Cash Flow Tax Research Articles

The Potential Distributive Effects of the Proposed Destination Based Cash Flow Tax (DBCFT)

The House GOP Blueprint for tax reform is the most ambitious corporate tax reform since the 1930s. It cuts business tax rates and allows immediate expensing of capital outlays. It accomplishes these goals by replacing the current corporate income tax which taxes profits to a destination based cash flow tax that taxes cash flow. The tax is a move from origin or production based to destination or consumption based. As Alan Auerbach said rather than figuring out “how do you measure income...with cash flow you just follow the money.” The cash flow tax is designed to accomplish a couple big goals. First, stop the gaming done by companies like Facebook to reduce their corporate tax burden. Second, encourage equity investment over borrowing. Finally, encourage exports while increasing the tax burden on imports. To put it mildly, the plan has caused quite a reaction. This essay considers the GOP proposals under the lens of whether the new corporate tax will disproportionately harm the lower boundaries. The new corporate income tax is being marketed as more progressive than the current corporate income tax because it will shift the tax from normal returns to supernormal returns, in other words from labor to capital. Since capital tends to be the wealthy; the tax will redistribute from the rich to the poor. In order to examine the progressivity of the proposal, I first discuss the proper comparative baseline for determining progressivity. Since the proposed tax, at first blush, appears to increase the deficit, the primary question is can the current structure ever be progressive. By cutting other social programs or raising the deficit to pay for the tax is not progressive. Then, assuming that the tax could be neutral in costs because rates can change, the essay concludes that the proposed corporate tax still fails short of being considered progressive. The distortions that continue to exist cause too much uncertainty that the distributive effects would benefit anyone but the owners of capital.

The Substantive Scope of Tax Treaties in a Post-BEPS World: Article 2 OECD MC (Taxes Covered) and the Rise of New Taxes

Several countries have recently either introduced or announced plans for new taxes addressing base erosion and profit shifting by multinational enterprises. These taxes include the Indian Equalization Levy, the UK Diverted Profits Tax, the announced Australian Diverted Profits Tax, the Netherlands Excessive Severance Tax as well as the Belgian Fairness Tax. Moreover, US Republicans plan to substitute the corporation tax with a (destination based) cash flow tax. It remains uncertain whether these hybrid taxes are covered by tax treaties. The uncertainty relates both to the definition of an income tax according to Article 2(2) OECD MC and to the term ‘identical or substantially similar taxes’ pursuant to Article 2(4) OECD MC. Against this background of legal uncertainty, the authors favour a procedural solution introducing an obligation for the contracting states to reach a mutual agreement as to whether or not new taxes are covered by the tax treaty.

The House GOP Blueprint Can Be Drafted to Comply with WTO Rules

The House GOP Blueprint can be drafted into legislation in a manner that would comply with the United States’ international trade obligations. This paper presents two alternative approaches that avoid the key WTO discrimination and subsidy issues often raised in discussions of destination-based cash flow tax proposals.

Effects of Consumption Taxes on Real Exchange Rates and Trade Balances

This paper examines the effects of border-adjusted consumption taxes (mainly value added taxes or VATs) in a sample of 34 advanced economies from 1970 through 2015. We find that the real exchange rate tends to rise by the full amount of any consumption tax increase, with little effect on the current account balance and modest offsetting effects on the trade and income balances. Case studies suggest that adjustment comes initially through prices. We note that the border-adjusted cash flow tax of the House Republicans differs in important ways from consumption taxes used in our study, which raises the possibility of a slower adjustment process with temporarily larger trade effects.

Tax Reform in the United States

Donald Trump has announced a historic tax reform, and the expectation is that the Destination-Based Cash-Flow Tax will be the blueprint. Besides having benefi cial effects on investment, this tax is suspected of having strong protectionist effects on trade. In this article, the latter concern is challenged. The US would only copy a reform Germany has already implemented in 2007.

A European Perspective on the US Plans for a Destination Based Cash Flow Tax

The Republican majority in the US House of Representatives is considering the introduction of a destination based cash flow tax (DBCFT). While its global implementation has the potential of substantially increasing welfare, a unilateral introduction of such a tax system raises a range of questions due to the co-existence with source based taxation systems abroad. We consider the US tax plans from an EU perspective. We show that European exporters may suffer, but European firms with affiliation in the US may benefit from a switch to the DBCFT. American multinational firms with affiliates in the EU will be the likely losers of this policy – a surprising finding given President Trump’s “America first!” rhetoric. Finally, tax competition over profits, IP location and investment will further intensify, which will require policy reactions by the EU and its member countries far beyond the implementation of the OECD BEPS project. We will therefore also discuss the legal and economic implications of possible adjustments in EU tax systems.

