The Coalition for a Prosperous America (CPA) appreciates the opportunity to provide testimony to the Committee on Ways and Means regarding the likely impact of tax reform on the US economy. CPA is a national, non-partisan organization focusing upon improving American trade performance, eliminating our persistent trade deficit, and growing domestic supply chains as a means to achieving broadly based prosperity in the US. Our members are organizations, companies and individuals involved in or representing manufacturing, agricultural and worker interests.
1.Summary
1.1The Coalition for a Prosperous America supports Chairman Brady’s commitment to the principles of border adjustable, destination based taxation. Rate reduction is less important for trade competitiveness and economic growth than moving our tax mix towards border adjustability. However, CPA has no position on the optimum business tax rate.
1.2.CPA supports a new border adjustable consumption tax (Goods and Services Tax) that funds a full credit against all payroll taxes.
1.2.1.The US over consumes, under saves and underutilizes our labor capacity.1.2.2.A new U.S. goods and services tax (GST) of approximately 12% should be enacted to shift taxation to consumption using the credit/invoice method.
1.2.3.GST proceeds should be applied as a full credit against the 15.3% rate of payroll taxes to reduce the cost of labor in the US while increasing after tax wages.
1.2.4.Exported goods and services would receive a full rebate. Imports would pay the GST.
1.2.5.Small business with less than, for example, one million dollars could be exempted without sacrificing significant tax revenue.
1.3.CPA also supports a change to a border adjustable profit tax (sales factor apportionment – SFA) for all business entities to replace the current corporate tax system.
1.3.1.SFA is a destination based profit tax. Pretax income is allocated to the US in proportion to the percentage of a company’s total sales in the US.
1.3.2.Pre-tax income earned outside the US is not taxed.
1.3.3.Tax rates can be lowered substantially while still meeting revenue targets.
2.Enact a 12% Consumption Tax and Eliminate the 15.3% Payroll Tax Burden
The US corporate tax system harms America’s trade competitiveness, overtaxes income from wages, undertaxes consumption and is bad at actually collecting what is owed. It also enables rampant base erosion through economically fictitious offshoring of profits. Full reform centered around destination based, border adjustment principles can result in an efficient, trade competitive, and largely tamper proof tax system
2.1.Neutralizing foreign VATS for trade competitiveness: Most countries in the world have shifted a significant portion of their tax mix to border adjustable consumption taxes – value added taxes (VATs) or goods and services taxes (GSTs). GSTs are tariff and subsidy replacements – mimicking a currency devaluation – if a country raises the GST AND uses proceeds to lower purely domestic taxes and costs.
The map below shows which nations have consumption taxes (red) and which do not (blue). Because foreign consumption taxes are border adjustable, CPA members who export are double taxed. They pay US taxes and the foreign border tax. Importers can ship cheaper products because they do not pay US taxes and receive a consumption tax rebate from their home country.
Consumption taxes are called goods and services taxes in Canada, Australia, New Zealand or value added taxes in other countries. Goods and services are taxed as to the incremental value that is added at each level of the supply chain. This is called the credit/invoice method. It is WTO legal. The figure below illustrates how it works.
The US should eliminate this global tax discrimination by enacting a goods and services tax (GST), using the added revenue to provide a full credit against both the worker and company share of the 15.3% payroll tax. The most significant economic gains from this shift arise from reducing domestic labor costs by 15.3% which are embedded in all US goods and services.
A broad based 12% GST could raise $1.4 trillion in new revenue. Payroll tax revenue in 2015 was 33% of total tax revenue at $1.056 trillion.
US trade competitiveness would be substantially improved because exports are freed from both the GST and payroll tax burden. Imports never include the cost of the US payroll tax but would pay the GST. This effect has been called Fiscal Devaluation because it mimics a currency devaluation for trade purposes. It only works if you combine a new GST with a ubiquitous domestic tax or cost reduction. The optimal domestic tax reduction is the payroll tax burden.
