A Border Adjustment Tax just means more new loopholes

by on March 8, 2017 at 12:42 am in Current Affairs, Economics, Law | Permalink

That is the focus of my latest Bloomberg column, here is one bit from it:

Under one somewhat-neglected feature of [one version of] the tax, companies could no longer deduct advertising, interest, rent and employee benefit costs from their bills for tax due. This is a recipe for major tax dodges and the further politicization of government-business relations.

To think through these problems, note that under circulating versions of the tax reform a company still can deduct its asset acquisition and inventory costs. So, to cite one potential problem, if a company acquires a building it can deduct that expense, but not if it rents a similar building. The result is that the rental market would suffer badly. Some companies would put up their own structures, but others might engage in temporary “repurchase” agreements so they are owning their space (“asset acquisition”) rather than renting it. That’s just one example of the big loopholes the new tax code could create.

There is no single canonical account of how a border adjustment tax would work, so maybe that loophole won’t apply to your preferred version. (Here is a 2016 outline, but expect further changes and details; this KPMG document is useful on options.) But the general point is this: By creating such a sharp distinction between deductible and nondeductible business expenses, the opportunities for tax arbitrage and tax-code lobbying are huge. The suspicion is that most business expenditures could, one way or another, be converted into forms that allow for full and immediate expensing.

How about a version of the tax that allows for deductibility of newly constructed but not purchased buildings? Well, that would encourage overinvestment in new construction. You can also imagine building purchases accompanied by overbilled site modifications (with some of that money being returned in another associated transaction), so the refitted structure could count as new construction.

As I say in the piece, please do note that many people have their particular favored versions of the tax, sometimes designed to avoid various specific problems that are raised.  But I don’t think any version of the tax will avoid these problems in general.  Full and immediate expensing is a potent lure, and it will attract a great of gamesmanship.

1 Amigo March 8, 2017 at 1:05 am

“By creating such a sharp distinction between deductible and nondeductible business expenses, the opportunities for tax arbitrage and tax-code lobbying are huge.”

Might that be the intent, to create dependencies within the system? Good way to raise campaign money. I understand investment tax credits are not made permanent for this very reason.

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2 Pshrnk March 8, 2017 at 11:20 am

Great way to drain the swamp???

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3 Zack M March 8, 2017 at 1:05 am

No comments from Ray Lopez on this important post?

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4 Rich March 8, 2017 at 7:50 am

… Ray had a bad plumbing problem to deal with and could not fulfill his normal 19 hours/day monitoring this blog. Thiago will pick up the slack.

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5 JWatts March 8, 2017 at 10:42 am

To be fair, Thiago needs the distraction. Since apparently the economy of Brazil is in free fall.

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6 polyglot March 8, 2017 at 2:26 am

Alan Auerbach’s proposals, taken together, do make sense. However, as Tyler rightly points out, what we are likely to get is ‘cherry picking’ by a K street cabal which will add further distortions to the corporate tax system while also hitting the real economy by triggering a trade war. We could end up in the worst of possible worlds- one where rent seeking thrives while productive enterprise is disrupted.

Sadly the unexpected success of Sanders & Trump has made the political elite distrustful of ‘wonkish’ policies because, they believe, the great unwashed can be easily inflamed against their pointy headed advocates.

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7 Troll me March 8, 2017 at 11:19 pm

Many forces seem to be moving towards rent seeking rather than productive enterprise.

By which I mean, far more so than before.

It kinds of adds up to sabotage at the economy-wide level. But hey, what does it matter, so long as the Russians are twice as corrupt? them pulling themselves down faster than we do to ourselves is basically like getting ahead faster, right?

(A.K.A., the problem with “realist” thinking.)

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8 Vivian Darkbloom March 8, 2017 at 4:19 am

“Under one somewhat-neglected feature of [one version of] the tax, companies could no longer deduct advertising, interest, rent and employee benefit costs from their bills for tax due.”

The bracketed language above is not contained in the original Bloomberg article. The “version” that allegedly contains the non-deductibility of rent (thereby causing this alleged “loophole”) is not even identified. The main document published by the Ways and Means Committee refers only to eliminating net interest expense. So, alleging that rent won’t be deductible (as opposed to an immediate write-off of a building) without even identifying the “version” being referred to constitutes a pretty flimsy basis to argue that this phantom tax reform package will result in *more* loopholes. And, are we mixing versions or matching them? The term “straw man” comes to mind here. Also, “more loopholes” suggests more than current law. Is that true? Has someone done a study of all the “loopholes” under current law and compared them to all the “loopholes” under what is not yet even a marked-up bill? Finally, it is news to me that one can, under current law, “deduct advertising, interest, rent, and employee benefit costs” from one’s “tax bill due” unless I’ve missed the revision that converted deductions from income to credits against tax.

It is not clear to me how articles like this Bloomberg piece add anything (rather than detracting from) the discussion on tax reform other than meeting a journalist’s quota.

