tv Alan Auerbach on Corporate Tax Policy CSPAN March 3, 2017 9:57am-10:34am EST
introduction of the person who needs no introduction. before i do that, i -- nor wyden mentioned the nba all-star metaphor, i just wanted to follow up on that, the score in the nba all-star game this year was 192-182. it was the highest scoring basketball game i think ever. we're hoping our speakers today don't take quite as much offense as the nba did, and we're hoping the speakers provide some defense as well. so we look forward to some very good discussions. alan is the robert d. burch professor of economics and law at university of california at berkeley. he's the director of the burch center research associate of the nber, in the tax world he's very well known as the former president of the national tax association, and he was deputy chief of staff at the joint committee on taxation in '92
when they did the landmark study of corporate tax incidents. beyond the economic -- beyond the narrow confines of the tax world, he is a leader in our profession in numerous honors and awards, the editor of not just one, but of two top journalists in economics. on top of that, i've been the great beneficiary, co-author with alan on many occasions. today, he's going to talk about the destination-based cash flow tax, a proposal for which he's done much of the heavy lifting and main proponent and we can all benefit from his explanation of how it works, why it is a good idea, and what some of the issues are and how they can be addressed. so alan, i'll turn it over to you. thank you. [ applause ] >> thank you, bill. so will my slides come up?
there we go. thank you. well, i told bill i shouldn't need more than two or three minutes to explain the destination-based cash flow tax. everybody in washington and elsewhere in the country already understands it so well. i would like to start with a stroll down memory lane or for many of you just sort of something that happened before you were born. just a notion of where this is all coming from. which is the evolution of the u.s. corporate sector. so here is a listing in 1964 and 2014, end of year, in each case, of the five largest companies as measured by market capitalization, five largest american companies. and in 1964, and 2014. well, of course , exxonmobil is there both times, wasn't exxonmobil, in 1964, it was exxon. but leaving that aside, when
you'll notice is that -- of course, texaco is there in '64 as well. if you look at the other companies, you'll see in 1964, the other three companies were companies that -- as they say make stuff. ibm, general motors and ttat&t. it was the ma bell at&t, u.s. telephone system. in 2014, three of the five largest companies were intellectual companies that do intellectual property. apple, alphabet, google's parent company, and microsoft. and the tale of where we -- what's happened in the corporate sector is pretty much summarized by this list. let me give you some other statistics as well. in the half century represented by those two snapshots, the share of intellectual property
assets in residential assets doubled. and data from -- i can give you background data from the bureau of economic analysis or federal reserve flow of funds accounts which are consistent with that number. the share of before tax corporate profits of u.s. resident companies, coming from overseas operations quadrupled during that period. so this is the rise of the u.s. multinational. so if one wants to summarize what happened in the corporate sector during this period, there was a rise -- a strong rise in multinational activity, increasing importance of intellectual property in value creation. now, something i didn't characterize here, but sort of goes with this, is a weaker link between production and sales because there are companies producing everywhere and selling everywhere, rather than either producing and selling in the same place or in cases producing
in a clearly defined location and exporting. and less ability to identify where that production is occurring. so one can think about where the value added is in the chain of iphone production, for example. and the implication of these changes in the nature of business operations is pressure on systems of taxation that based the locatous of taxation either on a company's residence or where -- where the source of income is, that is where the profits are earned. so this has given rise to a number of different proposals, of course, but one i've been associated with over the years, destination-based cash flow tax. and so i wanted to spend the remaining time i had to talk about its economic effects and i have a list here of various things i want to talk about. just to review what the -- this
