There’s a Better Way to Reform the Corporate Tax

That would, at least in theory, have a couple of beneficial effects. By itself, it probably wouldn’t raise investment much — companies would repatriate cash being held overseas, but they’d probably just return it to shareholders. However, ending the incentive for companies to shift profits overseas would result in increased collections, allowing the headline corporate tax rate to be safely reduced without affecting revenue.

Also, a substantial amount of the U.S. trade deficit probably comes from companies’ efforts to shift their profits to overseas subsidiaries — if Auerbach’s plan became reality, the trade deficit would appear to shrink enormously, almost overnight. That would reduce political pressure for dangerous protectionist measures.

So Auerbach’s plan is smart for a number of reasons. But there are some major issues with implementation. One big problem — and possibly the reason that the idea was nixed earlier this year — is that many people believe the plan violates World Trade Organization rules. The reason is that it works by taxing imports more than exports — a feature commonly called the “border adjustment.” That could be construed as an export subsidy, which the WTO forbids. Switching to a new system would not be worth the cost of withdrawing from the WTO and starting a global trade war.

But as Auerbach shows, there may be a way around the problem. His plan is really just the combination of two other policies — a value-added tax on consumption and a wage subsidy. Neither is banned by the WTO — most countries use VATs, in fact. So, instead of the DBCFT, the U.S. could simply replace the corporate tax with a VAT plus a wage subsidy whose rate is equal to that of the VAT. Voila!

One added benefit of this plan is that the wage subsidy could be tweaked to make it progressive — if the subsidy is less for high-wage workers than for low-wage ones, it could be used to do some income redistribution. In fact, much of the subsidy could be accomplished simply by cutting payroll taxes. This sort of redistribution would be both easier and more efficient than most other methods currently in use.

So Auerbach’s tax represents a challenging but ultimately very promising way to overhaul the creaky, outdated U.S. corporate tax system. It could offer the U.S. a chance to increase investment, improve efficiency, lower the trade deficit and redistribute some income from the rich to the poor, all at once. It’s the kind of smart policy that doesn’t get much attention as a political rallying cry, but that has the potential to do some real good for the economy. Hopefully, politicians will give it a second look after the current tax reform battle is over.

— For more Bloomberg View columns, visit http://www.bloomberg.com/view.