I've had a few questions from friends and reporters asking what I thought of the GOP tax plan set out here. This is a key excerpt from the plan:
Today, all of our major trading partners raise a significant portion of their tax revenues through value-added taxes (VATs). These VATs include “border adjustability” as a key feature. This means that the tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country. These border adjustments reduce the costs borne by exported products and increase the costs borne by imported products. When the country is trading with another country that similarly imposes a border-adjustable VAT, the effects in both directions are offsetting and the tax costs borne by exports and imports are in relative balance. However, that balance does not exist when the trading partner is the United States. In the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to a self-imposed unilateral penalty on U.S. exports and a self-imposed unilateral subsidy for U.S. imports.
Because this Blueprint reflects a move toward a cash-flow tax approach for businesses, which reflects a consumption-based tax, the United States will be able to compete on a level playing field by applying border adjustments within the context of our transformed business and corporate tax system. For the first time ever, the United States will be able to counter the border adjustments that our trading partners apply in their VATs. The cash-flow based approach that will replace our current income-based approach for taxing both corporate and non-corporate businesses will be applied on a destination basis. This means that products, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced. This will eliminate the incentives created by our current tax system to move or locate operations outside the United States. It also will allow U.S. products, services, and intangibles to compete on a more equal footing in both the U.S. market and the global market.
The rules of the World Trade Organization (WTO) include longstanding provisions regarding the use of border adjustments. Under these rules, border adjustments upon export are permitted with respect to consumption-based taxes, which are referred to as indirect taxes. However, under these rules, border adjustments upon export are not permitted with respect to income taxes, which are referred to as direct taxes. This disparate treatment of different tax systems is what has created the historic imbalance between the United States, which has relied on an income tax – or direct tax in WTO parlance – for taxing business transactions, and our trading partners, which rely to a significant extent on a VAT – or indirect tax in WTO parlance – for taxing business transactions. Under WTO rules, the United States has been precluded from applying the border adjustments to U.S. exports and imports necessary to balance the treatment applied by our trading partners to their exports and imports. With this Blueprint’s move toward a consumption-based tax approach, in the form of a cash-flow focused approach for taxing business income, the United States now has the opportunity to incorporate border adjustments in the new tax system consistent with the WTO rules regarding indirect taxes.
Territorial Taxation of Global American Companies
This Blueprint will replace the existing outdated worldwide tax system with a 100-percent exemption for dividends from foreign subsidiaries. This will allow American-based companies to compete in global markets on an equal footing. It also will eliminate the “lock-out effect” of current law, allowing American-based companies to bring home their foreign earnings to be reinvested in United States without additional tax cost.
My response to the questions has been that I'm not really sure how this new proposal is supposed to work, and I need some more details.
But now I see some explanations of what I think is the GOP proposal in this regard. This is from the WSJ:
As a rule, taxing a behavior makes people do less of it, and that principle applies to anything from cigarette smoking to realizing capital gains.
That principle, though, isn’t so clear regarding a Republican proposal that for the first time would tax American imports while exempting exports from U.S. tax. And economists question whether such a policy, known as a border adjustment, would diminish imports into the country or increase exports.
...
Rep. Kevin Brady (R., Texas), the border-adjustment plan’s chief proponent, says the current tax code contains backward incentives that encourage imports and discourage exports. “By leveling the playing field between imports and exports, we expect much stronger demand here in the United States,” he said. “That’s a good thing.”
...
Most major nations levy corporate income taxes and value-added taxes that are a sort of consumption tax applied at each stage of production. VAT, however, is removed from exports, so it applies only to a country’s domestic consumption. The U.S., which has a relatively low general tax burden, doesn’t impose VAT.
Mr. Brady’s plan, though he doesn’t describe it this way, could be thought of as in effect repealing the 35% corporate income tax in the U.S. and replacing it with a 20% tax that appears in many ways like a value-added tax that would apply only in relation to sales of domestically produced products and services sold in the U.S. and to imported goods.
As with VAT regimes abroad, Mr. Brady’s proposed border levy is applied where a product is consumed, not where a company’s corporate headquarters or intellectual property is located, as would be the case with a corporate income tax.
In Mr. Brady’s plan and in a VAT, a company’s capital expenses could be deducted immediately, though net interest wouldn’t be deductible. The only major difference between Mr. Brady’s plan and other countries’ VAT is that those taxes generally don’t allow tax deductions for wages, while his proposal would.
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In the simplest terms, here’s how the Brady plan would appear to work:
Today, a U.S. manufacturer exporting, say, machinery to France would pay U.S. corporate income tax and France’s VAT. Competing French machinery would bear the cost of the French income tax and VAT.
Under Mr. Brady’s plan, all U.S. taxes come off at the border. So U.S.-produced machinery sold in France would bear only French VAT, while French-made counterparts would be subjected to French income tax and VAT.
The same occurs in the opposite direction. A British drugmaker exporting to the U.S. would pay U.K. corporate tax and VAT. But that VAT would come off at the British border. A competing U.S.-made product sold domestically at present would be subjected to U.S. corporate income tax, which generally is higher than that of many other countries.
But under Mr. Brady’s plan, the imported U.K. drug, already bearing U.K. income tax, would get slapped with the new tax at the U.S. border.
If that British company were to move production to the U.S., it would avoid U.K. corporate tax and pay just the new 20% American tax.
To be clear, we have no draft statute to look at yet, or at least I'm not aware of one, so this is all somewhat speculative. But as described above, when you hear that "U.S. taxes come off at the border," it sounds like foregone revenue that is otherwise due, and thus a financial contribution under SCM Agreement Article 1.1(a)(ii) (and presumably conferring a benefit as well). It also sounds like it would be tied to export in a way that results in a finding of contingency on export performance under Article 3.1(a).
Now, maybe they can do some magic with the drafting to turn the measure into, effectively, an indirect tax, and thus benefit from the special rules that apply to those taxes. The way the WSJ article describes things, the tax would act as a tax on U.S. sales of products and services (of whatever origin). But I think I would need a tax expert to walk me through exactly how they are going to design and structure the tax before judging whether they have been successful. As for the GOP drafters of this plan, they seem confident, according to this Politico article:
"We are now in the process of designing all aspects of our 'Build for Growth' tax plan to withstand any WTO challenge," Ways and Means Chairman Kevin Brady (R-Texas) said in a statement. "We're confident we can win any case."
The Politico article has additional details and is worth reading, but at the end of it all, I'm still not exactly sure what the new tax plan will say.
Another question here is, with all the talk from the Trump people about the distortions caused by foreign VATs, is this GOP plan going to satisfy the incoming administration? What kind of response are they looking for?