proposal is, and, it is in theory, not just any specific version such as currently is considered here in washington, it has two pieces, at least i can think of it, one can think of it that way, cash flow tax, replaces depreciation allowances with expensing, and eliminates interest deductions for nonfinancial companies. and then moving the determination of where taxes are -- the kinds of companies on -- and transactions on which taxes are assessed, by moving to a destination basis, which involves, first of all, eliminating all offshore income from the u.s. tax base and that is in common with what a territorial tax system would do, but that imposing border adjustments, which effectively take export receipts and import costs out of the tax base. in common discussions in recent
weeks, people talk about -- some people talk about the border tax adjustment as a separate tax, but it doesn't really make sense to think of it that way, part of a tax system that both has domestic changes as well as changes involving imports and exports. there is a clear connection between this proposal and the value-added tax. it is a value added tax, but with the deduction for labor costs. you can imagine an equivalent system, first imposing a value added tax, using what is called a subtraction method rather than the credit invoice method and having a payroll credit tax credit at the same rate. as the tax is being imposed. and the result is a progressive consumption tax. that's what it is. now, there are specifics in the house blueprint version of the
destination-based cash flow tax, specific to that proposal, one is the tax rate, 20% for corporates, 25% for past amenities. let me mention in passing that one would typically want border adjustments to apply to the uniform rate and not vary by entity. there is a one time tax, that doesn't have anything to do with the destination-based cash flow tax, but a common proposal win, tax systems move away from taxing offshore income, the camp proposal would have had a one time tax as well. a tax on the net interest income of nonfinancial companies and a tbd for various alternatives. i guess in sports parlance to carry on bill's analogy, a player to be named later.
talking about the economic effects now, first of all, having to do with investment and finance, and this is really largely -- has nothing to do with the border adjustment piece, moving to investment expensing provides a bigger incentive for domestic investment as many people have noted. loss of interest deduction goes in the other direction, of course, the net effect depends on the kind of company you are, but a major reason for taking interest out of the tax base is to level the playing field between debt and eke quit, the distinction between debt and eke quit and the incentive to borrow has long been noted to be a problem of our existing corporate tax system. just to note, this would probably put downward pressure on private interest rates in the u.s. because of a lower demand for borrowing. a big issue having to do with the move to a destination principle is the change in
incentives for profit shifting and corporate inversions. basically the move to a destination basis means that related party trends, cross border transactions are no longer in a tax base at all. that means transactions that companies engage in to shift their profits to low tax jurisdictions would no longer be possible. it would still be possible to increase the profits in foreign jurisdictions, just not reduce profits in the u.s. so companies would have a reverse incentive, shift profits back to the u.s., even from a low tax jurisdiction. if the u.s. is the only country that adopts this plan, the loss of an interest deduction probably means they'll be shifting in the other direction as well with respect to interest. that is multinationals that can borrow in more than one location will to the extent allowed by laws in other countries be encouraged to borrow there rather than the u.s.
and the elimination of tax on foreign sourced income, which is, as i say, also true in a territorial system, removes the incentive, which many companies have been responding to in recent years, to invert. that is to relinquish u.s. corporate residents to avoid paying taxes on repatriation of offshore earnings. no longer would be any such tax to the extent that other companies have minimum taxes or other taxes on their resident companies under their current territorial tax systems, that would actually, again, as in the case of profit shifting reverse the direction of activity and encourage companies to invert into the united states rather than out of the united states. now, this is obviously an important point that has come up in the recent discussion. if one just looks at the border adjustments in isolation and without thinking about the economic responses to them, they
