The Republican tax reform plan looks like it will contain few or none of the innovative, interesting ideas that were being thrown around a few months ago. That’s too bad. But when the smoke clears from the current political battle, whichever side wins, hopefully there might be room for smart reforms to sneak in.
One of the smartest ideas comes from Alan Auerbach, an economist at the University of California, Berkeley. Auerbach’s baby goes by the incredibly unwieldy, nerdy-sounding name of the Destination-Based Cash Flow Tax. It was part of the original Republican tax reform effort, but was axed fairly early on.
If the name is a mouthful, the substance is even trickier to grasp. In a new essay, Auerbach explains the essence of the policy, including its potential advantages and the difficulties with implementation.
The biggest change would be to stop taxing corporate profits — as the U.S. and most countries now do — and start taxing corporate cash flow instead. In the long run, these two should be roughly equal, so this wouldn’t change the corporate tax base very much. But it would involve two other changes to the way companies get taxed, all of which could yield big benefits for the U.S.
First, a cash flow tax means that investments don’t get expensed over time, as they depreciate, but immediately, when the investment is made. That allows companies to write off investments sooner, rather than later. Because accelerated depreciation is widely believed to give investment a boost, immediate expensing — which is just an extreme form of accelerated depreciation — would probably have an even bigger effect in terms of getting companies to make capital outlays. More investment means more jobs in the short run, and a higher national savings rate in the long run.
Second, Auerbach’s tax would eliminate interest deductibility for most companies. Currently, tax law favors debt finance over equity finance, encouraging companies to borrow more. But leverage is inherently dangerous, so switching to a system that wouldn’t encourage excessive borrowing would help make the economy more robust against future financial crashes.
The other big change involves how overseas business activity is taxed. It would be levied where sales are made, instead of where a company is officially headquartered. So if Apple, for example, decided to move its headquarters to the Virgin Islands, it would still be taxed just the same based on the iPhones and iPads it sold in the U.S.