As part of its massive infrastructure plan, President Joe Biden’s administration is seeking to raise the US corporate tax rate from 21% to 28%, with a 21% “minimum” tax on profits earned abroad by US corporations. In the words of secretary of the Treasury Janet Yellen, the goal is to arrest an international “race to the bottom” by getting other countries to adopt similar minimum corporate taxes.
Unfortunately, the measures being proposed seem designed for an earlier era, when it was easy to identify the factories and refineries where companies produced and earned their profits, and when a corporation’s nationality was largely determined by the location of its main operations and its shareholders. In the modern era, multinational companies with international shareholder bases operate global supply chains, creating value using intangible capital with no natural location. As such, trying to modify a tax system based on a company’s residence and where its profits are earned amounts to trying to replace the race to the bottom with a race to the past.
If the United States adopts the proposed measures but fails to get others to go along, it will have saddled itself with a less competitive tax system. But even if it succeeds, it will have locked in a system that will require constant modification to keep up with economic realities that are departing ever further from the core concepts on which the system is based.
Fortunately, there are alternatives that are much more attuned to the realities of the modern economy. Policies enacted in the US at the state level in recent decades have steadily moved toward taxing corporations based on the location of their sales. For these jurisdictions, shifting away from taxes based on the location of payroll and tangible assets has proved salutary for investment and employment. Moreover, if adopted at the national level, “destination-based” taxation could solve the problem of international profit-shifting that the Biden reforms are intended to confront.
The most decisive reform would be a destination-based cash flow tax (DBCFT). Among other things, this would provide immediate expensing for all investment, eliminate the tax advantage for corporate borrowing, and impose border tax adjustments to eliminate taxes on export revenues and tax deductions for import costs. At the end of the day, only domestic cash flows would be taxed. And, because transactions between domestic companies and related foreign parties would have no US tax consequences, the practice of profit-shifting would disappear.
Moreover, the border tax adjustments would move the locus of taxation from where products are produced to where they are sold. Because domestic production would impose no additional tax on companies, America’s attractiveness as a location for employment-generating investment would be enhanced. A major added benefit would be that the welter of complicated tax rules aimed at preventing corporations from shifting profits and production abroad could be repealed as unnecessary artifacts of a bygone era, rather than being augmented even further under the Biden plan.
Likewise, with the tax system imposing no special burdens on US corporations, all measures aimed at preventing them from moving their headquarters abroad in order to escape US nationality could be consigned to history, rather than confounding matters further. And tying tax liability only to transactions within the US would relieve the Internal Revenue Service of the burden of chasing down information about companies’ foreign operations.
Readers may recognize the DBCFT from its appearance in 2016, when House Republicans Paul Ryan and Kevin Brady proposed it. The scheme ultimately did not make it into the 2017 Tax Cuts and Jobs Act, because its sponsors’ insistence on the immediate, full-scale adoption of a then-unfamiliar reform drew opposition from other Republicans. Moreover, the Trump administration’s belligerence toward America’s traditional allies created an adversarial relationship in which there was little attempt to explain the rationale for the reform, let alone push for its adoption abroad.
But the Biden administration, with its expressed desire for international cooperation and domestic bipartisanship, has a better chance at success. As an effective tax on corporate profits, the DBCFT is not only progressive; it is actually more progressive than the current US corporate tax, which makes US workers less productive by discouraging investment.
A straightforward tax that provides a sustainable, progressive source of revenue and incentives for domestic investment and employment (even if the tax rate is increased) should appeal to many in Congress, regardless of their political orientation. The choice between a modern corporate tax and a race to the past should be clear.
Alan J. Auerbach is a professor of economics and law at the University of California, Berkeley.
Copyright: Project Syndicate