While House and Senate GOP leaders still insist they can enact a major tax reform this year, tax experts predict it could take years for lawmakers to sort through the technical problems surrounding just one element of the House Republican plan—the destination-based cash flow tax (DBCFT).
At a conference last Friday, Michael Keen of the International Monetary Fund warned that his organization advises nations that it normally takes two-and-a-half years to create a value-added tax, which is similar in many respects to the DBCFT.
The House GOP plan is a form of consumption tax. But while it is similar to VATs around the world, the technical details differ from those VATs—and that’s the rub. It means the proposal is likely to generate unique issues which could take even longer to resolve. “There is no tax like this anywhere in the world,” said Columbia University law professor Michael Graetz, who has written extensively on his own VAT proposal. Both men spoke at a program sponsored by the International Tax Policy Forum and the Georgetown University law school’s Institute of International Economic Law.
The DBCFT not only suffers from having an incomprehensible name. It also would fundamentally change the way the US taxes business income. It includes two elements: The cash-flow piece that would tax the difference between cash income and cash expenditures and the destination-based feature that would tax imports but not tax exports.
Tax writers will have to resolve scores of legal and economic problems before enacting this plan. Addressing any one will be a complex and time-consuming. Dealing with them all could be a policy nightmare. Here is a brief summary of just five of the landmines ahead:
Exemptions: How would the DBCFT treat non-profits? Or imported goods purchased for personal consumption? What about financial transactions by banks and other intermediaries? VATs always struggle with this issue. If these activities or entities are carved out, what else would be exempted? House Ways & Means Committee Chair Kevin Brady (R-TX) said Friday he anticipates no exemptions, but can he hold that position? Note that the more exemptions Congress approves, the less money the tax will raise.
Distinguishing imports from exports. It may seem simple, but in the real world it is not. For instance, does moving software to the cloud for downloading by customers make it a tax-favored export? The IRS has limited ability to answer these questions, which are largely irrelevant in the current tax code.
Exchange rates: Many economists are convinced that the DCBFT would result in a stronger dollar which, in turn, would help protect US consumers from price hikes caused by the import tax. But if they are right, what would a stronger dollar mean for the sovereign debt of developing nations and, thus, their economic stability? If they are wrong, what would rising prices mean for the US economy? Thinking through these questions will not be easy.
Tax agreements. The US tax system must comply with the trading rules of the World Trade Organization as well as with tax treaties with scores of countries around the world. The DBCFT will have to be designed to comply with WTO rules, which permit import levies for consumption taxes but not for income taxes (which this tax is, since it technically retains the legal framework of a business income tax). And the US may have to renegotiate all those bilateral tax treaties-- which may not be easy given the exchange rate issues.
Transition rules: These are always a challenge with major tax legislation, but the DBCFT creates particular problems. For instance, if the new tax regime does result in big currency adjustments, what would happen to US citizens that hold $8 trillion in assets abroad?
On Friday, Graetz predicted that even if Congress does decide to build a destination-based cash flow tax, it is likely to produce an imperfect, but politically acceptable version-- not the ideal model designed by economists.
I’m not suggesting the destination tax is a bad idea, or that it wouldn’t be an improvement over the current system (it almost certainly would). But these challenges are an important warning that shifting to such a new system will be much more difficult—and time consuming—than backers suggest.
