Hey Econoboi, great article and an interesting concept. I'm not sure how exactly does a DBCFT ends the deduction of interest from taxes. I just cant understand how the implementation of a DBCFT removes debt tax subsidies exactly. Isn't that a separate thing entirely? Maybe giving a hypothetical example with a random company that operates in a DBCFT-country would help me understand better. Thx for the great article again!
I explain in the article. Currently, interest fees are deducted from a company’s taxable income. Under a proper DBCFT, any interest expense incurred is no longer deductible.
Sure, though you could just stop allowing deduction of interest from the corporate tax-it's not really a reason to prefer one kind of tax over the other.
Does the export bias not clash with WTO and EU rules, though? Not saying it's not a good tax, but that global capitalists might not appreciate taxing imports while exempting exports, thus "unfairly" targeting foreign companies and serving as a major trade barrier.
People have analyzes this question before, and I think I agree with the 'this doesn't really matter' opinion. Exchange rate movements means trade flows shouldn't change post-DBCFT, and it's not clear the WTO could do much in this regard anyways.
Thinking some more on this: I'm not so sure that a DBCFT only taxes super-normal returns, or that it should. Seems like the tax base of a DBCFT (ignoring trade for a moment) is income - investment - costs (including wages but not including interest). If a company is earning normal profit (in the usual sense of the term), I would still expect their tax base to be positive (they have to pay debtors and pay dividends at least, and should generally be growing their savings too).
I mostly agree with your listed problems with the corporate tax. I'll also add another issue:
"today large firms rely on a veritable army of lawyers, accountants, and financial engineers for assistance in devising creative ways to reduce their tax liabilities" but "individual shareholders have very limited ability to invest in tax avoidance relative to corporations, especially multinational ones. Further, they cannot as easily legally conglomerate and experience the “economies of scale” that corporations themselves have with regard to investments in accounting, law and sophisticated financial instruments strategies. "
But I think this part is confusing: "Taxing normal returns reduces the pool of investment dollars"
I mean... sort of, insofar as lowering the deficit reduces private savings. But it's not like there's a limited pool of "investment dollars": as you mention, companies can borrow money too, which means banks creating new money.
why is this any different from a tariff? You say: "When imports are taxed, domestically there is less demand for foreign products, which lowers the demand for foreign currency (since U.S. dollars are now exchanged less for foreign currency). This, in turn, strengthens the dollar. The strengthened dollar helps buyers import foreign products, offsetting some of the depressed demand from the import tax." but that's also true for tariffs no? they decrease demand for foreign goods
I explain, directly in the piece, how it is different. Tariffs are allocatively inefficient. The DBCFT is not. This is because the DBCFT taxes imports and subsidizes exports, so trade decisions do not change.
Similarly, the VAT other countries charge on imports is not a tariff in the traditional sense.
can you explain that more, like, if the dbcft taxes imports and subsidizes exports, that still means foreign goods are comparatively more expensive than domestic goods, so if i'm a company who needs steel or something, and foreign steel is taxed, that means i might go with the domestic steel instead. from what i understand the VAT in europe applies for any sort of cost or production, regardless of whether its domestic or foreign. but under this dbcft, costs of production would be exempt from taxation EXCEPT imports
The appreciation of the USD makes American exports more expensive to buy and foreign imports cheaper to import, so these combination of things wouldn't significantly change trade decisions.
if decreased demand for foreign products --> decreased demand for foreign currency --> stronger usd, why doesn't this apply to tariffs which also decrease demand for foreign products?
Is this similar to VAT in that domestic inputs to a company are also taxed with the DBCFT rate, or is the tax levied only on imports? It's not immediately clear to me from you're article and there seems to be a lot of either misleading or conflicting information on this online, where most places seem to compare it to VAT but with payroll deductions and no deductions on interest, but I've seen other sources that seem to imply that the tax is levied only on imports, and is effectively just across-the-board tariffs with some minor domestic changes to how stuff is financed.
My takeaway from your explanation was that it was essentially VAT with some minor tweaks and seen from a different viewpoint.
Sorry, I perhaps didn't explain properly. That makes sense, but I'm still struggling to see how this meaningfully differs from a system like in the UK. To my understanding, expenses and investments here (in the UK) are already deducted at time of purchase (i.e. the deduction is based on the amount paid, not the asset value at time of taxation). I'm sure there are some exceptions with how certain investments or expenses are considered, but generally you only pay corporate taxes on supernormal profits as described above, and the issue of destination-based taxation is then addressed by VAT. It seems like this system checks almost all the boxes for DBCFT - just split between two taxes (corporate tax and VAT) instead of unified under a single system. DBCFT seems to only offer some minor additions like no deductions on interest, which could easily be implemented in the UK's system. I believe that most of Europe follows a similar system - why not just replicate this in the US?
It seems like DBCFT would still require a corporation to report, and the IRS to possibly audit, its internal finances, expenses, etc., continuing the full employment program for accountants and tax attorneys and continuing to create all kinds of opportunities for mischief.
I would suggest replacing the corporate income tax with an "X" percent tax on dividends and the same X percent tax on stock buybacks.
