The major potential impact of a corporate tax overhaul

The United States system for taxing businesses is a mess. If there’s one thing nearly everyone can agree upon, it is that.

The current corporate income tax manages the weird trick of both taxing companies at a higher statutory rate than other advanced countries while collecting less money, as a percentage of the overall economy, than most of them. It is infinitely complicated and it gives companies incentives to borrow too much money and move operations to countries with lower tax rates.

Now, the moment for trying to fix all of that appears to have arrived. With the House, Senate and presidency all soon to be in Republican hands and with all agreeing that a major tax bill is a top priority, some kind of change appears likely to happen. And it may turn out to be a very big deal, particularly if a tax plan that House Republicans proposed last summer becomes the core of new legislation.

Among Washington’s lobbying shops and policy analysis crowd, it’s known as a “destination-based cash flow tax with border adjustment.” It’s easier to think of it as the most substantial reworking of how businesses are taxed since the corporate income tax was introduced a century ago. And it could, if enacted, have big effects not just in the tax departments of major corporations but in global financial markets and the aisles of your local Walmart.

This possible revamping of the corporate tax code is less politically polarising 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 DBCFT (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, 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.

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.

© 2017 The New York Times News Service