Destination-Based Cash Flow Taxation

This paper presents, analyses, and further develops the idea of a destination-based cash-flow tax (DBCFT). Its purpose is expositional: to describe the DBCFT, how it might work, what its effects would be and some of the challenges that its implementation would face. The paper starts by introducing the basic mechanics of the DBCFT before evaluating it against five criteria: economic efficiency, robustness to avoidance and evasion, ease of administration, fairness and stability. It does so both for the case of universal adoption by all countries and the more plausible case of unilateral adoption. The paper then looks closely at the application of DBCFT treatment to the financial sector, which is a familiar problem under the VAT but has been little considered under the DBCFT. Finally, the paper sets out some core implementation issues, and how they might be addressed. It also compares the implementation of a DBCFT with the economically equivalent reform option that introduces a broad-based, uniform rate VAT (or achieves the same effect through an existing VAT), and reduces taxes on payroll by the same proportion.

The Known Unknowns of the Business Tax Reforms Proposed in the House Republican Blueprint

This set of slides raises important issues and questions concerning the potential effects of a border-adjusted destination-based cash flow tax (DBCFT) as proposed in the 2016 House Blueprint “A Better Way.” This will form the basis for an article forthcoming in the Columbia Tax Journal. Citations have been omitted here.

Die radikalen Steuerpläne der US-Republikaner und die Folgen für die EU

The Republican majority in the US House of Representatives is considering the introduction of a destination-based cash flow tax (DBCFT). While its global implementation has the potential to substantially increase welfare, a unilateral introduction of such a tax system raises a range of questions due to the existence of source-based taxation systems abroad. We consider the US tax plans from an EU perspective. We show that European exporters may suffer, but European firms with affiliation in the US may benefit from a switch to the DBCFT. American firms will be the likely losers of this policy. Finally, we discuss potential policy reactions by the EU and its member countries as well as legal and economic implications of possible adjustments in EU tax systems.

Does Tax Risk Affect Investor Valuation of Tax Avoidance?

We examine how investors value tax avoidance (measured as the level of cash effective tax rates [ETRs]) and tax risk (measured as the volatility of cash ETRs), and how these constructs interact to influence firm value. Our results suggest that investors positively value tax avoidance but negatively value tax risk and, most importantly, that greater tax risk moderates the positive valuation of tax avoidance. In additional analyses, we find that contemporaneous measures of tax avoidance and tax risk provide insight into future tax cash flows and that our results hold using GAAP ETR-based measures of tax avoidance and tax risk. Finally, our results are robust to a battery of sensitivity checks including controlling for idiosyncratic and systematic risk, the cost of equity capital, and unrecognized tax benefits in the post-FIN 48 period, among others. Broadly, our findings provide new evidence on how taxes affect firm value and suggest that tax avoidance and tax risk should be considered jointly rather than in isolation.

Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing

One of the fundamental questions in business tax reform is whether to allow firms to immediately expense investments or require economic cost recovery. The conventional view is that expensing would generate stronger growth effects holding revenues constant. This view is rooted in traditional models of corporate finance that assume firms look at the net present value of expected tax payments when incorporating taxes into investment decisions. But this traditional view ignores the possibility that firms focus on more salient measures of taxes as well. If so, they may respond less to expensing than this theory suggests because expensing does not lower their financial accounting tax liability and, all else equal, requires a higher statutory rate.This paper considers whether firms undervalue expensing due to a focus on these non-economic tax metrics and, if so, what this implies about business tax reform if the goal is to increase US investment. It develops a framework for what cost recovery rules are optimal, and then uses new and existing data to parameterize this framework, holding constant long-run revenues and the relative tax treatment of debt and equity. While the empirical evidence is still nascent, it tentatively concludes that applying economic cost recovery to public and very large companies in order to pay for a lower statutory tax rate would generate more US investment and growth than expensing — reducing the relevant tax rate on such companies by more than two percentage points estimated conservatively, and possibly by much more. This estimate is sensitive to the underlying empirical parameters and could easily change. But it does cast doubt on the conventional view that expensing would generate much more US investment and growth than the alternatives. It also contrasts with estimates by non-partisan Congressional staff that expensing as part of a business cash-flow tax would generate modestly higher growth, and with far more dramatic positive growth estimates by some prominent think tanks.

Critical Issues in Understanding the House GOP Tax Reform Blueprint

The House Republican Task Force on Tax Reform released its Blueprint for tax reform in June 2016, at the center of which is a destination-based cash-flow tax (DCFT) to replace the current federal income tax on corporations. The House GOP Blueprint represents the first time that the DCFT has been promoted by political leaders. Initial commentators have stressed the capacity of such a tax (if adopted in the U.S.) to reduce U.S. companies’ incentives for international tax planning and profit shifting, and to allow the U.S. to “leapfrog to the front of the pack” in its tax competitiveness. In this essay I discuss issues that are crucial for understanding the DCFT. I start off by examining border adjustments required under DCFT, and argue that we should not see the “perennial question” concerning such adjustments as being about whether it is in violation of WTO agreements. Instead, the question should be whether we truly understand the DCFT’s potential impact on trade, aside from WTO legal concerns. I identify a couple of ways in which objections against the DCFT have not been adequately answered. I then examine how the loss carry-forward aspect of the Blueprint interacts with border adjustments, and how things get even more complex when non-corporate entities are also taxed on a destination basis. The implementation issues for the DCFT I highlight would not arise if the U.S. were to adopt a VAT instead. I conclude by comparing the DCFT with the VAT in respect of the issue of progressivity, and considering the question of how other countries would respond to a U.S. DCFT.