would appear to make imports more expensive and exports cheaper. but the border adjustment should lead to dollar appreciation that offsets the potential rise in u.s. import prices and the fall in world prices of exports. that is, trade -- to put it another way, the u.s. trade balance is determined by a variety of things, and simply undergoing what is called a fiscal devaluation that is lowering the world price of u.s. exports and raising the u.s. price of imports is not going to have an appreciable efebt fect the trade balance. the way that plays out is through appreciation of the u.s. dollar. just to review how that would work, in terms of the operations of u.s. importers and exporters, let me give you to simple examples. the u.s. importer and we'll assume we already have a 20% tax
rate, and just imagine that we're now having put the 20% tax rate in place, we now implement the border adjustment, suppose that the dollar and the euro are roughly of equal value, pretty close to the way it is right now. so that 100 euro import to the u.s. would cost 100 dollars to the importer. and that importer now under current law, but with a 20% tax rate, would deduct it and be out of pocket $80. after the destination-based portion of the bord area adjustment goes into effect, the dollar appreciates, the euro is now worth 80 cents, the $100 import costs $80, not deductible but the after tax cost is still $80. the effective tax rate change is no change in the bottom line. for the u.s. exporter, i can go through the same analysis, u.s. export border selling something for 100 euros, paying tax on it,
and getting $80, the euro deprecia depreciates, the sale not only nets $80 but is not taxable. the effective tax rate falls, no change in the bottom line. a symmetric border adjustment is what border -- these border adjustments are, should have a neutral impact on trade. it would be different, of course, if this were just a tax on imports. that would cause the dollar to go up, but not by enough to keep imports whole. imports would decline, there would be a decline in trade, and the result would be quite different than with border adjustments. and i this just say in passing, some people, particularly when thinking about the wto, have criticized the border adjustment as applying to all revenues rather than just the taxable -- tax base of the companies subject to the destination-based tax, adjusted at the border. if you actually change the border adjustments, so that it
only applied to the tax base rather than it all revenues, that would lower the border adjustment on exports, and would effectively move the system closer to a tariff. so ironically, the change that many people have suggested should be done to make this more compatible with sort of world trade norms would actually convert a trade neutral policy into an import tariff. now, on the exchange rate, the dollar should adjust. there is fine print here in the sense that there is a basic story which i've told you, which i think is the basic story, but there are many complications. the complications don't necessarily point to less dollar appreciation, some of them actually point to more dollar appreciation. and many of them are not necessarily very significant. but just to say that, you know, you can't say that there is going to be -- it is not a
mathematical identity that there will be an exact appreciation of 25% in the dollar, just that it will be approximately that amount. other thing to point out is the timing, people say, well, how long will this take? well, it should take negative time. that is it should -- capital markets move faster than trade, and before the border adjustments come into effect, the knowledge that the dollar will be stronger should be enough to cause the dollar to rise. and so that's actually a concern. one wants to adopt this relatively quickly once it becomes clear it is going to be adopted. just one final point on this, if adjustment of exchange rates is complete, and i'm not saying it would be, that's not of course the end of the story. there would be an alternative mechanism for adjustment of u.s. wages and prices upward, that is it would be reflected in the u.s. wages and prices rather than in the dollar exchange rate. i don't view that as something likely thoo happen. that is what would happen if the
exchange rate did not fully adjust. another point, observation that has been made, made by many people recently, though not a new point and understood for a very long time, is that with dollar appreciation comes a decline in the dollar value of assets held by american companies and u.s. individuals. i have little hyperlink here on the slides that are online, to give you my own estimate of what that would be, around $2 trillion. i have seen much larger estimates by other people. i lay out my methodology in the document for which there is a hyperlink here. i would be happy to compare my methodology to those that give you a larger number. finally, important point, on the location of production, this along with the elimination of profit shifting is praperhaps t most important reason why we
