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Friday, February 4, 2022

Weekly SSRN Tax Article Review And Roundup: Kim Reviews Warren's Evaluating The Oxford Corporate Cash Flow Tax Proposal

This week, Young Ran (Christine) Kim (Utah; Google Scholar) reviews a new work by Alvin C. Warren Jr. (Harvard), Evaluating the Oxford Proposal for a Corporate Cash Flow Tax, 173 Tax Notes Fed. 1223 (Nov. 29, 2021).  

Kim

Many tax commentators would remember the discourse on the proposed "destination-based cash flow tax (DBCFT)" during the presidential election debate in 2016-17. Although I lamented the acronym of the proposal, DBCFT, as an unwelcome addition to the already-crowded alphabet soup in tax law, such as CFC, ECI, PE, TOB, CEN, CIN, UBIT, DRD, GILTI, and so on, I enjoyed the concept itself, which is to replace the traditional corporate income tax with taxation of a corporation's domestic cash flow. I particularly enjoyed the comments by Michael Devereux (Oxford) and Alan Auerbach (Berkeley), who are renowned experts in business cash flow taxation. The DBCFT proposal was not included in the Tax Cuts and Jobs Act (TCJA) of 2017.

Recently, Devereux and Auerbach have formed a group called the Oxford International Tax Group along with Michael Keen (IMF), Paul Oosterhuis (Skadden), Wolfgang Schön (Max Planck), and John Vella (Oxford) (hereinafter "Oxford Group"), and released a report, Taxing Profit in a Global Economy, to review the global tax reform proposals for combatting profit shifting and addressing tax challenges in the digitalized economy. The report proposes the Residual Profit Allocation by Income (RPAI) and the DBCFT proposal as two alternatives to the existing international tax system. I have reviewed the RPAI proposal here, and have argued  the limitations of DBCFT as an international tax reform proposal for the digital economy (here), noting that 1) there are significant amounts of barter transactions in the platform economy – which is one of the most important sectors of the 21st digital economy, 2) these digital barter transactions do not involve cash flow, and thus are not captured under the traditional tax system, and 3) a cash flow tax, including the DBCFT, cannot resolve the problem.

Alvin C. Warren Jr. (Harvard) has recently examined the Oxford Group's DBCFT proposal as well, but from a slightly different perspective. Warren explains that the DBCFT is a cash flow tax on the business entity level, compares it with Shareholder Cash Flow Taxation (that is, a cash flow tax on the shareholder level), and implies that a further study on the Shareholder Cash Flow Taxation would be required to successfully defend the DBCFT.  

First, under a basic (domestic) business cash flow tax, a corporation with no cross-border transactions would include all receipts and deduct all payments, other than the tax itself and payments to and from shareholders. Such a tax would have a tax base that would include real and financial cash flow, and as a result capital expenditures would be immediately deductible, and borrowings and principal repayments would be included and deducted respectively, unlike traditional corporate income tax. (The same could be said about another version of the cash flow tax that only considers real cash flow.)

Second, the basic model expands to a cross-border setting where a DBCFT applies. This proposal would have countries ignore cross-border payments and receipts. The United States, for example, would tax domestic and foreign companies on their U.S. receipts minus their U.S. costs. DBCFT has often been explained as a means to encourage exports and discourage imports. However, many economists and the Oxford Group reject this argument because floating exchange rates would adjust to offset the stated effects on exports and imports.

Third, a cash flow tax at the entity level, such as the DBCFT, would be equivalent to a cash flow tax at the shareholder level. In a domestic context, a real plus financial cash flow company tax (as discussed above) is identical to a tax on the net cash flows to shareholders, because the source of a corporation’s net funds (the tax base of the former) must equal the uses of those funds (the tax base of the latter). The Shareholder Cash Flow Tax would make investments by individuals in company shares deductible while disinvestments would be taxable—similar to the tax treatment of traditional (non-Roth) retirement savings. The same holds in the international context. A DBCFT on domestic cash flows of domestic and foreign firms is equivalent to a tax on the net cash flows of domestic owners of firms worldwide.

Fourth, Warren criticized the Oxford Group report for lacking a comparison between the DBCFT and the Shareholder Cash Flow Tax. The Oxford Group indicates that the DBCFT proposal would be progressive because its incidence would fall primarily on the shareholders who are residents of the home country. For this argument, the said equivalence is central to the Oxford Group’s support to the DBCFT proposal. In addition to the rationales for the DBCFT proposal, such as efficiency (only pure profits above the normal rate of return would be taxed) and administrability (shifting accounting profits abroad would not reduce taxes), the Oxford Group considers this progressive incidence to be an important strength of the DBCFT proposal. However, the Oxford Group stops here, and does not further compare the two taxes. In this article, Warren instead shows that a Shareholder Cash Flow Tax would be simpler to administrate than the DBCFT because the tax at the shareholder level would not have to track as many transactions of companies, including cross-border ones. Furthermore, a Shareholder Cash Flow Tax may avoid the complicated issues of adjustments in exchange rates, which was a significant weakness of the DBCFT proposal during the TCJA discussion.

In short, Warren argues that since the DBCFT and a Shareholder Cash Flow Tax would likely be economically equivalent, the Oxford Group should have provided the reasons why they prefer the DBCFT to the Shareholder Cash Flow Tax. Warren offers some factors that would support the latter rather than the former. However, Warren indicates that the issues he raised cannot be fully resolved in this short article. Nonetheless, Warren provides a very clear and exemplary explanation of business cash flow taxation. For those who research or teach cash flow taxation, I highly recommend this article as an essential reading. For those who have enjoyed thought experiments on cash flow taxation, this article offers more advanced points, which I believe will make them eager to read Warren’s future work in developing those points. I also wonder what Warren thinks about the tax problems associated with barter transactions in the platform economy. 

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2022/02/weekly-ssrn-tax-article-review-and-roundup-kim-reviews-warrensevaluating-the-oxford-corporate-cash-f.html

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