The Economic Distortions of a Border-Adjusted Corporate Cash Flow Tax

This paper explores the efficiency distortions under two types of destination-based corporate cash-flow taxes. Auerbach and Devereux (2015) have shown that a sales-apportioned cash-flow tax will distort consumer prices; this paper shows that those distortions are generally quite small, and are limited solely to industries in which economic profits are earned, and consumption is already significantly distorted. This paper also shows that a border-adjusted cash-flow tax will distort consumption decisions that cross borders, such as travel, higher education, and retirement location. In addition, it would affect labor migration decisions, especially for migrants who plan either to migrate only temporarily, or to remit a substantial fraction of their earning back to their home country.

No Business Taxation Without Model Representation: Adding Corporate Income and Cash Flow Taxes to GIMF

The Global Integrated Monetary and Fiscal model (GIMF) is a multi-region, forward-looking, DSGE model developed at the International Monetary Fund for policy analysis and international economic research. This paper documents the incorporation of corporate income, cash-flow and destination based cash-flow taxes into the model. The analysis presented considers the transmission mechanism of these taxes and details how financial frictions interact with each of the taxes.

No Business Taxation Without Model Representation: Adding Corporate Income and Cash Flow Taxes to GIMF

The Global Integrated Monetary and Fiscal model (GIMF) is a multi-region, forward-looking, DSGE model developed at the International Monetary Fund for policy analysis and international economic research. This paper documents the incorporation of corporate income, cash-flow and destination based cash-flow taxes into the model. The analysis presented considers the transmission mechanism of these taxes and details how financial frictions interact with each of the taxes.

How Should Europe React to US Corporate Tax Reform Plans?

On April 26, President Trump presented a one page sketch of his long-heralded major tax reform, including some bare bones on corporate taxation. Besides slashing corporate income tax rates to a flat 15 percent and an even lower one-off rate for repatriating offshore funds, the plan remains quiet on the financing side. To balance some of the costs of a substantial tax cut, Congress Republicans have actively advanced a destination-based cash flow tax with border adjustment. This in mind, the EU should be aware of possible threats to its international competitive position. Any reaction should defy a tax race to the bottom and rather resort to early negotiations with US officials on a competition-friendly final version of the tax reform.

Rethinking the corporate tax base: Evidence of the relationships between cash flow and net incom

This study examines how the operating cash flow net of cash from investing activities (CFINV) is correlated with the net income for a sample of 189 Italian listed firms from 2011 to 2015. Research findings revealed three main results. First, firms that have a positive amount of CFINV greater than the amount of net income are unprofitable and levered. Second, CFINV is positively affected by firm profitability, efficiency and leverage. Third, the corporate tax burden is positively affected by firm profitability and efficiency, but negatively influenced by leverage. A similar association between corporate tax burden and CFINV was also found. The relations we present aim to provide additional evidence for the debate about the use of a cash-flow tax base as an alternative solution to the traditional income tax base.

Identical Twins? Destination-Based Cash-Flow Taxes Versus Consumption Taxes with Payroll Subsidies

The Global Integrated Monetary and Fiscal model (GIMF) is a multi-region, forward-looking, DSGE model developed by the Economic Modeling Division of the IMF for policy analysis and international economic research. This paper uses GIMF to illustrate when a destination-based cash-flow tax is equivalent to a combination of a consumption tax and a labor subsidy, as the latter combination have been advocated as proxies for the implementation of destination-based cash-flow taxes. The paper documents the conditions under which both types of taxes are identical and how the equivalence in terms of the real economy and tax revenue responses can be broken, namely after the introduction of finitely lived consumers that value government debt as net wealth (real economy) and the introduction of untaxed government expenditure (tax revenue).

Identical Twins? Destination-Based Cash-Flow Taxes Versus Consumption Taxes with Payroll Subsidies

The Global Integrated Monetary and Fiscal model (GIMF) is a multi-region, forward-looking, DSGE model developed by the Economic Modeling Division of the IMF for policy analysis and international economic research. This paper uses GIMF to illustrate when a destination-based cash-flow tax is equivalent to a combination of a consumption tax and a labor subsidy, as the latter combination have been advocated as proxies for the implementation of destination-based cash-flow taxes. The paper documents the conditions under which both types of taxes are identical and how the equivalence in terms of the real economy and tax revenue responses can be broken, namely after the introduction of finitely lived consumers that value government debt as net wealth (real economy) and the introduction of untaxed government expenditure (tax revenue).

Demystifying the Destination-Based Cash-Flow Tax

This paper describes the Destination-Based Cash-Flow Tax (DBCFT), as proposed in 2016 by Republicans in the US House of Representatives, and its potential economic effects. As a new approach and a major departure from the existing business tax system, the DBCFT and its motivation have been poorly understood by many in government, the business community, and the economics profession.