would want to adopt a system like this. moving to a destination-based tax eliminates -- it is what chairman brady called the made in america tax, or it is a tax that is assessed because we locate profits in the u.s., locate production in the u.s. that would no longer be here. there are many different i wwayf explaining that. if you're a company, thinking of locating a production facility profitable production facility in another country or the united states, locating in another country is now 20% less valuable to you in terms of the profits that it generates because that currency is 20% less relative to the dollar. it is as if the 20% u.s. tax rate were being imposed on activities throughout the world, whether in the u.s. or
elsewhere. and, of course, because you pay foreign taxes when you operate, forei foreign countries, you pay the u.s. tax in the u.s. there would be no u.s. additional tax imposed by locating production in the u.s. this is logic that holds not only for u.s. companies, it would hold for gm thinking about whether to build its automobile plant in the u.s. or not. but it would also hold for bmw, or toyota, thinking about whether to build their next auto plant in the u.s. and i think it is an extremely important change in economic incentives, which would really obviate the need to engage in the kind of tax competition in terms of corporate rate reductions and other countries have been engaging in. so just to summarize, this is a simple and it is a durable tax system because it would bring the u.s. to a tax system where further changes are not needed to react to what foreign
countries do. it is a progressive tax system. progressive in its own, but also relative to our current u.s. corporate tax system. it does not distort trade. it is neutral with respect to debt and equity. and it eliminates incentives for profit shifting and inversion, and by eliminating the tax on u.s. source profits, it encourages companies to locate profitable production activities in the u.s., which should also improve u.s. productivity and returns to workers as well. so that is the summary of how i -- what i think of the important points of the plan, and also why i think it is something worth considering and something that really deserves bipartisan support. thank you. [ applause ]
>> okay, thank you. let's start with something very basic. the public discussion in general in the administration in particular seems to confuse the effect of a tariff and effect of a border adjustment. what in your view are the key differences in design and effects and how we should think about them? >> border adjustment is -- has two pieces. the treatment of exports, and the treatment of imports. if we took the treatment of
imports alone, that would be a tariff. and the tariff alone would cause the dollar to appreciate and would discourage imports and trade. and export subsidy, the other part of the border adjustment alone, would also push the dollar up, but would actually encourage trade. so if you add the two together, you get an increase in the dollar, even bigger increase in the dollar, but the effects on trade are neutralized, it is neutral with respect to trade. and it is, as i said, it is exactly, the border adjustments are in the destination-based cash flow tax are simply lifted, the design of the border adjustment is simply lifted from existing value-added taxes around the world. >> all right, one of the big concerns with the cash flow taxes that is not wto compatible, i won't go through all the arguments, but what are
your thoughts about that and how we can respond to it. >> the first is that we could engineer a takeover of the wto by the economics profession. it is a little bit hard to make arguments. there is two worlds, there is economics and then there is wto economics. and wto economics is not a subject that i've ever learned. and in fact it is incomprehensib incomprehensible. so your question about, you know, how do you deal with the wto, this is a legal question. it is not a question for an economist. an economist can't answer a question which has nothing to do with economics. at least not based -- at least not based on an economist knowledge of economics. there are various equivalences among different systems, i mentioned that a value added tax
and wage credit is the equivalent to the system, as far as i understand it, suitably designed value added tax and separate wage credit would be wto compatible. the combined destination based cash flow tax for a variety of reasons is considered not to be or may be considered not to be wto compatible. i think a combination of negotiation, modifying and careful drafting is what would be called for in this case. but this is really not my area of expertise. i think it is important that in adopting the legislation, the u.s. anticipate and indeed start to lay the ground work for what will be dealings with the wto on this. i don't -- i think it would be unfortunate if we just steamed ahead, did it and then just let things happen. and i assume that will not be the way things play out.