Dividends are the true "bottom line" of corporate profits, the money paid out to shareholders, the owners of the corporation. The dividend tax would be in addition to shareholders' individual tax liability.
The buyback tax would discourage the use of buybacks as an end-around to avoid the dividend tax.
This way, a corporate tax return would consist of two questions:
1. How much did you pay in dividends?
2. How much did you spend on buybacks?
Both answers are relatively easy to discern and verify without dumpster diving into the corporate ledgers.
A DBCFT, as with any tax, requires accountants and lawyers, but a DBCFT would require substantially less of them and be non-distortionary compared to a dividend specific tax or a stock buyback tax. See my part 1 as to why we wouldn’t necessarily want to tax dividends or buyback income specifically vs consumption.
If the issue is wealth inequality or accumulation, there are better ways to address that than a dividend or buyback tax.
Really interesting. I wonder if one issue with implementing a tax like this might be figuring out how to handle cases where a company is headquartered in a country with a conventional corporate income tax. Wouldn't they end up getting double taxed?
That depends on the corporate income tax country's tax rules. The country might exempt foreign income. If the country doesn't exempt foreign income, the company would face double taxation.
Double taxation, in this case, would incentivize countries to adopt destination based tax systems.
Never heard of this tax before so thanks for showing this to us.
If I understand correctly, under DBCFT, investments for rental income rather than just pure speculative property investments would be more incentivized? Wealthier individuals buying up property and becoming corporate landlords still isn't great, but a much better option nonetheless and I expect other solutions would also need to be put in place.
The rate could be quite high as you mentioned, given the super-normal returns. However, it's important to note that you arguably need some level of supernormal return in some industries like pharmaceuticals, though my preferred policy would be heavy subsidies and heavy back-end taxes or even buy-outs vs IP rents.
This paper seems to imply the U.S. could rate about double the money from a DBCFT compared to the corporate tax, and this was before Trump's tax cut, so presumably we could raise even more than current policy.
Any revenue estimates you trust?
I posted on another comment an IMF estimate which is old, but it seems to suggest a DBCFT could roughly double the pre-TCJA corporate tax revenue.
Hey Econoboi, great article and an interesting concept. I'm not sure how exactly does a DBCFT ends the deduction of interest from taxes. I just cant understand how the implementation of a DBCFT removes debt tax subsidies exactly. Isn't that a separate thing entirely? Maybe giving a hypothetical example with a random company that operates in a DBCFT-country would help me understand better. Thx for the great article again!
I explain in the article. Currently, interest fees are deducted from a company’s taxable income. Under a proper DBCFT, any interest expense incurred is no longer deductible.
Sure, though you could just stop allowing deduction of interest from the corporate tax-it's not really a reason to prefer one kind of tax over the other.
Does the export bias not clash with WTO and EU rules, though? Not saying it's not a good tax, but that global capitalists might not appreciate taxing imports while exempting exports, thus "unfairly" targeting foreign companies and serving as a major trade barrier.
People have analyzes this question before, and I think I agree with the 'this doesn't really matter' opinion. Exchange rate movements means trade flows shouldn't change post-DBCFT, and it's not clear the WTO could do much in this regard anyways.
Fair enough, I quite like the idea of a government telling Brussels and the WTO to f off and mind their own business lol.
Thinking some more on this: I'm not so sure that a DBCFT only taxes super-normal returns, or that it should. Seems like the tax base of a DBCFT (ignoring trade for a moment) is income - investment - costs (including wages but not including interest). If a company is earning normal profit (in the usual sense of the term), I would still expect their tax base to be positive (they have to pay debtors and pay dividends at least, and should generally be growing their savings too).
I mostly agree with your listed problems with the corporate tax. I'll also add another issue:
"today large firms rely on a veritable army of lawyers, accountants, and financial engineers for assistance in devising creative ways to reduce their tax liabilities" but "individual shareholders have very limited ability to invest in tax avoidance relative to corporations, especially multinational ones. Further, they cannot as easily legally conglomerate and experience the “economies of scale” that corporations themselves have with regard to investments in accounting, law and sophisticated financial instruments strategies. "
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3200249
But I think this part is confusing: "Taxing normal returns reduces the pool of investment dollars"
I mean... sort of, insofar as lowering the deficit reduces private savings. But it's not like there's a limited pool of "investment dollars": as you mention, companies can borrow money too, which means banks creating new money.
why is this any different from a tariff? You say: "When imports are taxed, domestically there is less demand for foreign products, which lowers the demand for foreign currency (since U.S. dollars are now exchanged less for foreign currency). This, in turn, strengthens the dollar. The strengthened dollar helps buyers import foreign products, offsetting some of the depressed demand from the import tax." but that's also true for tariffs no? they decrease demand for foreign goods
I explain, directly in the piece, how it is different. Tariffs are allocatively inefficient. The DBCFT is not. This is because the DBCFT taxes imports and subsidizes exports, so trade decisions do not change.