2.2. Domestic Prices vs. Wages would not Worsen: The domestic consumers and workers are held harmless for these reasons. The payroll tax is embedded in the cost of all goods and services. Thus eliminating it lowers goods and services prices – or increases wages depending upon the particular competitive forces in each product sector. A GST raises goods and services prices. The GST/payroll tax combination would largely cancel each other out thereby holding the domestic economy harmless.
2.3. Improve upon the modern GSTs of Canada, Australia and New Zealand: The more modern GSTs implemented by free market economies are in Canada, Australia and New Zealand. The compliance and administration burdens are relatively low in comparison to other taxation methods. The US can learn from those and other countries’ experiences to implement the most modern, streamlined GST in the world.
3. Enact a Destination Based Profit Tax (Sales Factor Apportionment) to replace the Corporate Tax System
CPA favors a border adjustable business tax (for all entity types) which allocates pre-tax income based upon the destination of sales. Formulary apportionment based upon a single sales factor (sales factor apportionment or SFA) is well established at the state level. It solves most of the base erosion/profit shifting and tax haven abuse problems facing tax writing committees. SFA eliminates the disparate tax treatment between domestic companies (who pay the full income tax burden on worldwide income), multinationals (many of which shift profits to tax havens), and foreign companies (which pay a territorial income tax).
CPA’s support is based upon our trade competitiveness preference for border adjustability. SFA taxes pre-tax income allocated to the US but not profits allocated to foreign sales. Domestic firms can legitimately “avoid” taxation by exporting more. Profits from imports are subject to tax. Domestic, multinational and foreign firms are on an equal tax footing.
The current corporate tax system cannot be fixed because it allows the fiction of intra-firm transactions to erode the tax base. Multinational companies use them to self-deal, strictly for tax purposes, shifting income to tax haven jurisdictions. Companies sell products or services to themselves, governed only by an “arms length” principle which allows them to create their own pricing terms subject to a nearly unenforceable “fair market value” constraint.
The intra-company transactions are not free market, arms length or true third party transactions. The only economically meaningful “sale” is one to a true third party outside the company. As much of 30% of tax revenue may be lost from profit shifting to tax haven jurisdictions which have effective tax rates of 0-4%. These include Bermuda, Netherlands, UK Caribbean Islands, Ireland, Luxembourg, Singapore, and Switzerland.
For example, assume a multinational corporation has worldwide sales of $100 billion, $50 billion sales in the US and company-wide pretax income of $10 billion. Fifty percent of the the profits, under SFA, are apportioned to the US. So the profits to be taxed in the USA in this case are $5 Billion. Using a 20% corporate tax rate yields an SFA tax of $1 billion. Intra-company transactions with a Bermuda subsidiary would be irrelevant.
Merely lowering the US corporate tax rate to, for example, 15% without further reform would not eliminate the tax competition with tax haven jurisdictions. SFA would make tax havens irrelevant because true sales to any foreign country would be ignored. IRS litigation centered around the proper fair market value of intra-firm transactions would disappear. Only profits allocated to the US in proportion to true third party sales would be taxable.
Virtually all states use formulary apportionment for their state corporate tax system to allocate pre-tax income fairly to the state tax base, ignoring income attributed to outside tax jurisdictions. Most states use a single sales factor, though some use payroll and property as factors.
SFA would allow a significant reduction in the business tax rate while collecting similar revenue because base erosion is largely fixed. By one estimate, a 13% corporate tax rate under SFA would collect the same revenue as the current system. Whether or not a 13% rate is the appropriate target given government revenue goals, it is clear that a lower rate is eminently achievable.
4. Conclusion
The US tax system should shift to more border adjustability through destination based taxation. If the House GOP Blueprint does not gain Senate or White House support, the Ways and Means Committee has solid alternatives to meet their goals. CPA supports enacting (1) a new GST to fund a full credit against payroll taxes, plus (2) a shift to sales factor apportionment of global profits as an alternative to our current corporate income tax system.
Respectfully submitted,
Daniel DiMicco, Chairman
Brian O’Shaughnessy, Vice Chairman
Michael Stumo, CEO
