Is a Destination-Based Cash Flow Tax “Highly Progressive”?
Lots of smart people have been saying that the House GOP’s proposed “destination-based cash flow tax” (DBCFT) would make our system of business taxation more progressive. Alan Auerbach, the intellectual architect of the proposal, says the system would be “highly progressive” because unlike other consumption taxes, the DBCFT exempts wages and salaries from the tax base. Stuart Leblang and Amy Elliott write in a BloombergView column that the DBCFT “should actually be more progressive than our current corporate income tax.” The UK-based Independent posted an op-ed earlier this month with the amusing (though moderately misleading) title: “Deluded Republicans are accidentally pushing for progressive corporation tax reform.”
Well, it all depends on what we mean by “progressive.” Kyle Rozema and I point out in an article forthcoming in the Tax Law Review that even the mortgage interest deduction can be characterized as “progressive” depending on which counterfactual you choose. Our analysis of the mortgage interest deduction applies similarly to the DBCFT. The House GOP plan reduces revenue: the Tax Policy Center pegs the revenue loss from the DBCFT and related corporate income tax reforms at $891 billion over the next decade, while the Tax Foundation estimates an even larger loss of $1.2 trillion (actually rising with dynamic scoring). Whether a DBCFT is “progressive” or “regressive” — i.e., whether it redistributes wealth from the rich to the poor or the other way around — depends entirely on how that gap is filled.
If we close the gap by raising individual income taxes proportionately, then implementation of a DBCFT would probably be progressive. Think about it this way: Treasury’s distributional analysis assumes that the share of the corporate income tax that burdens the normal return to capital is split between labor and capital (a reasonable assumption, though not a universally accepted one). A DBCFT effectively exempts the normal return to capital, and thus eliminates the burden of the corporate income tax on labor. Treasury’s distributional analysis also suggests that the top 10% of taxpayers bear an even larger share of the individual income tax burden than of the corporate income tax burden. Reduce the burden on labor of the corporate income tax and make up for the revenue through higher individual income taxes and you quite plausibly have a shift in wealth from the rich to the poor.
But what if we close the gap by reducing federal spending? Well, then it depends what gets cut (and who benefits from the programs that are reduced or eliminated). Implementing a DBCFT and then patching over the budget gap with cuts to Medicaid would not be progressive by (virtually) any definition: lower-wage workers would receive some of the benefit from the exemption of the normal return on capital, but lower-income households would bear almost all of the costs. Implementing a DBCFT and making up the shortfall by cutting military spending would be more complicated distributionally. (Who benefits from military spending? Part of it depends on whether the potential invaders want to take our bodies or our bank accounts . . . . )
And what if we don’t close the budget gap, but simply let the federal government fall deeper in debt? Then the distributional effects of the DBCFT depend on who (if anyone) bears the cost of debt overhang, and on who will bear the cost of higher taxes or lower spending at a later date. (Arguably, but only arguably, deficit spending tends to be progressive because it shifts wealth from future generations to the present, and our grandkids are likely to be richer than us.)
There is much more to be said about all of these scenarios. (Kyle and I discuss the issue at greater length in our paper; David Kamin addresses similar questions here.) The point is: The distributional impacts of the DBCFT can’t be assessed unless we know what other changes will occur when the DBCFT takes effect. Yes, implementing a DBCFT and making up the shortfall with higher individual income taxes that fall primarily on the rich might be described as a “highly progressive” reform. But that’s not exactly what Paul Ryan and Kevin Brady have in mind.