On the other hand, here’s something more concrete worth pondering: The Ways and Means Blueprint proposes eliminating business net interest expense and allowing individuals to deduct 50 percent of their capital gains, dividends *and* interest income. This attempt to put debt and equity on equal tax footing and encourage saving suggests to me that the amount of corporate bonds available to investors will be dramatically reduced (in favour of preferred equity?). More importantly, it means that US Treasury obligations should be much more attractive to domestic individual investors. The tax on interest paid on federal debt is currently fully taxed at normal rates to US persons. If the stock of dollar denominated corporate debt decreases, this should also increase the demand for Treasury obligations among other investors such as pension and insurance funds looking for fixed returns. The combination of these factors would very likely have a significant lowering effect on the rate of interest paid on newly issued and refinanced US government debt and the overall long-term debt forecasts.

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9 Cody March 8, 2017 at 9:29 am

I’m not accustomed to seeing a thoughtful and accurate explanation of something in a comments section. I’m impressed.

Under the ideal cash flow tax, the expensing deduction should apply to investment as well as all the expenditures that can be expensed under current law. It is important that expensing be applied neutrally. The Blueprint comes close to this, with exceptions for land and inventory investment. The reason for disallowing the net interest expense is that interest is not an expense; it is a means of returning money to investors. I can’t see where Tyler got the idea that the plan would disallow expensing for advertising and rent, considering that the Blueprint does not mention either of those at any point.

As much as I usually enjoy Tyler’s posts, his understanding of a DBCFT has been thoroughly disappointing. As an example, his Bloomberg piece describes the plan as “a move toward a value-added-tax structure with corporate investment subsidies built in.” It’s a value added tax with a wage deduction. But perhaps he forgot the part about the “cash flow” tax. Corporate investment is negative cash flow; of course it should be deducted from income. If not, then this wouldn’t be a cash flow tax.

I highly recommend that Tyler actually read some of the more serious (and peer-reviewed) work on DBCFTs. It seems he’s neglected to actually learn about a subject before writing multiple columns on it.

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10 JWatts March 8, 2017 at 10:49 am

Nice post! +1

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11 Troll me March 8, 2017 at 11:23 pm

Regardless of whether other loopholes exist in relation to the same types/sources of taxation which are being modified, adding new loopholes does not beome an unloophole for the fact of other loopholes.

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12 James Drogan March 8, 2017 at 7:46 am

I think there is an argument to be made the the US tax system has, over the years, been modified to such an extent that it has become incomprehensible to all but a class of cognoscenti relishing it for the income they derive from their understanding of the arcane. The interstices therein provide opportunity for action that benefits the few and confuses the many.

Perhaps the tax system needs to be reimagined. This has the potential for simplifying its contingent systems. It also has the potential for creating howling and screaming from those who would subsequently be speaking a dead language.
Jim

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13 Pshrnk March 8, 2017 at 11:23 am

A hell of a way to squander human talent and effort.

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14 AlanG March 8, 2017 at 8:06 am

Yet another fine argument for ending all tax preferences, going to an extremely low corporate tax rate (or Zero) and add in a VAT which cannot be gamed.

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15 AnthonyB March 8, 2017 at 9:25 am

Within the past year Belgium and the Netherlands adjusted their border, presumably untaxedly.

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16 Donald Pretari March 8, 2017 at 11:59 am

When you atempt to explain a baroque or complicated tax, you’ve already bought into the game. When complexity is a feature, it’s a blank check for crony capitalism. Some of us believe that taxes must be perfectly plain, written in crayon, if you will, for us. That criterion limits the number of possible taxes, causing tax attorneys, accountants, corporations, and politicians, to plotz. Taxpayers need to be able to independently decide if a tax is effective or fair. More than likely my favorite tax, a progressive income tax, won’t be popular nowadays, but that’s just too bad for me.

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17 BrianM March 8, 2017 at 2:16 pm

Indeed, on this 50th anniversary of Gordon Tullock’s classic 1967 paper, it is remarkable how readily people will conjure an imaginary world in which rent-seeking doesn’t exist. If you propose a “Border Adjustment Tax,” it really doesn’t matter what version you have in your head or on paper. Even just the title will attract the rent-seeking interests. And, however enthusiastically you argue for your fair and efficient version, the other interests around the table will be playing for much higher stakes, with much deeper pockets. The outcome is predictable, and will not conform to your good intentions, however sincere.

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18 spencer March 8, 2017 at 4:05 pm

Remember, when looking at this while the legal corporate tax rate in the US is 35%, the effective tax rates corporations actually pay — including all taxes so it includes state and local taxes — over the last few years has been:

Q1-2011-22.7
Q2-2011-21.2
Q3-2011-19.7
Q4-2011-20.3
Q1-2012-20.4
Q2-2012-21.4
Q3-2012-21.1
Q4-2012-21.2
Q1-2013-21.2
Q2-2013-21.8
Q3-2013-21.9
Q4-2013-21.9
Q1-2014-24.3
Q2-2014-24.4
Q3-2014-23.1
Q4-2014-22.4
Q1-2015-25.7
Q2-2015-24.6
Q3-2015-24.8
Q4-2015-28.8
Q1-2016-25.4
Q2-2016-24.9
Q3-2016-25.1
Q4-2016

Normally, this average is a balance of large firms paying much lower rates and small firms paying closer to the 35% rate.

