Should-Read: Alan Auerbach: Understanding the destination-based approach to business taxation

Should-Read: Alan Auerbach: Understanding the destination-based approach to business taxation: “The rising importance of multinational companies and the changing nature of production represents a challenge to the traditional ways that countries try to tax corporate profits…

…This column examines one potential policy response – a destination-based cash-flow tax…. A fundamental tax reforms that can deal more adequately with the new economic realities…. builds on the concept of business cash-flow taxation…. A destination-based cash-flow tax (DBCFT)… adds ‘border adjustment’ to cash-flow taxation and has the effect of basing the tax on the location of consumers rather than on the location of profits, production, or corporate residence. As described in a series of papers, including Auerbach (2017), converting an origin-based cash-flow tax into a destination-based cash-flow involves relieving tax on export revenues and imposing tax on imports, in precisely the same manner as is done under existing value-added taxes (VATs). The key difference from a VAT is that the DBCFT maintains the income tax deduction for wages and salaries, and thus amounts to a tax on domestic consumption not financed by labour income, in principal a much more progressive tax than the VAT….

There is little doubt that a large border adjustment can lead to large real exchange rate responses, through some combination of nominal exchange rate appreciation and domestic price and wage increases.  Under simplifying assumptions, the Lerner symmetry theorem predicts that such responses should neutralise any effects on trade.  But there are many possible complications to the analysis…