Economic View: The Major Potential Impact of a Corporate Tax Overhaul

Economic View: The Major Potential Impact of a Corporate Tax Overhaul

- in Business
150
0

This possible revamping of the corporate tax code is less politically polarizing than the debates sure to unfold in the months ahead over health care, or even over individual income taxes. But the consequences for business — and for the long-term trajectory of the economy — are huge.

The basic idea behind a D.B.C.F.T. (to use the abbreviation that has taken hold in a particularly nerdy corner of Twitter) is this: Right now companies are taxed based on their income generated in the United States. But there are countless tricks that corporate accountants can play to reduce the income companies report and to reduce their tax burden, and those tricks distort the economy.

Two prime examples are transferring intellectual property to overseas holding companies and engaging in corporate inversions that move a company’s legal headquarters to a country with lower taxes. Moreover, because interest payments on debt are tax-deductible, the current system makes it appealing to take on as much debt as possible, even though that can increase the risk of bankruptcy when a downturn comes along.

The House Republicans’ approach, instead of taxing the easy-to-manipulate corporate income, goes after a firm’s domestic cash flow: money that comes in from sales within the United States borders minus money that goes out to pay employees and buy supplies and so forth. There’s no incentive to play games with overseas companies that exist only to exploit tax differences or to relocate production to countries with lower taxes because you’ll be taxed on things you sell in the United States, regardless.

“With an income tax, one of the key issues is ‘how do you measure income,’ ” said Alan Auerbach, an economist at the University of California, Berkeley, who is a leading advocate of the idea. “But with cash flow you just follow the money.”

And the tax, Mr. Auerbach argues, could spur business investment while not encouraging companies to rely on debt. It allows companies to enjoy the tax savings of capital investments immediately rather than depreciating them over time. And it doesn’t give favorable treatment to debt, as opposed to equity.

Major retailers who sell imported goods, like Walmart, are potential losers in a move toward a cash-flow-based corporate income tax.

Credit
Dolly Faibyshev for The New York Times

That alone would amount to a major shift in the tax system. Congressional staff members, the incoming administration and armies of lobbyists will spend countless hours hammering out the details of any such proposal: how it might be phased in, and how to treat financial services, and much more.

Some of the most complex, and politically problematic, elements of the plan revolve around its treatment of international trade, which creates winners and losers. And some of those potential losers are powerful.

Consider what border adjustment means: When an American company exports goods under this new tax system, it would not pay any taxes on its international sales, while its imports would be taxed. So a company that spent $80 making something that it sold overseas for $100 would pay no tax on its earnings. A company that imported goods worth $80 from abroad and them sold them domestically for $100 would pay tax on the full $100.

At first glance this looks as if it would boost exports and reduce the trade deficit. Indeed, it might prove politically promising for advocates of the strategy to pitch the plan as one that would do this.

Many economists think it won’t work that way, however. That’s because as soon as a cash-flow-based tax with border adjustment looks likely to become law, the value of the dollar should rise in currency markets. And that stronger dollar could eliminate the apparent pro-export, anti-import effects of the tax. The dollar could rise by, say, 20 to 25 percent, and the trade balance could remain about where it started.

Essentially, moving to this system means betting on a “textbook economic theory,” as analysts at Evercore ISI put it, becoming a reality even though the effect hasn’t been tested in practice.

If the dollar doesn’t strengthen as expected, for example, import-dependent industries, especially those with lean profit margins, could face disaster. That helps explain why some of the stiffest opposition to this tax overhaul is coming from the retail industry. Essentially, economists are telling them “trust us, our models say the currency will adjust and it will all come out in the wash,” but if the models are wrong, for companies like Walmart, Target and many others that sell large volumes of imported goods, their viability could be threatened.

If the models turn out to be right, there is a different set of risks. The United States dollar is the linchpin of the global financial system, and a large move in its value triggered by changes in domestic tax policy could have unforeseen effects.

Many companies worldwide, especially banks and especially in emerging markets, have debt denominated in dollars, which would become more of a burden after a new dollar appreciation. A big dollar rise would also effectively shift trillions in wealth from American investments overseas toward global investors with assets in the United States.

As Jared Bernstein of the Center on Budget and Policy Priorities has noted, we don’t really know what the distributional consequences of this tax overhaul would be. It could increase the costs of imported goods that the poor spend a disproportionate portion of their income on, like clothing and gasoline. That would be bad news for poorer Americans even as it makes the overall economy more efficient.

There’s still a lot of work to be done to understand the far-reaching consequences of the D.B.C.F.T. (also, work to be done to find a catchier name). But there’s a broader point about the nature of any major policy reform. The benefits of a reworked corporate tax code would emerge slowly; these disruptions and costs could arrive almost instantly.

No matter the outcome, 2017 will be a fascinating year in which core components of the tax system — with long-lasting economic consequences — will be up for grabs.

Continue reading the main story

Source link

Facebook Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

You may also like

Medicaid’s Data Gets an Internet-Era Makeover

Health data on its own — billing, diagnostic