Continuing from Simon’s interesting post on The GOP’s Response to VAT. . . . In June 2016, the House Republican Tax Reform Task Force, led by Congressman and House Ways and Means Chair Kevin Brady, published a “Tax Reform Task Force Blueprint.” The Blueprint proposes repealing the current corporate income tax, and replacing it with a 20% “flat tax” applied to “business cash flow.” (Blueprint page 23, 28). The Blueprint’s “business cash flow” tax (“BCFT”) is not a VAT. It is derived from legislation introduced by Rep. Devin Nunes of California, the American Business Competitiveness Act (H.R. 4377). Under H.R. 4377, “net business tax income” is taxed at specified rates. “Net business tax income” is defined as “the amount by which the taxable receipts of the business entity for the taxable year exceed the deductible amounts for the business entity for the taxable year.” This is still a net income tax, not a VAT. For WTO law purposes, the important point is that it does not seem (to me) possible to characterize it as a tax on a product. It is a tax on a firm, calculated by reference to a new and simplified definition of net income, but a definition of net income nonetheless. It is an income tax. By contrast, a VAT is a tax on a product. Bill Gale has a nice description of how a VAT is calculated here.
The Blueprint would apply the BCFT to imports, and would exempt exports from the BCFT. This is an import border tax adjustment (“BTA”) and an export BTA. I address each in turn.
There are two WTO law problems with the import BTA. First, under WTO law, in order for a tax to be border tax adjustable in this way, it must be a tax on a product. Under GATT Article II:2(a), WTO member states are permitted to impose “a charge equivalent to an internal tax imposed consistently with the provisions of paragraph 2 of Article III in respect of the like domestic product or in respect of an article from which the imported product has been manufactured or produced in whole or in part.” It is well-understood in GATT and WTO jurisprudence that an income tax is not a tax on a product. Therefore, this tax, when imposed on imported goods, would not be adjustable and would violate U.S. WTO tariff commitments.
I think the Blueprint gets this wrong on page 28, where it asserts the following: “The rules of the World Trade Organization (WTO) include longstanding provisions regarding the use of border adjustments. Under these rules, border adjustments upon export are permitted with respect to consumption-based taxes, which are referred to as indirect taxes. However, under these rules, border adjustments upon export are not permitted with respect to income taxes, which are referred to as direct taxes.” The WTO law issue is not whether it is a consumption versus income tax, but whether it is a tax on a product or not. For the details, see Steve Charnovitz’ paper here.
There is probably a second problem. Under H.R. 4377, “only taxable receipts and deductible amounts which are effectively connected with the conduct of a trade or business within the United States shall be included or deducted in the computation of net business income.” On the deduction side, this means that the cash flow tax is a net income tax for U.S. producers. But for imported goods, it is a gross basis tax, applying its 20% rate to the gross price of the imported goods. So, even if this tax is otherwise adjustable, it does not meet the anti-discrimination requirements of Articles II and III of GATT. A possible counterargument is that this is precisely what a VAT border tax adjustment does, and presently, U.S. goods are subject to a full application of VAT, with no deductions, when imported to countries applying VAT. As the Republicans point out, VAT countries have a kind of isomorphic bias—they don’t inappropriately tax goods coming from other VAT countries, but they structurally impose an additive burden on goods coming from income tax countries like the U.S. Of course, the U.S. has the option to exclude from income taxation its exports—to move to a territorial system such as that proposed in the Blueprint—and this would eliminate the unfairness on export.
Now let’s turn to the export BTA—the rebate or exemption of taxes upon export of goods from the U.S. Under Article 1.1(a)(1)(ii) of the WTO Agreement on Subsidies and Countervailing Measures: there is a subsidy when “government revenue that is otherwise due is foregone or not collected.” Now it is possible to argue that the Blueprint proposes a consumption tax, such that government revenue is not otherwise due—the structure of the tax never included domestic consumption. This argument might be plausible if the Blueprint truly proposed a consumption tax, but it looks more to me like an income tax. And, as an income tax, it might fall into the WTO jurisprudence arising from the U.S. Foreign Sales Corporation tax law, finding that exemption of foreign source income is a subsidy, and because it is contingent on export, it is a prohibited export subsidy. The problem with that line of cases is that no one seems to argue that a true territorial tax regime—excluding foreign source income altogether from taxation—constitutes an export subsidy. The WTO jurisprudence there seems to rely on the prior structure of U.S. tax law, and the subsequent exemption. It has always seemed to me somewhat unfair to the U.S.
Footnote 1 to the WTO Agreement on Subsidies and Countervailing Measures, expanding on Article VI:4 of GATT, provides that “the exemption of an exported product from duties or taxes borne by the like product when destined for domestic consumption, or the remission of such duties or taxes in amounts not in excess of those which have accrued, shall not be deemed to be a subsidy.” This provision raises again the question of what it means for a tax to be “borne by a product.” Again, a VAT seems clearly to be “borne by a product,” while the Blueprint’s BCFT looks more like an income tax on a firm.
Just to add some confusion, the structure of paragraph (g) of Annex I to the Agreement on Subsidies and Countervailing Measures, the Illustrative List of Export Subsidies, suggests under an a contrario interpretation that an export BTA would not constitute an export subsidy where it provides a remission of indirect taxes not “in excess of those levied in respect of the production and distribution of like products when sold for domestic consumption.” (emphasis added) But the reference to indirect taxes, generally understood as distinct from income taxes, makes it less likely this would provide an exception for the proposed export BTA. Footnote 58 to the Agreement on Subsidies and Countervailing Measures makes clear that (i) direct taxes include only income taxes and taxes on real property, and (ii) indirect taxes include all other taxes.
To conclude, if the BCFT is characterized as an income tax, as I think it must be, the related import BTA and export BTA are likely to be illegal under WTO law. Perhaps the Republicans should reconsider a VAT.