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Republican Plans To Cut Corporate Taxes May Have Unpleasant Side-Effects
Republican Plans To Cut Corporate Taxes May Have Unpleasant Side-Effects
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From the print edition | Finance and economics
Dec 17th 2016 | WASHINGTON, DC
America’s corporate-tax rate, which reaches 39.6% once state and local levies
are included, is the highest in the rich world. But a panoply of deductions and
credits keeps firms’ bills down. These include huge distortions, such as a
deduction for debt-interest payments, as well as smaller scratchings of pork
like special treatment for NASCAR racetracks. After all the deductions are
doled out, corporate-tax revenues are roughly in line with the average in the
rest of the G7, according to economists at Goldman Sachs.
Still, a high tax rate and a narrow tax base is a glaringly inefficient
combination. Politicians of all stripes have sought to improve things. For
instance, since 2012 Barack Obama has proposed cutting the rate to 28%,
while doing away with (mostly unspecified) tax breaks. That idea never got a
look in. But analysts are poring excitedly over Mr Ryan’s plan, which is for
now the most detailed Republican offering. It proposes to expand the tax base
in two main ways. The first is to kill off the deduction for debt interest,
putting a welcome end to the incentive for companies to binge on debt. The
savings from this would be spent on letting businesses deduct the full cost of
their investments when they make them, however they are financed.
The second concerns geography. Uniquely in the G7, America taxes firms’
global profits (net of any payments to foreign taxmen). But companies need
pay only when they bring profits home, so they keep cash overseas—some
$2.6trn-worth, by one estimate. Some escape Uncle Sam’s clutches altogether
by merging with a foreign company and moving to its tax jurisdiction
(although the Obama administration has penned rules making such
“inversions” harder).
Mr Trump wants to offer a one-time tax rate of 10% to firms that repatriate
their cash. To put an end to the barmy incentives, Mr Ryan, adopting a pet
cause of Kevin Brady, chairman of the influential House Ways and Means
Committee, would stop taxing foreign profits. In fact, he wants to ignore
foreign activity altogether, including profits made selling American goods
abroad. Meanwhile, firms would no longer be able to knock off the cost of
imported goods when adding up their profits. In combination, these two
changes are dubbed “border adjustment”.
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This would make America’s corporate tax very similar to a value-added tax
(VAT), a kind of border-adjusted sales tax, says Kyle Pomerleau of the Tax
Foundation, a think-tank. Most rich countries have both a VAT and a
corporate tax (see table). When, say, Rolls-Royce exports a jet engine from
Britain to France, it pays French VAT on the sale and British corporate tax on
its profits. But while America levies the corporate tax on exporters’ profits, it
imposes no VAT on imported goods (except for state and local sales taxes).
Mr Ryan’s proposal would more or less reverse this.
In reality, it might take time for the dollar to rise. If so, American exporters
would benefit in the interim. But big importers would take a hit. The Retail
Industry Leaders Association, a trade group, is already campaigning against
the change.
However long the dollar took to appreciate, it would be no small adjustment.
To offset a border-adjusted tax of 20%, the greenback would have to rise by a
staggering 25%, according to Goldman. It is already up by 24% on a trade-
weighted basis since mid-2014; repeating that appreciation would hammer
those emerging markets with sizeable dollar-denominated debts and threaten
the health of the world economy. It would also reduce the dollar value of
American investments abroad.
Despite the plan’s appealing simplicity, it seems unlikely that Congress will
pass a proposal that would cause such volatility in currency markets. Senate
Republicans have been largely mum on the House plan. And unless America
switches to a full-fledged VAT, border adjustability may also be judged to
breach World Trade Organisation rules.
That bodes ill for the size of the overall corporate-tax cut. Since America
imports much more than it exports, border adjustability would raise fully
$1.2trn over a decade, covering almost two-thirds of the cost of cutting the
tax rate to 20%, according to the Tax Policy Centre, a think-tank. Without
that money, Republicans would have to scale back their plans, disappointing
investors. And it might force the government to borrow more, widening the
budget deficit, and putting short-term upward pressure on the dollar. Either
way, markets could be in for a few surprises yet.
This article appeared in the Finance and economics section of the print edition under the