>> okay. i'll ask one more question and then there are mikes -- roving mikes, if any of you have questions. the last question is, is this a policy that we can transition into, like could we say that taxes 25% in the cash flow tax, could we border adjust 5% the first year, 10% the second year, and apply that, or would that cause dynamics, because the financial markets react so fast, would that cause dynamics that actually made things worse? >> well, i think you basically answered the question. in practice, when you say, what if countries that have vats around the world done, they have done it gradually, but not with a laid out transition plan over a long period of time. they just started low vats and worked t eed their way up. could you have a four-year transition where, you know, you added 5% of border adjustment
each year, i think that kind of announced short run transition could well run into the problem of having exchange rate appreciation that anticipate the coming adjustment. and that would actually hurt the competitiveness of u.s. exporters and it would have the opposite effect on importers, of course. but i think -- that could cause significant disruptions in the u.s. economy. i would prefer to see transition provisions aimed at easing the transition of companies that might be adversely affected in the short run, an example being companies with outstanding contracts in dollars which even if the dollar adjusts would not necessarily, you know, respond, because the contracts have already been signed. i obviously there are a number of transition issues, what to do about existing depreciation allowances, what to do about interest on existing loans. there are all kinds of important
transition issues to be considered, and one could do that as well thinking about the import and the export side. that would be the place to focus rather than thinking about a gradual implementation of the border adjustment. >> great. questions. yes. mike is coming around. >> thank you. amill sunday. suppose the u.s. and the rest keeps with the origin system. then you have serious transfer prices as a u.s. manufacturer will sell to a related distributor, inflate the export price and you reduce the tax base in both countries. >> yes. so as i said in my comments, the incentives that current companies -- that companies currently face to shift profits out of the u.s. to lower tax can
countries will reverse because the u.s. will now effectively be the lowest tax country, up there with tax havens, having zero tax. and so the incentives for multinationals to engage in profit shifting will not disappear, it will no longer be of a direct concern to the u.s. because it won't affect our tax revenue. but it will certainly affect the tax revenue in other countries. now, i view this as a positive step in the sense that it encourages other countries to adopt this tax system as well. i guess some might review that as coercive. but i don't think it is any more coercive than the policies that other countries have been adopting and reducing their tax rates. that also encourages transfer pricing to shift profits out of the u.s. to those countries. i view this as really just figure out what the end of the logical end of the process will be of tax competition among countries and then moving
directly to that end point rather than going through a period of painful transition. >> and just to be clear, what makes the u.s. tax haven under this proposal is not the reduction of the rate to 20%. it is the changing of the tax base to be essentially aggregate consumption rather than aggregate production. so the tax on profits goes to zero, even though the consumption tax rate is 20%. yes. >> i knew you would have a question. i just didn't know when. >> david brazile. given the impact on dollar denominated assets, and dollar denominated debt in particular, are you concerned at all with perhaps creating a financial
crisis, particularly with sovereign debt and so forth? and is there perhaps a policy -- what do you think about policy that would perhaps encourage domestic inflation, adjustment through wages in prices rather than through depreciation of the currency? >> well, that -- the second part of your question is an interesting one. the -- certainly the case that if the u.s. adopted a much easier monetary policy, that, you know, would obviate the need for a full dollar adjustment. i think practically speaking, generating a lot of inflation in the u.s. is not so easy right now. ask the bank of japan how easy it is to generate inflation. and so practically speaking i'm not sure that's an alternative.
the issue about dollar -- debtors abroad, nothing directly to do the u.s. economy, who have borrowed in dollars rather than their own unstable domestic currencies, that is a concern. there is also -- now has been and is ample time for borrowers in those situations to take precautionary measures. they -- one can engage in a hedge, a currency hedge. it doesn't have to be dollars against their own currency. that won't work. nobody wants to transant ct in their currencies. there is nothing to stop a foreign borrowering from hedging their dollar against the yen or sterling. those are liquid markets. they should be able to engage in such hedges. the optimal hedge wouldn't be complete at this point. we don't know if the legislation
will be undertaken. but certainly some sorts of optimal hedging could be going on right now. i assume it is going on right now. we have a -- still have a large financial sector looking for customers. and i would hope that they're finding them in the form of sovereign borrowers. >> thanks. we're running out of time. one last question over here. yes. and then thornton and then quick answer. >> hi. thornton matheson, imf. i think you touched on this point in one of your slides but i was hoping you could clarify it. regarding the trade neutrality of the border adjustment, some people maintain that for the domestic production in sales, you're deducting the wage cost. where as for imports, you're taxing the entire value added of the import. this creates a nonneutrality of the treatment of domestic and foreign production. is that correct? or if not, then why not?
>> i'll make these answers short. for the first question, the answer is no. the answer to the second question is is a value added tax trade distortionary? no. is a reduction in payroll taxes of all u.s. employees distortionary? no. okay. >> all right. thank you. sounds like we're ready to take a vote. we're going to take a break at this point for ten minutes and we'll meet back here. thank you. [ applause ]