(Here's why it's so hard to get it done.)

The Washington Post Sunday - - BUSINESS - BY STEVEN PEARL­STEIN

If Pres­i­dent Trump was sur­prised by how com­pli­cated health care could be, he’ll be in for a real shock when he gets around to busi­ness tax re­form.

Ev­ery­one agrees that the way the United States taxes busi­ness prof­its needs an over­haul. The cur­rent tax regime en­cour­ages com­pa­nies to move op­er­a­tions, as­sets and even cor­po­rate cit­i­zen­ship over­seas, while rais­ing less and less money ev­ery year as com­pa­nies come up with ever more in­ge­nious and eth­i­cally ques­tion­able ways to avoid it. For most big com­pa­nies, the of­fi­cial 35 per­cent cor­po­rate tax rate is ir­rel­e­vant. The av­er­age rate ac­tu­ally paid is about 24 per­cent, with some com­pa­nies rou­tinely pay­ing no tax at all.

So why have three pres­i­dents and count­less Con­gresses been un­able to fix it? The an­swer is that de­spite all the belly­ach­ing by busi­ness lead­ers about our un­com­pet­i­tive tax sys­tem, it is the busi­ness lobby it­self that has stood in the way of re­form. The rea­son is sim­ple: To re­struc­ture the tax code while still rais­ing the same amount of rev­enue, all those com­pa­nies pay­ing less than the av­er­age ef­fec­tive rate would have to pay more so those pay­ing un­com­pet­i­tive rates could pay less. And the low-tax com­pa­nies have made it their busi­ness to pre­vent that from hap­pen­ing.

Now, House Speaker Paul D. Ryan (R-Wis.) and his Ways and Means chair­man, Rep. Kevin Brady (R-Tex.), are de­ter­mined to try again, propos­ing to re­place the ex­ist­ing busi­ness prof­its tax with a “des­ti­na­tion-based cash flow tax. ”

The wonky-sound­ing idea — long cham­pi­oned by econ­o­mist Alan Auer­bach of the Univer­sity of Cal­i­for­nia at Berke­ley — has been kick­ing around in tax pol­icy cir­cles for more

than 20 years, win­ning plau­dits from think tanks on the right and left. De­spite what you may have read, it is not part of a Repub­li­can con­spir­acy to elim­i­nate taxes on cap­i­tal. It is not a dis­guised tar­iff, or sales tax or value-added tax, al­though it would mimic their eco­nomic im­pact in some re­spects. It would not raise the price of im­ports by any­where near 20 per­cent, nor would it bring mil­lions of man­u­fac­tur­ing jobs back to the United States.

So what is it? Visit in­cometax to learn more.

Let’s start with the “cash flow” part, which has re­ceived too lit­tle at­ten­tion. What that means is that com­pa­nies would deduct the full value of any in­vest­ments they make in the year they make them, rather than spread­ing them out — or de­pre­ci­at­ing them — over many years, as now re­quired by tax and ac­count­ing rules. It also means that in­ter­est pay­ments used to fi­nance those in­vest­ments could no longer be de­ducted as a busi­ness ex­pense.

This switch from a prof­its tax to a cash-flow tax makes things sim­pler, en­cour­ages in­vest­ment and elim­i­nates the in­cen­tive for busi­nesses to bor­row rather than raise cap­i­tal from in­vestors. This is the part of the Ryan-Brady plan that economists love and most busi­nesses sup­port be­cause of the way it sim­pli­fies busi­ness tax­a­tion and re­moves taxes as a fac­tor in busi­ness in­vest­ment de­ci­sions. In the short run, it also re­duces the amount of prof­its that are sub­ject to tax.

More con­tro­ver­sial is the “des­ti­na­tion” part of “des­ti­na­tion-based tax flow tax.” What that means is that com­pa­nies will be taxed only on prof­its from sales made in the United States. Con­sider four dif­fer­ent sce­nar­ios.

The first is an Amer­i­can com­pany pro­duc­ing goods or ser­vices at home and sell­ing them to Amer­i­can cus­tomers. That’s a big chunk of the econ­omy, and the tax struc­ture for those com­pa­nies would re­main largely un­changed.

