Tax Reform Japanese Style

Alan Auerbach and Michael Devereux are pushing their Destination Based Cash Flow Tax (DBCFT):

This reform should appeal broadly, to Democrats and Republicans alike. The border adjustments would strongly discourage the shifting of profits and activities offshore and eliminate incentives for corporate inversions.

As I noted over at Mark Thoma’s blog earlier this morning:

(1) it would make the US a tax haven as it effectively eliminates the corporate profits tax replacing it with a sales tax - a long time Republican goal. Shifting of profits would still occur but the transfer pricing manipulation games would be at the expense of Canada, Mexico, China, Japan, and Europe. (2) corporate inversions is a gigantic canard. The easy way to do this is to eliminate the repatriation tax (another GOP goal) and to beef up transfer pricing enforcement.

The proponents conceded my first point earlier this year:

the distinction between universal and unilateral adoption is important. With adoption by only a subset of countries, those not adopting are likely to find their profit shifting problems to be intensified: companies operating in high tax countries, for instance, which may seek to artificially over-price their imports, will face no countervailing tax when sourcing them by exporting from related companies in DBCFT countries.

The problem with DBCFT is that it would make us the tax haven while most of our trading partners continue to tax both corporate profits and have a VAT. This source compares corporate profit taxes internationally while this source shows that VAT rate for our European partners. Many European nations have VAT rates near 20% even as their profit tax rates are 20% or more. Japan is an interesting case as they went to a territorial system (ending the repatriation tax) a few years ago but they also are very diligent in enforcing transfer pricing. They also lowered their profits tax from just over 40% to just over 30% as they have been raising their VAT rate, which is scheduled to be 10% in a couple of years. The Senate Republicans seem confused if not nervous about Paul Ryan’s DBCFT ideas. Their preference is to simply lower the 35% U.S. tax rate to something akin to what we see in Europe and switch to a territorial system. If we decided to also vigorously enforce transfer pricing and also passed say a 10% VAT, then maybe all this controversy go away. In other words – let’s be Japanese.