President Obama is thinking about a broad overhaul of the income tax system, closing loopholes and lowering rates. (“Obama Weighs Tax Overhaul in Bid to Address Debt”).
But in today’s global economy, any attempt to ‘fix’ the U.S. income tax system is fundamentally doomed. Financial and product markets are so deeply globally integrated that multinationals and wealthy individuals can easily recognize their income in lower-tax countries, if they choose.
One simple statistic: In 2009 40% of U.S. imports and exports was ‘related-party trade’ –”trade by U.S. companies with their subsidiaries abroad as well as trade by U.S. subsidiaries of foreign companies with their parent companies.” That means companies are effectively trading with themselves, so they can choose which side of the transaction books the profits.
To put it another way, the global economy is the biggest loophole of all, and it can’t be closed without layer after layer of intrusive rules and regulations. In a global economy, you can’t have a simple income tax system.
What we need is a ‘global-compatible’ tax system: That is, a tax system which acknowledges the existence of a global economy, so it doesn’t continually need to be patched to close loopholes.
The best global-compatible tax system that I know of is the value-added tax. The value-added tax, as the name suggests, taxes the value added in a country, not the income. Equally important, A VAT taxes imports but not exports. As a result, it offers far less chances for gaming the system.
Now, countries can still compete on their level of VAT. Moreover, there are a lot of controversial issues that can seriously affect competitiveness. These include: How to make the VAT progressive; whether medical care and housing should be exempt; how to treat capital investment and R&D spending; and so on. Big important questions, but ultimately solvable.
If you want tax simplicity and fairness, global-compatible is key.
This piece is cross-posted at Mandel on Innovation and Growth