Then there are sales from over­seas di­vi­sions of Amer­i­can com­pa­nies to cus­tomers who are also over­seas. Right now, prof­its from th­ese trans­ac­tions are not sub­ject to U.S. tax as long as they are left over­seas. A des­ti­na­tion tax would ig­nore them as well.

Then there are sales of goods and ser­vices pro­duced in Amer­ica but sold to cus­tomers over­seas — think Boe­ing. Un­der the des­ti­na­tion tax, the over­seas sales would not be counted as rev­enue, but the ex­pense of pro­duc­ing them would still be de­ducted as a busi­ness ex­pense in cal­cu­lat­ing the com­pany’s tax­able profit. That’s the tax equiv­a­lent of all gain, no pain.

And the op­po­site would be true of a com­pany that im­ports prod­ucts, or parts of prod­ucts, for sale in Amer­ica — think Wal­mart or Nike. In that case, the rev­enue will be counted, but the cost of the im­ported goods or ser­vices will not. All pain, no gain.

By low­er­ing taxes for ex­porters and rais­ing them for im­porters, this “bor­der ad­just­ment” is meant to re­move the cur­rent in­cen­tive for com­pa­nies to lo­cate pro­duc­tion and in­tel­lec­tual prop­erty, or re­al­ize prof­its, in tax havens such as Ire­land or the Ba­hamas. As a re­sult — and this is what gets Pres­i­dent Trump all ex­cited — jobs would come back, tax rev­enue would in­crease and the trade deficit would dis­ap­pear.

Or not. For if those good things ac­tu­ally hap­pen, or even look like they are about to hap­pen, then some­thing else might also hap­pen — namely, that the value of the dol­lar would rise sharply against other cur­ren­cies, which for Amer­i­cans will lower the price of im­ports and makes ex­ports seem more ex­pen­sive to buy­ers over­seas. Eco­nomic the­ory, in fact, pre­dicts that the dol­lar would rise just enough to off­set the new tax ad­van­tage that would flow to ex­porters as a re­sult of a bor­der ad­just­ment, and off­set the tax hit to im­porters and their cus­tomers. What the new tax code giveth in terms of higher or lower taxes, the cur­rency ex­change mar­ket would taketh away in the form of lower or higher prices.

If eco­nomic the­ory is right, in other words, the only last­ing eco­nomic im­pact of bor­der ad­just­ment im­pact might be a nasty global fi­nan­cial cri­sis as some for­eign coun­tries and com­pa­nies that bor­rowed cheap dol­lars would find them­selves un­able to re­pay more ex­pen­sive ones. In ad­di­tion, as the dol­lar rises, the value of for­eign in­vest­ments held by Amer­i­cans would fall, while for­eign­ers’ ap­petite for in­vest­ing in the United States would wane, po­ten­tially de­press­ing stock prices and push­ing up in­ter­est rates.

While economists are fairly united in pre­dict­ing that bor­der ad­just­ment will lead to an equal and op­po­site cur­rency ad­just­ment, busi­ness ex­ec­u­tives aren’t so sure. That’s why im­porters have mounted a fu­ri­ous ef­fort to kill the Ryan-Brady plan, while ex­porters are push­ing it with the ur­gent con­vic­tion of new con­verts at a tent re­vival. Of­fi­cials in the Trump ad­min­is­tra­tion are said to be sim­i­larly di­vided.

There is good rea­son to be skep­ti­cal that global mar­kets are so ef­fi­cient that the dol­lar will rise to off­set the eco­nomic im­pact of the bor­der tax. If mar­kets were that ef­fi­cient, cur­rency ad­just­ments would have pre­vented the United States from run­ning large and per­sis­tent trade deficits all th­ese years. The rea­son that didn’t hap­pen was be­cause the flow of in­vest­ment cap­i­tal across bor­ders is even greater than the flow of goods and ser­vices, with an op­po­site ef­fect on the dol­lar ex­change rate. The same dy­namic could limit the rise of the dol­lar in re­sponse to a bor­der-ad­just­ment tax.

