to understand that border adjustability is not necessary to achieve that goal. The flat tax is the gold standard of tax reform and it also is a consumption-based tax. The difference is that the flat tax is an “origin-based” tax and the House plan is a “destination-based” tax.

P.P.S. Speaking of which, proponents of the so-called Marketplace Fairness Act are using a destination-based scheme in hopes of creating a nationwide sales tax cartel so that states with high rates can make it much harder for consumers to buy goods and services where tax rates are lower.

Read Full Post »

I wrote yesterday to praise the Better Way tax plan put forth by House Republicans, but I added a very important caveat: The “destination-based” nature of the revised corporate income tax could be a poison pill for reform.

I listed five concerns about a so-called destination-based cash flow tax (DBCFT), most notably my concerns that it would undermine tax competition (folks on the left think it creates a “race to the bottom” when governments have to compete with each other) and also that it could (because of international trade treaties) be an inadvertent stepping stone for a government-expanding value-added tax.

Brian Garst of the Center for Freedom and Prosperity has just authored a new study on the DBCFT. Here’s his summary description of the tax.

The DBCFT would be a new type of corporate income tax that disallows any deductions for imports while also exempting export-related revenue from taxation. This mercantilist system is based on the same “destination” principle as European value-added taxes, which means that it is explicitly designed to preclude tax competition.

Since CF&P was created to protect and promote tax competition, you won’t be surprised to learn that the DBCFT’s anti-tax competition structure is a primary objection to this new tax.

First, the DBCFT is likely to grow government in the long-run due to its weakening of international tax competition and the loss of its disciplinary impact on political behavior. … Tax competition works because assets are mobile. This provides pressure on politicians to keep rates from climbing too high. When the tax base shifts heavily toward immobile economic activity, such competition is dramatically weakened. This is cited as a benefit of the tax by those seeking higher and more progressive rates. …Alan Auerbach, touts that the DBCFT “alleviates the pressure to reduce the corporate tax rate,” and that it would “alter fundamentally the terms of international tax competition.” This raises the obvious question—would those businesses and economists that favor the DBCFT at a 20% rate be so supportive at a higher rate?

Brian also shares my concern that the plan may morph into a VAT if the WTO ultimately decides that is violates trade rules.

Second, the DBCFT almost certainly violates World Trade Organization commitments. …Unfortunately, it is quite possible that lawmakers will try to “fix” the tax by making it into an actual value-added tax rather than something that is merely based on the same anti-tax competition principles as European-style VATs. …the close similarity of the VAT and the DBCFT is worrisome… Before VATs were widely adopted, European nations featured similar levels of government spending as the United States… Feeding at least in part off the easy revenue generate by their VATs, European nations grew much more drastically over the last half century than the United States and now feature higher burdens of government spending. The lack of a VAT-like revenue engine in the U.S. constrained efforts to put the United States on a similar trajectory as European nations.

And if you’re wondering why a VAT would be a bad idea, here’s a chart from Brian’s paper showing how the burden of government spending in Europe increased once that tax was imposed.

In the new report, Brian elaborates on the downsides of a VAT.

If the DBCFT turns into a subtraction-method VAT, its costs would be further hidden from taxpayers. Workers would not easily understand that their employers were paying a big VAT withholding tax (in addition to withholding for income tax). This makes it easier for politicians to raise rates in the future. …Keep in mind that European nations have corporate income tax systems in addition to their onerous VAT regimes.

And he points out that those who support the DBCFT for protectionist reasons will be disappointed at the final outcome.

…if other nations were to follow suit and adopt a destination-based system as proponents suggest, it will mean more taxes on U.S. exports. Due to the resulting decline in competitive downward pressure on tax rates, the long-run result would be higher tax burdens across the board and a worse global economic environment.

Brian concludes with some advice for Republicans.

Lawmakers should always consider what is likely to happen once the other side eventually returns to power, especially when they embark upon politically risky endeavors… In this case, left-leaning politicians would see the DBCFT not as something to be undone, but as a jumping off point for new and higher taxes. A highly probable outcome is that the United States’ corporate tax environment becomes more like that of Europe, consisting of both consumption and income taxes. The long-run consequences will thus be the opposite of what today’s lawmakers hope to achieve. Instead of a less destructive tax code, the eventual result could be bigger government, higher taxes, and slower economic growth.

