Written by guest blogger, Wei Cui.
In June 2016, Paul Ryan and Kevin Brady, Republican Party leaders in the U.S. House of Representatives, advanced a proposal for sweeping business and individual tax reform in the United States. In recent months, as Donald Trump’s presidency loomed, the Republican tax plan has drawn intense public attention. Many claim that U.S. business tax reform in 2017 is a certainty, and that if the Republican plan is adopted, it would be the country’s biggest tax reform in a hundred years. One need not be American or even interested in tax policy to want to take notice of the U.S. debate: enactment of the Republican tax plan could cause the U.S. dollar to appreciate up to 25% (leading to huge shifts in the global distribution of wealth and disrupting world financial markets), or result in substantial tariffs on imports into the U.S. and subsidies for American exports—or it could even do both.
The core of Republican tax plan is a new business tax called the destination-based cash flow tax (“DCFT”). It is fair to say that before summer 2016, discussions of the DCFT had been confined to obscure corners of academia and think tanks. The tax was envisioned by some highly respected economists, who are driven by three strong convictions. First, they are deeply skeptical—indeed often outright dismissive—of traditional ways of allocating taxing rights over multinational’s profits based on where production occurs. In their view, such “source-based” taxation is entirely arbitrary, and therefore not surprisingly gives rise to much tax avoidance on the part of multinational companies. Second, they believe that the best international tax design is marked by neutrality with respect to multinationals’ investment decisions. Third, they intuit that such neutrality cannot be achieved through traditional principles of international taxation, including taxation on the basis of where individual shareholders of multinationals reside. Instead, they want to abandon the traditional dichotomy of “residence v. source” taxation, and design a way of taxing profits based on where businesses make sales to final consumers.
My forthcoming article, “Destination-Based Cash Flow Taxation: A Critical Appraisal”, analyzes the conceptual roots of, and deep tensions within, this vision. In particular, the article shows how the economists who came up with the DCFT have been led astray by the second and third convictions described above. In relation to the second conviction, I show that neutrality with respect to multinationals’ investment decisions turns out to be a poor guide for evaluating international tax design. In particular, the value added tax (VAT) also achieves such neutrality, and therefore DCFT proponents have not shown the superiority of the DCFT to the VAT. DCFT proponents claim that the DCFT is more progressive than the VAT. But, it must be remembered, source- and residence-based corporate income taxation is more progressive than the DCFT. The original argument for the DCFT precisely depended on setting the issue of progressivity aside.
In relation to the third conviction of DCFT proponents—namely multinationals should be taxed on their profits depending on where they make sales to final consumers—I argue that DCFT proponents have sowed much confusion. Most readers naturally and reasonably take the idea of allocating taxing rights to the countries of consumer sales to mean the following. If a U.S. company (like Starbucks or Apple) makes sales to consumers living in Canada, Canada would get to tax the profit earned from such sales. Conversely, if a Canadian company exports consumer goods and services to the U.S., the U.S., and not Canada, should be given the right to tax the profits generated by such sales.
There is currently no intellectual, social or political consensus that such a reallocation of taxing rights among nations is desirable or morally compelling. But my article argues that leaving aside how normatively persuasive this allocation is, no tax has been—and arguably none can be—designed to implement this allocation. By contrast, the version of the DCFT contained in the U.S. Republican tax plan is implementable—indeed, its implementability, especially under the Trump presidency, is rather scary. My article shows that this is because this particular version of the DCFT does not re-assign rights of taxing profits to countries where profitable consumer sales are made. Instead, it simply taxes U.S. residents when they make consumption purchases in the U.S., financed by corporate profits (wherever earned).
What about the first conviction of the DCFT’s intellectual advocates —that source-based taxation is entirely arbitrary? In other papers and ongoing research, I argue that this conviction is probably also erroneous and has led DCFT proponents astray. That all of the basic convictions driving some genuinely serious thinkers about international taxation could be wrong is unsettling. Checking these convictions may prevent unintended consequences in the real world.
Wei Cui’s article, “Destination-Based Cash Flow Taxation: A Critical Appraisal” will appear in Volume 67 Issue 2 (Spring 2017) of the University of Toronto Law Journal. Be sure to check out the full article when it becomes available this spring!
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