Tax reform is discussed in terms of progressivity, gross revenue, compliance and administrative costs. All key factors.
But how does the U.S. tax system impact our trade deficit? The answer is “quite a lot”. And not in the ways you’ll hear from the talking heads.
The effective tax rate (different than the marginal tax rate, because it is the taxes actually paid) is quite low in the U.S. Our tax revenue as a percent of GDP is lower than other developed (OECD) countries. This means that the marginal impact of lowering taxes in an absolute sense will have little impact on trade competitiveness.
But… comprehensive tax reform could have a big impact if we (1) added a consumption tax; (2) reduced other taxes; (3) maintained progressivity; and (4) maintained overall tax revenue.
Here’s why. The U.S. has dropped import tariffs for decades, gaining little revenue from imports. Other countries have dropped tariffs (in large part because of trade deals) BUT they then raised consumption taxes (like value added taxes) which are charged on imports. Consumption taxes are charged on imports, and rebated/refunded on exports (because the consumption occurs somewhere else, not the home country). The net result is that the U.S. dropped import charges (via tariffs) and other countries did not drop import charges (because of consumption tax hikes). And the U.S. does not subsidize exports (because its WTO illegal) but foreign countries subsidize exports to the U.S. with consumption tax rebates (because its WTO legal).
Stated another way, (1) U.S. exports are double taxed: the products bear a 100% U.S. tax load PLUS a partial foreign tax load when the consumption tax is applied at the foreign border. And (2) foreign imports to the U.S. bear only a partial tax load: they rebate the consumption tax when exporting and the U.S. does not charge an import tax.
This is the biggest trade distortion in the world, from the U.S. perspective. Pat Choate has quantified the unfairness with 2008 global figures here… and the bilateral distortion (adding the import and export effects on goods and services) is $500 billion. Bigger than any other trade hurdle we face. By far. A CPA report showed that China gains a whopping 20% of its national tax revenue by charging taxes on imports.
So why don’t we have “border adjustable” consumption taxes in the U.S.? (Border Adjustable means the tax is added to imports and refunded on exports). Because (a) we just never have done it, (b) conservatives don’t want a new tax; and (c) liberals don’t like consumption tax progressivity. The second and third reasons are easily dealt with… its just math, after all. And the first reason isn’t really a substantive reason.
Michael Graetz of Columbia University has developed a method of comprehensive tax reform that adds a consumption tax, reduces reliance on income taxes, retains progressivity, and retains the same revenue. Additional attractive elements are (1) 100 million (lower end income) people would no longer file tax returns; (2) we would SUBSTANTIALLY increase trade competitiveness; (3) imports would pay a share of the taxes to support the society in which they sell and benefit from; (4) investment and savings would be incentivized.
While federal legislators are not openly clamoring for a consumption tax, CPA has found significant quiet support, including support in tax leadership positions. And the so-called “fiscal cliff” is transforming into a tax reform debate. The Congressional Budget Office, the Government Accountability Office and the International Trade Commission have all conducted consumption tax studies in the last 30 years… though not directly on tax reform including both consumption and income taxes.
Today, the NY Times held a written op-ed forum on comprehensive tax reform. Four outside tax expert writers contributed. Three of the four proposed some sort of consumption tax as part of the proper plan. The best method is proposed by Michael Graetz. Another contributor included both income and consumption taxes. A third contributor wants to end income tax in favor of consumption taxes, which is probably not preferable or do-able.
We, as a country, need to consider the proper way to include a consumption tax to neutralize the biggest foreign trade unfairness we face. Perhaps now is the time.