Similarly, the VAT other countries charge on imports is not a tariff in the traditional sense.
can you explain that more, like, if the dbcft taxes imports and subsidizes exports, that still means foreign goods are comparatively more expensive than domestic goods, so if i'm a company who needs steel or something, and foreign steel is taxed, that means i might go with the domestic steel instead. from what i understand the VAT in europe applies for any sort of cost or production, regardless of whether its domestic or foreign. but under this dbcft, costs of production would be exempt from taxation EXCEPT imports
The appreciation of the USD makes American exports more expensive to buy and foreign imports cheaper to import, so these combination of things wouldn't significantly change trade decisions.
if decreased demand for foreign products --> decreased demand for foreign currency --> stronger usd, why doesn't this apply to tariffs which also decrease demand for foreign products?
David… read the article. This is all explained in the article lol. I talk about why not just do tariffs and how this is different.
Is this similar to VAT in that domestic inputs to a company are also taxed with the DBCFT rate, or is the tax levied only on imports? It's not immediately clear to me from you're article and there seems to be a lot of either misleading or conflicting information on this online, where most places seem to compare it to VAT but with payroll deductions and no deductions on interest, but I've seen other sources that seem to imply that the tax is levied only on imports, and is effectively just across-the-board tariffs with some minor domestic changes to how stuff is financed.
My takeaway from your explanation was that it was essentially VAT with some minor tweaks and seen from a different viewpoint.
It is not equivalent to a VAT because wages would not be included in the consumption base (wages are a deductible expense for business purposes). Some additional reading for you -> https://www.urban.org/sites/default/files/publication/88546/2001166-what-is-the-difference-between-thecurrent-corporate-income-tax-and-a-destination-based-cash-flow-tax.pdf
Sorry, I perhaps didn't explain properly. That makes sense, but I'm still struggling to see how this meaningfully differs from a system like in the UK. To my understanding, expenses and investments here (in the UK) are already deducted at time of purchase (i.e. the deduction is based on the amount paid, not the asset value at time of taxation). I'm sure there are some exceptions with how certain investments or expenses are considered, but generally you only pay corporate taxes on supernormal profits as described above, and the issue of destination-based taxation is then addressed by VAT. It seems like this system checks almost all the boxes for DBCFT - just split between two taxes (corporate tax and VAT) instead of unified under a single system. DBCFT seems to only offer some minor additions like no deductions on interest, which could easily be implemented in the UK's system. I believe that most of Europe follows a similar system - why not just replicate this in the US?
It seems like DBCFT would still require a corporation to report, and the IRS to possibly audit, its internal finances, expenses, etc., continuing the full employment program for accountants and tax attorneys and continuing to create all kinds of opportunities for mischief.
I would suggest replacing the corporate income tax with an "X" percent tax on dividends and the same X percent tax on stock buybacks.
Dividends are the true "bottom line" of corporate profits, the money paid out to shareholders, the owners of the corporation. The dividend tax would be in addition to shareholders' individual tax liability.
The buyback tax would discourage the use of buybacks as an end-around to avoid the dividend tax.
This way, a corporate tax return would consist of two questions:
1. How much did you pay in dividends?
2. How much did you spend on buybacks?
Both answers are relatively easy to discern and verify without dumpster diving into the corporate ledgers.
A DBCFT, as with any tax, requires accountants and lawyers, but a DBCFT would require substantially less of them and be non-distortionary compared to a dividend specific tax or a stock buyback tax. See my part 1 as to why we wouldn’t necessarily want to tax dividends or buyback income specifically vs consumption.
If the issue is wealth inequality or accumulation, there are better ways to address that than a dividend or buyback tax.
The more I learn about DBCFT the more I like it. Thanks!
Really interesting. I wonder if one issue with implementing a tax like this might be figuring out how to handle cases where a company is headquartered in a country with a conventional corporate income tax. Wouldn't they end up getting double taxed?
That depends on the corporate income tax country's tax rules. The country might exempt foreign income. If the country doesn't exempt foreign income, the company would face double taxation.
Double taxation, in this case, would incentivize countries to adopt destination based tax systems.
Never heard of this tax before so thanks for showing this to us.
If I understand correctly, under DBCFT, investments for rental income rather than just pure speculative property investments would be more incentivized? Wealthier individuals buying up property and becoming corporate landlords still isn't great, but a much better option nonetheless and I expect other solutions would also need to be put in place.
I'm doing landlords next.
Bro hasn't heard of Land value tax lmaoo
What an odd assumption to make
The rate could be quite high as you mentioned, given the super-normal returns. However, it's important to note that you arguably need some level of supernormal return in some industries like pharmaceuticals, though my preferred policy would be heavy subsidies and heavy back-end taxes or even buy-outs vs IP rents.
Here's the best paper I could find on revenue -> https://www.imf.org/en/Publications/WP/Issues/2019/01/15/Revenue-Implications-of-Destination-Based-Cash-Flow-Taxation-46506
This paper seems to imply the U.S. could rate about double the money from a DBCFT compared to the corporate tax, and this was before Trump's tax cut, so presumably we could raise even more than current policy.
What do you mean by "buy-outs vs IP rents"?
Instead of providing monopoly rights (patents), we could buyout IP, making it public domain. There’s also harberger taxes or escalating taxes on IP.