The tax reform idea that has received the most attention recently is replacing the corporate income tax with a cash-flow tax on domestic business — and imposing a tax on imports into the United States.
The current personal and corporate tax system impose taxes on productive activities that contribute to economic growth, such as working, investing and saving. Consider dividends paid by corporations to shareholders: They are taxed at the corporate level, then taxed again at the shareholder level. On the other hand, our current tax system also subsidizes consumption and debt. Think of interest deductions on personal mortgages and corporate debt.
Taxes on corporations encourage firms to relocate to lower-tax jurisdictions. If they repatriate any profits back to the United States, they must pay the U.S. tax minus any taxes paid in the country of origin. Since the United States now has the second highest marginal corporate tax rate in the world, there is no incentive to repatriate. Instead, it is more profitable to locate production in a country with cheaper labor and lower taxes, and export goods to the United States.
Cash Flow Business Tax. A tax reform plan proposed by a House Republican task force in 2016 would replace the corporate income tax with a flat business tax of 20 percent. Among the features of the plan:
- Businesses would deduct (immediately expense) capital expenditures from revenues without a complicated depreciation schedule. Businesses could also deduct labor costs.
- Businesses could no longer deduct net interest payments on loans, ending the current tax code’s bias in favor of debt over equity financing.
- “Pass-thru” businesses, such as partnerships, would also be taxed at a lower rate — putting them on a more equal footing with corporations.
- U.S. taxes on income from overseas investments would be eliminated.