Destination-based cash flow taxation
This paper sets out a possible approach to the international taxation of corporate profit: a destination-based cash flow tax (DBCFT). The idea of the DBCFT was first set out in a paper by Stephen Bond and Michael Devereux in 2001, and is one of a number of options that have been considered over the last three years by CBT’s group of economists and lawyers, chaired by Michael Devereux. The other current members of the group are Alan Auerbach, Michael Keen, Paul Oosterhuis, Wolfgang Schön and John Vella. In June 2016, the Ways and Means Committee of the US House of Representatives published a Blueprint document “A Better Way for Tax Reform”, which proposes a version of a DBCFT. Given the recent US debate on this proposal, we summarise the paper in some detail here.
The DBCFT has two basic components.
• The “cash flow” element gives immediate relief to all expenditure, including capital expenditure, and taxes revenues as they accrue.
• The “destination-based” element introduces border adjustments of the same form as VAT: exports are untaxed, while imports are taxed.
This is equivalent in its economic impact to introducing a broadbased, uniform rate VAT and making a corresponding reduction in taxes on wages and salaries.
The paper evaluates the DBCFT against five criteria: economic efficiency, robustness to avoidance and evasion, ease of administration, fairness and stability. It does so both for the case of universal adoption by all countries and the more plausible case of unilateral adoption.
• A central motivation for the DBCFT is to improve economic efficiency by taxing business income in a relatively immobile location – the location of final purchasers of goods and services (the “destination”). The DBCFT should not distort either the scale or the location of business investment and eliminates the tax bias towards debt finance.
• Taxing business income in the place of destination has the advantage that the DBCFT is robust against avoidance through inter-company transactions. Common means of profit shifting – including the use of inter-company debt, locating intangible property in low-tax jurisdictions and mispricing inter-company under a DBCFT.
However the distinction between universal and unilateral adoption is important. With adoption by only some countries, those not adopting are likely to find their profit shifting problems to be intensified as companies may seek to shift profit to countries adopting a DBCFT. These issues are explored in more detail in a separate paper by the same co-authors: “International tax planning under the destination-based cash flow tax”, CBT Working Paper 17/17.
• The DBCFT provides long term stability since countries would broadly have an incentive to adopt it – either to gain a competitive advantage over countries with a conventional origin-based tax, or to avoid a competitive disadvantage relative to countries that had already implemented a DBCFT. It would also be resistant to tax competition in tax rates.
The effective incidence of the tax would be on domestic residents financing consumption other than from wages, including from profit subject to the DBCFT. The DBCFT would be more progressive than a single rate VAT, and probably more so than existing corporate taxes. Fairness between countries is harder to assess, but – combined with taxes on natural resources – preliminary evidence suggests that few countries would be likely to see a reduction in their tax base as a result of border adjustment in itself.
The paper also looks closely at the application of DBCFT treatment to the financial sector, and raises and discusses a number of significant implementation issues - both administrative and legal.
Alan Auerbach, Michael Devereux, Michael Keen and John Vella, CBT Working Paper 17/01