FT letter: tax reform is needed, but not the destination-based cash flow tax

The Financial Times has published a letter from a wide range of tax justice specialists (including this blogger) commenting on a proposal from Martin Wolf that the corporate income tax (CIT) be replaced by an entirely different tax called the destination-based cash flow tax.  In response we argue that the DBCFT does not provide an answer to the problems confronting the CIT, and will almost certainly worsen global inequality if it were implemented:

(the DBCFT), in effect, is nothing more than an additional VAT in those places with the biggest consumer markets in the world.

The consequence is that it will be regressive within a state as the incidence will be highest on those with lowest income, since the tax will be easy to pass on to consumers. It will reapportion taxable income from the world’s poorer regions and states to the richest ones of all. It will, as a result, increase global inequality when the precise opposite is needed.”

Others have reached similar conclusions.  The members of the International Commission for the Reform of International Corporation Taxation (ICRICT) made a comparative study of various ways of taxing corporations and concluded that DBCFT had several inherent flaws which render it unacceptable:

The commission identifies a wide range of weaknesses for the destination-based cash flow tax (DBCFT) which for a period dominated policy discussions in the United States. First, it would require much greater cooperation between states to resolve issues around MNE operations where there is minimal physical presence in a jurisdiction. Second, the likely violation of World Trade Organisation rules would encourage protectionist conflict. And third, importantly but completely overlooked in the US debate, a global shift towards DBCFT would exacerbate rather than ameliorating the tax injustices that lower-income countries already face.”

Instead, we suggest in our response to Martin Wolf’s article that the time has arrived for the CIT debate to accept that the logical way forward is to adopt the unitary approach to taxing multinationals and apportion the profits to different countries on the basis of economic substance, i.e. sales, employment and where productive assets are actually located:

There is a basis available for global international tax reform. It is to apportion the global profits of companies to states on the basis of where their sales, employment and assets are located. This would deliver global tax justice and coincidentally achieve the other objectives of an effective corporation tax. This is the required direction in which reform must take place.”

We have written extensively about unitary taxation, see here and here, for example.  Beyond the tax justice community the momentum for change in this direction is steadily building; just yesterday, for example, we expressed our support for a new IMF report on corporate taxation which proposes replacing the existing arm’s length based approach with unitary taxation and formulary apportionment:

We also welcome the IMF’s support for replacing the arm’s length approach with unitary taxation and formulary apportionment, so that tax is paid where real business happens – not where profits are surreptitiously shifted to. As the IMF report says, this ‘would greatly reduce the scope for profit shifting’. The IMF’s research confirms that if multinationals were to be taxed in line with where their employees actually work, developing countries would see their tax revenue rise by over 30 per cent on average, with the greatest benefits for smaller and lower-income countries.”

Read Martin Wolf’s article here. And read our response here.