You can calculate this from BEA data on taxes actually paid and corporate pre-tax profits.

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19 spencer March 8, 2017 at 4:07 pm

Remember, when looking at this while the legal corporate tax rate in the US is 35%, the effective tax rates corporations actually pay — including all taxes so it includes state and local taxes — over the last few years has been:

Q1-2011-22.7
Q2-2011-21.2
Q3-2011-19.7
Q4-2011-20.3
Q1-2012-20.4
Q2-2012-21.4
Q3-2012-21.1
Q4-2012-21.2
Q1-2013-21.2
Q2-2013-21.8
Q3-2013-21.9
Q4-2013-21.9
Q1-2014-24.3
Q2-2014-24.4
Q3-2014-23.1
Q4-2014-22.4
Q1-2015-25.7
Q2-2015-24.6
Q3-2015-24.8
Q4-2015-28.8
Q1-2016-25.4
Q2-2016-24.9
Q3-2016-25.1
Q4-2016

Normally, this average is a balance of large firms paying much lower rates and small firms paying closer to the 35% rate.

You can calculate this from BEA data on taxes actually paid and corporate pre-tax profits.

The high was 50% in 1951.

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20 Vivian Darkbloom March 8, 2017 at 4:40 pm

I tend to be very skeptical of these effective tax rate calculations unless there is a very detailed description of methodology attached and even then, it’s a muddle.

It should not surprise you that the “effective tax rate” of large corporations is lower than 35 percent. That is because these taxes almost certainly include not only federal, state and local, but most likely *foreign taxes* and *foreign income*. If Apple Computer Inc, a very large international corporation, earns half of its income outside the United States and on that income is subject to a much lower statutory *and* effective rate than 35 percent, one would expect their effective rate on *global income” to be much lower than the US statutory rate of 35 percent. Apple’s (and other major US multinational’s) effective rate would be higher if it were not for the fact that their foreign earnings are, due to the comparatively high US corporate tax rate, trapped outside the US. So, these large global corporations with significant foreign earnings are subject to higher taxes in the US than they are in most jurisdictions abroad. And yet this lower blended US/foreign effective tax rate is often followed the comments such as “see, the US doesn’t need to change anything! Those large US corporations are not paying anything close to the US statutory rate!” All that without once digging a bit deeper and asking why that might be so.

Effective tax rates are generally the rate of actual tax paid as calculated against pre-tax income as computed under the applicable financial accounting rules rather than tax accounting rules (each, respectively, in this case, exclusively US rules). This is foggy terrain. I’ve often wondered where folks get the idea that somehow financial accounting numbers are the best, if not the only, way to determine “income” and therefore the sacred book against which one should determine how much tax should have been due on that “income” (“income”, like “reality” are two words that should always be in quotation marks).

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21 Jackson Layers March 9, 2017 at 3:51 am

These things are so complicated that it’s hard to really comments much on it. I don’t worry much for tax, as I think it should not be major issue for anyone. As a trader, I always follow these things closely for obvious reasons. I feel absolutely privileged that I work under broker like OctaFX, as they are outstanding for all reasons with having small spreads at 0.1 pips for all major pairs while there are over 70 instruments to pick from, it’s amazing.

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22 Massimo March 9, 2017 at 2:07 pm

Why nobody mentions the anti-federalists anymore?

Think about a US whose federal government has only defense, diplomacy and political processes costs to maintain (the cost of Congress, Scotus and presidency). Ideally with a foreign policy based on self-defense, like Switzerland. All the other expenses (health-care, police, education, welfare…) back to the states, as it was until FDR. To give a number, as late as the second presidency of Grover Cleveland, federal taxes were less than 3% of GDP and the books were balanced. With such a level of expenses, you can imagine a Georgist-like way of paying for it, for example leasing the electromagnetic spectrum. Who knows, maybe you have to kick in another 1% paid by the States, for example in base of population, like a simple and low poll-tax, but paid by the each State, rather than the individual. If citizens of a specific state wants to have public supported health-care or education, they can vote for it, and those who don’t want it, can move to another state. Californian or New Yorkers should like it, because now they are subsidizing “Trump” states, and fly-over country people also, because they get rid of the centralized state they say they despise so much. So, why it doesn’t happen? Because, as Bastiat said, “The State is that great fiction by which everyone tries to live at the expense of everyone else”.

The worst thing happened to the US is Hamilton’s coup to change the Articles of Confederation with this Constitution, taking advantage of the absence of Jefferson and the gullibility (or worse) of Madison.

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23 Tommy Richy March 11, 2017 at 6:26 pm

There might be many new loopholes, but one got to take it into stride, I don’t think there are too many options for us. I always do it all confidently with TradeWiseFX using their 50% bonus on deposit offer while there are many such things which make me work well under them.

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