Amen.

My concern with the DBCFT is partly based on theoretical objections, but what really motivates me is that I don’t want to accidentally or inadvertently help statists expand the size and scope of government. And that will happen if we undermine tax competition and/or set in motion events that could lead to a value-added tax.

Let’s close with three hopefully helpful observations.

Helpful Reminder #1: Congressional supporters want a destination-based system as a “pay for” to help finance pro-growth tax reforms, but they should keep in mind that leftists want a destination-based system for bad reasons.

Based on dozens of conversations, I think it’s fair to say that the supporters of the Better Way plan don’t have strong feelings for destination-based taxation as an economic principle. Instead, they simply chose that approach because it is projected to generate $1.2 trillion of revenue and they want to use that money to “pay for” the good tax cuts in the overall plan.

That’s a legitimate choice. But they also should keep in mind why other people prefer that approach. Folks on the left want a destination-based tax system because they don’t like tax competition. They understand that tax competition restrains the ability of governments to over-tax and over-spend. Governments in Europe chose destination-based value-added taxes to prevent consumers from being able to buy goods and services where VAT rates are lower. In other words, to neuter tax competition. Some state governments with high sales taxes in the United States are pushing a destination-based system for sales taxes because they want to hinder consumers from buying goods and services from states with low (or no) sales taxes. Again, their goal is to cripple tax competition.

Something else to keep in mind is that leftist supporters of the DBCFT also presumably see the plan as being a big step toward achieving a value-added tax, which they support as the most effective way of enabling bigger government in the United States.

Helpful Reminder #2: Choosing the right tax base (i.e., taxing income only one time, otherwise known as a consumption-base system) does not require choosing a destination-based approach.

The proponents of the Better Way plan want a “consumption-base” tax. This is a worthy goal. After all, that principle means a system where economic activity is taxed only one time. But that choice is completely independent of the decision whether the tax system should be “origin-based” or “destination-based.”

The gold standard of tax reform has always been the Hall-Rabushka flat tax, which is a consumption-base tax because there is no double taxation of income that is saved and invested. It also is an “origin-based” tax because economic activity is taxed (only one time!) where income is earned rather than where income is consumed.

The bottom line is that you can have the right tax base with either an origin-based system or a destination-based system.

Helpful Reminder #3: The good reforms of the Better Way plan can be achieved without the downside risks of a destination-based tax system.

The Tax Foundation, even in rare instances when I disagree with its conclusions, always does very good work. And they are the go-to place for estimates of how policy changes will affect tax receipts and the economy. Here is a chart with their estimates of the revenue impact of various changes to business taxation in the Better Way plan. As you can see, the switch to a destination-based system (“border adjustment”) pulls in about $1.2 trillion over 10 years. And you can also see all the good reforms (expensing, rate reduction, etc) that are being financed with the various “pay fors” in the plan.

I am constantly asked how the numbers can work if “border adjustment” is removed from the plan. That’s a very fair question.

But there are lots of potential answers, including:

  • Make a virtue out of necessity by reducing government revenue by $1.2 trillion.
  • Reduce the growth of government spending to generate offsetting savings.
  • Find other “pay fors” in the tax code (my first choice would be the healthcare exclusion).
  • Reduce the size of the tax cuts in the Better Way plan by $1.2 trillion.

I’m not pretending that any of these options are politically easy. If they were, the drafters of the Better Way plan probably would have picked them already. But I am suggesting that any of those options would be better than adopting a destination-based system for business taxation.

Ultimately, the debate over the DBCFT is about how different people assess political risks. House Republicans advocating the plan want good things, and they obviously think the downside risks in the future are outweighed by the ability to finance a larger level of good tax reforms today. Skeptics appreciate that those proponents want good policy, but we worry about the long-run consequences of changes that may (especially when the left sooner or late regains control) enable bigger government.

P.S. This is not the first time that advocates of good policy have bickered with each other. During the 2016 nomination battle, Rand Paul and Ted Cruz plans proposed tax reform plans that fixed many of the bad problems in the tax code. But they financed some of those changes by including value-added taxes in their plans. In the short run, either plan would have been much better than the current system. But I was critical because I worried the inclusion of VATs would eventually give statists a tool to further increase the burden of government.

Read Full Post »

Older Posts »

%d bloggers like this: