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It’s High Time for Tax Reform, but the Republicans Are Doing It Wrong

Veronique de Rugy
The Best Ways to Use Your Tax Refund – and the Worst

Complying with tax laws shouldn't be complicated or punishing to economic growth. Unfortunately, the current tax code is anything but simple, and the price tag of that complexity is enormous. In particular, our high tax rates distort business decisions and are destructive to economic growth. According to an Internal Revenue Service report, corporations alone spent $104 billion complying with the tax code in 2012. That's a ton of money, especially considering that corporate tax revenues are only about $500 billion a year.

In other words, it’s high time for tax reform. Unfortunately, the House Republicans may be jeopardizing the first opportunity they have had in over 30 years to implement desperately needed tax changes by insisting on one very problematic tax feature on the corporate side called the border adjustment tax. The reform would slap a 20 percent tax on imports to the United States while exempting exports. For the proposal to not become a protectionist tax increase, proponents assume a large and unrealistic strengthening of the U.S. dollar.

Related: Republican Hopes for Tax Reform Hinge on a Trillion-Dollar Gimmick 

One rationale for the border adjustment tax is that other countries’ tax codes give an unfair advantage to their companies over U.S. ones. That’s actually false. First, other countries may have Value Added Taxes that are rebated at the border when companies sell their goods abroad; however, they also have a corporate income tax. The United States is lucky this way, in that it only has a corporate income tax.

Second, at the retail level the United States taxes goods imported from Japan, for instance, and domestic goods equally. Also each country taxes their companies with a corporate tax. So that’s fair. There’s parity of treatment in Japan too, where goods imported from the U.S. are taxed at the retail levels by the Japanese government the same way as Japanese goods. Again, each country taxes their companies with the corporate tax as well. Also worth noting is that economists have repeatedly debunked the claim that Value Added Tax systems boost exports.

Now, it’s true that U.S. companies are at a competitive disadvantage, but this is because our corporate income tax system has the highest statutory rate of all developed countries, and because — unlike most of our competitors — it taxes U.S. companies’ profits no matter where they’re earned in the world. The solution to this disadvantage is to reduce the rates and move toward a territorial system. That’s what the House plan is trying to do, but it’s going about it the wrong way by adding an import tax and exempting our exports. This behavior opens the United States to a costly challenge before the World Trade Organization, which carries its own set of risks for our country.

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Rather than adopt a destructive border tax to address imaginary trade distortions, Congress could address the real problems with our tax code by following the example of the United Kingdom, which decided to leave its competitive disadvantage behind and move to a non-border tax territorial system in 2009. The benefits proved effective by getting rid of a major corporate incentive to leave the U.K. Japan made the same move in 2009 and followed up a few years later by cutting the tax rate.

Finally, it seems that another popular reason for the border adjustment tax is that the new levy, no matter how problematic it is, will help pay for the tax reforms we like. Indeed, the tax is credited for raising $1.2 trillion over 10 years while the economic growth comes from the other aspects of the plan. While the concern for our deficit is understandable, the idea of paying for a pro-growth tax reform by raising taxes is troublesome. Congress should instead pay for lower tax rates and a move to a territorial system through reductions in spending.

Thankfully, there are easy ways to achieve that goal. Corporate welfare programs that benefit special corporate interests at the expense of everyone else cost $56 billion annually. Improper payments total $137 billion a year, while there are easily tens of billions of dollars to save from unauthorized appropriations (spending that occurs without having been authorized by Congress). The Congressional Budget Office estimates that we could save $68 billion annually by imposing caps on federal spending for Medicaid, $126 billion by repealing all insurance coverage provisions of the Affordable Care Act, $41 billion by repealing the individual mandate and $42 billion by ending the tax preferences for employment-based health insurance. We could also save $36 billion a year if Congress converted multiple assistance programs for lower-income Americans into smaller block grants to states, $9 billion if we tightened eligibility rules for food stamps and up to $19 billion by reducing Social Security benefits for new beneficiaries.

Related: Why Trump Won’t Touch Entitlement Reform…Yet ​

Academic research consistently shows major benefits to economic growth and efficiency from lowering the corporate income tax rate and moving to a territorial regime. That should be the focus of any corporate tax reform proposal. There are plenty of spending reform options to pay for a reduction in the corporate rate to 20 percent and a move toward a territorial regime without resorting to a border-adjustment tax, which is poorly understood and presents unnecessary risks to the U.S. economy.

Veronique de Rugy is a senior research fellow with the Mercatus Center at George Mason University.

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