No ‘Miracle Cure’ for Reforming U.S. Corporate Tax Code, Says Dallas Fed Economic Letter
A border-adjusted cash-flow tax would likely raise U.S. standard of living over time but at a short-term cost to many
For Immediate Release: June 1, 2017
DALLAS—The U.S. statutory corporate tax rate is undeniably high and provides an incentive for firms to locate elsewhere; however, some of the proposed solutions present thorny issues of their own, according to the Federal Bank of Dallas’ latest Economic Letter.
In “Corporate Tax Reform: Potential Gains at a Price to Some,” Dallas Fed economists Evan Koenig and Jason Saving examine the implications of broad reforms that have been proposed to address the U.S. tax rate, which at 39.1 percent (prior to application of deductions and exemptions) is the highest among developed-world competitors.
“Existing U.S. tax rates are said to encourage tax avoidance and motivate firms to move overseas, reducing revenue and eliminating opportunities for U.S. workers,” the authors write. “Moreover, some view the tax code as discouraging saving and investment while incentivizing firms to use debt rather than equity financing, distorting resource allocation and slowing economic growth. The corporate tax system is even said to put the U.S. at a competitive disadvantage vis-à-vis the country’s major trading partners.”
Simply lowering the corporate tax rate would increase the nation’s fiscal imbalance unless coupled with revenue-raising measures such as a broadening of the tax base, according to the authors. Other proposed changes, such as depreciating a firm’s capital investments over a shorter period or limiting interest deductibility, fail to address some of the broader issues inherent to income taxation.
A more far-reaching reform known as a destination-based, or border-adjusted, cash-flow tax, taxes sales rather than income and is a variation on the consumption taxation commonly used elsewhere in the developed world, the authors explain.
Under the proposed system, goods or services purchased within the U.S. would be taxed by the U.S. regardless of the producer’s location, while goods or services purchased outside the U.S. would not be taxed by the U.S. even if they were produced entirely within the U.S.
Because the U.S. imports more than it exports, a cash-flow tax would generally be expected to generate revenue for the government. Furthermore, “analyses suggest that the U.S. standard of living might be 6 to 9 percent higher over the long run with a consumption tax relative to where it would be if the country stayed with the current tax system,” according to the authors.
The implications of a cash-flow tax regime are complex and wide-ranging, however, and would have a significant impact on both firms and individuals.
“On one hand, it would be expected to increase U.S. investment, remove artificial distortions that influence where U.S. firms locate production facilities (and book profits), and bring U.S. tax treatment of corporations more into line with the rest of the world,” they write. “On the other hand, it would bring about a one-time capital loss on Americans’ asset portfolios and might usher in a temporary period during which U.S. exporters would have a competitive advantage and U.S. importers a corresponding disadvantage.”
The authors conclude that: “In short, there is no miracle cure for all of the issues people might have with the corporate tax code. Proposed solutions all either enlarge the deficit or create winners and losers.”
Koenig is senior vice president and principal policy advisor, and Saving is a senior research economist at the Dallas Fed.
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