A destination-based cash flow tax system, which House Republicans are proposing, would improve simplicity, help reduce income inequality, and spur economic growth, according to a report from the Office of Tax Analysis.
House Republicans, led by House Speaker Paul Ryan (R., Wis.), introduced their Better Way agenda last June, which included their blueprint for tax reform.
Under this plan, Republicans would replace the current corporate income tax with a destination-based cash flow tax, which would be border-adjusted. Currently, corporations are taxed 35 percent on profits and have to depreciate capital investments over many years. They also are taxed on profits they earn overseas.
The destination-based cash flow tax would reduce the corporate tax rate to 20 percent, allow businesses to write off capital investments in the way they purchased them, eliminate taxes on profits made overseas and the ability to deduct interest as an expense. Additionally, the corporate tax would be border adjusted, which means imports would be taxed but not exports.
For example, a corporation that purchases a product from an overseas supplier would not be able to deduct that purchase from its taxes. However, if that corporation sells a product to someone overseas, the profit from that sale would not be added to its taxable income.
"Another way to think about the border adjustment is that the corporate tax would ignore revenues and costs associated with cross-border transactions," according to the Tax Foundation. "The tax would be solely focused on raising revenue from business transactions from sales of goods in the United States."
Two economists from the Treasury Department and the Congressional Budget Office evaluated how replacing the current corporate tax system with a destination-based cash flow tax system would impact the economy.
"There are reasons why a cash flow business tax paired with an individual income tax on wages and capital income might be sensible in the United States," the authors said. "For example, as reform options are considered in the current public discourse, there have been broad calls for reforms that would simultaneously spur growth and help address increasing income inequality."
"The combination of a business tax on cash flow and a progressive individual income tax on wages and capital income might prove to be a path forward," they said.
The authors noted that the cash flow system would simplify the tax system by focusing on the point of purchase or sale instead of the types of goods purchased or sold. The new system also would spur growth by removing a disincentive to investment. Finally, the cash flow system could reduce income inequality since the current corporate tax system adversely affects labor.
"Our findings, coupled with the potential advantages that a cash flow tax provides in terms [of] simplicity, incentives for growth, potential progressivity, and fewer distortions on firm location choices, lead us to conclude that this style of reform is promising," the report states.
William Gale, a co-director at the Urban-Brookings Tax Policy Center, spoke at a Tax Foundation event where the paper was introduced. He said the cash flow system would solve the problem of overseas tax avoidance.
"The destination-based cash flow tax is a really elegant and simple system," Gale said. "It solves a lot of the problems people have with the current corporate income tax."
"One of the most amazing things about it is it solves all of these international tax avoidance things through the simple expedient of simply ignoring international transactions," Gale said. "In all the transactions people can do to move tax liabilities overseas, they can still do them in the cash-flow tax, it just wouldn’t affect their liabilities so it’s a really amazing proposal in that regard."