A so-called “destination-based cash flow” taxation system is currently the hot topic of discussion around tax reform in this country. Speaker of the House Paul Ryan is pushing the idea hard, but just about every other day it seems the prevailing wisdom says the idea is dead, and then alive again. But just what is it, and how does it work?
A so-called “destination-based cash flow” taxation system is currently the hot topic of discussion around tax reform in this country. Speaker of the House Paul Ryan is pushing the idea hard, but just about every other day it seems the prevailing wisdom says the idea is dead, and then alive again.
But just what is it, and how does it work?
In its simplest form, a “cash flow” tax plan taxes the cash that flows through a firm, minus cash expenses. In many ways, this is similar to the Value Added Tax (VAT) used by many other advanced national economies worldwide. The crux of the “destination-based” aspect, or a Border Adjusted Tax (BAT), is what expenses can be deducted and what can’t. Under this policy, companies can deduct export sales from taxation, and can no longer deduct import costs.
It’s a step toward a more universal consumption tax, and a move away from taxing production. Since the United States imports more goods than it exports, the idea is that there is more revenue to be had by shifting the focus to the other side of the ledger. Under Ryan’s proposal, this new revenue could be used to pay for cuts in the corporate tax rate. What’s crucial here is the assumption that this import-export balance won’t shift as a result, because the dollar will presumably strengthen. More on that later.
Also baked into the proposal is a cut to the corporate tax rate from 35 percent to 20 percent, and what amounts to a wage subsidy by allowing firms to deduct the cost of their domestic labor. The wage subsidy makes this distinct from VATs (and likely very unpopular globally as foreign firms compete against goods produced with subsidized labor).
Finally, the proposal would end the system of taxing American companies’ profits, no matter where they are earned, to only taxing profits earned domestically. This is also similar to the approach taken by countries using VATs.
This plan is totally contingent on whether you believe the dollar will fully adjust and strengthen to the degree predicted by economic models and fully offset the higher price of imports.
The idea is that because we’ll see more U.S. goods exported to foreign markets, foreign consumers will need more dollars to buy them – raising the value of the dollar. Therefore, it won’t matter that U.S. workers pay higher prices for Mexican avocados or tennis shoes manufactured in India, because they’re getting paid each month with more valuable dollars. There is a lot of disagreement on whether this will actually happen.
What makes this proposal tricky is it is trying to kill several birds with one stone. Because of this, there are aspects of this plan that blur traditional ideological lines of support.
First, there’s the idea that under current tax policies, U.S. exporters are disadvantaged. Here’s a nice example, excerpted from a recent Forbes article:
As a result of having to pay both an income tax at the point of production and a VAT tax at the point of sale, the American exporter pays much more tax selling one widget than the French importer. This creates a bad incentive for companies to move production and jobs offshore. With a new corporate tax rate of 20 percent and a BAT … American exporting company ends up only paying the French VAT of 20 percent while the French importer pays the 20 percent U.S. corporate income tax rate. The American company selling domestically pays only 20 percent. All three companies now pay the same tax rate…
Second, the new policy would indirectly shift tax incidence away from domestic production towards domestic consumption—an incentive to make things here rather than import them, which is something the Trump administration has been pushing.
Third, it would dis-incentivize stashing profits overseas or outsourcing. The 20 percent tax on imports would dissuade companies who attempt to get around the new system by outsourcing production or intellectual property overseas, to a low-tax or low-labor cost country, then continue selling products here.
Finally, it’s a Republican plan that will probably only get Republican votes. For a while, some Republicans have been pushing for a national sales tax instead of high corporate taxes. This plan isn’t administered like a sales tax, but a consumption tax and sales tax aren’t all that dissimilar.
Losers:
Winners:
Firms may be more likely to:
The New York Federal Reserve is skeptical, finding “that both firms and households will be faced with higher prices for imports and domestically produced goods alike.” And it doesn’t take a foreign exchange expert to understand that currency markets are fickle. If the dollar doesn’t strengthen as expected, it could be a regressive shift and really hurt U.S. consumers – especially retirees that won’t be able to take advantage of the wage subsidy included in the proposal.
According to Phil Gramm from the American Enterprise Institute: “If everything eventually returns to where it started – an improbable event, given that the value of the U.S. exports plus imports makes up only 0.3 percent of total dollars traded – border adjustment is simply a gimmick that convulses $5.2 trillion of the economy to collect $120 billion in new taxes. If the value of the dollar does not rise by 25 percent, border adjustment is a massive industrial policy that distorts a larger share of the economy than all the special-interest provisions in all the other U.S. tax laws combined.”
Could be minimal or substantial, depending how quickly and fully the dollar adjusts. If the dollar fully adjusts as predicted the real estate industry would likely be agnostic to the shift.
If the dollar doesn’t fully adjust, however, we could see a large decline is purchasing power among consumers, which would undoubtedly trickle into real estate. Many construction materials (i.e. Canadian lumber), appliances and furniture are all heavily imported and could jump in price.
Builders might benefit by being able to deduct labor costs and pay a lower corporate tax rate, which could affect construction rates.
Low-Income Housing Tax Credits (LIHTC) depend on corporate profits and the desire to reduce taxable income. Participation in LIHTC programs dip during times of lower corporate profits, so it’s probably a good assumption that if corporate taxes are lowered, demand for credits to reduce taxes will also fall.
Finally, depending what service exemptions are carved out, if the BAT ends up operating like other VATs around the world, the cost of professional services (including the real estate sector) could rise.
Although it seems to have enough support in the House of Representatives, the White House’s opinion can currently best be summarized as ¯\_(ツ)_/¯. The bigger hurdle is in the Senate, where Republicans are unlikely to get any votes in support from Democrats, and cannot afford any defections. Sen. Cotton (R-AR) and Sen. Perdue (R-GA) have already come out against the proposal, and Sen. Cornyn (R-TX), Sen. Boozman (R-AR), Sen. Scott (R-SC), Sen. Rounds (R-SD) and Sen. Lee (R-UT) have expressed doubts.