What­ever hap­pens with the dol­lar, bor­der ad­just­ment will put an end to ridicu­lous and costly shell games played by vir­tu­ally ev­ery global cor­po­ra­tion to shift ac­tiv­ity and prof­its over­seas, where nearly $2 tril­lion sits idle in the bank ac­counts of for­eign sub­sidiaries of U.S. com­pa­nies. Other coun­tries will al­most cer­tainly mount le­gal chal­lenges to bor­der ad­just­ment, claim­ing that it vi­o­lates global and bi­lat­eral tax treaties. But there is also a pos­si­bil­ity that other coun­tries could re­al­ize what a good idea it is and copy it. That would neu­tral­ize some of the eco­nomic ben­e­fits to the U.S. econ­omy.

There is de­bate about whether the Ryan-Brady pro­posal would shift the bur­den of the cor­po­rate tax from share­hold­ers and em­ploy­ees to con­sumers, which would make it less pro­gres­sive. Lib­eral economists such as Jared Bern­stein think so, but Kyle Pomer­leau at the con­ser­va­tive Tax Foun­da­tion thinks not. In the end, it would de­pend on how much the dol­lar ad­justs and whether im­porters would be able to pass tax in­creases on to con­sumers rather than to their share­hold­ers and em­ploy­ees. In other words, it’s any­one’s guess — al­though ei­ther way, the ef­fect will prob­a­bly be mod­est.

For me, the prob­lem with the Repub­li­can busi­ness tax plan is not so much the struc­ture of the tax, but the fact that the pro­posed 20 per­cent rate is too low.

As Howard Gleck­man of the Tax Pol­icy Cen­ter has writ­ten, if bor­der ad­just­ment in­creases ex­ports and dis­cour­ages im­ports to the de­gree promised by some pro­po­nents, then the 20 per­cent tax rate will not raise any­thing close to what the cor­po­rate tax raises now.

Ed­ward Klein­bard, a tax ex­pert at the Univer­sity of South­ern Cal­i­for­nia law school, fig­ures a rate of 25 per­cent would be needed for the plan to be rev­enue neu­tral. Wil­liam Gale of the Brook­ings In­sti­tu­tion thinks it would be 30 per­cent.

“The 20 per­cent rate is not eco­nom­i­cally driven,” Klein­bard said. “It’s purely a po­lit­i­cal num­ber.”

The House plan also re­tains the cur­rent tax ad­van­tage en­joyed by small busi­nesses, part­ner­ships, pro­pri­etor­ships, in­vest­ment trusts and lim­ited li­a­bil­ity cor­po­ra­tions — en­ter­prises that, as a re­sult of this tax ad­van­tage, ac­count for half of all busi­ness prof­its.

Such en­ter­prises — some of which are very large and very prof­itable — are not sub­ject to ei­ther the cor­po­rate tax or to the ad­di­tional 20 per­cent tax on div­i­dends and cap­i­tal gains that cor­po­rate share­hold­ers pay. In­stead, they are taxed only once at the per­sonal in­come tax rate of the own­ers. The House pro­posal would ex­pand this boon­dog­gle by cre­at­ing a spe­cial new tax rate of 25 per­cent for th­ese “pass throughs” — a rate that is not only un­de­servedly low but will cre­ate a whole new tax scam, as highly paid em­ploy­ees rush to turn them­selves into in­de­pen­dent con­trac­tors to take ad­van­tage of it.

Be­cause of th­ese and myr­iad other prob­lems, the Ryan and Brady pro­posal needs lots more study and de­bate — it shouldn’t be rushed through to meet ar­ti­fi­cial po­lit­i­cal dead­lines. But by the same to­ken, it de­serves se­ri­ous con­sid­er­a­tion.

“I’m very in­trigued by it, par­tic­u­larly the eco­nomic ben­e­fits,” said Martin Sul­li­van, the re­spected colum­nist and chief econ­o­mist at Tax Notes. “There are con­cerns with it, no ques­tion. But the rea­son we are still talk­ing about it is that there is no ob­vi­ous al­ter­na­tive.”


An aerial photo taken on Mon­day shows new cars in a park­ing lot in Shenyang, in north­east China’s Liaon­ing prov­ince. China recorded an un­ex­pected 60.36 bil­lion yuan trade deficit in Fe­bru­ary.

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