Value Added Tax Proposal

The Washington Post Reports on a rumblings of a re-though on the Value Added Tax:

With budget deficits soaring and President Obama pushing a trillion-dollar-plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax.

Common around the world, including in Europe, such a tax -- called a value-added tax, or VAT -- has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity.

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Obama and International Tax Reform Part 2

President Obama unveiled his plans for international tax reform today.  The response from the business community, Republicans and Democrats was to be expected.  In this piece I will propose a better alternative to President Obama's proposal and I open to any criticism or faults my plan might have.  But, first a rehash of President Obama's proposal and the reactions from various leaders.  

• The Republicans are against any reform that would increase taxes, arguing that corporate tax rates in the United States are among the highest in the world.  Obvious response and expected.  
  

• Democrats, are reluctant to endorse such a sweeping change.  Many are enthusiastic about Obama's plans to reduce tax deferral, align deductions with income earned, and crack down on tax havens.  Others, are concerned that reform efforts could harm growth and employment.  Such as Max Baucus Chairman of the Senate Finance Committee, who in response to the plan said, "...further study is needed to assesses the impact of this plan on U.S. businesses."

• The business community is afraid and getting read to launch an all out attack on Obama's proposal.  That is an expected response.  Who wouldn't fight for $700 billion?  Or in reality, roughly, 245 Billion in taxes at 35%.  Assuming that is, they do not have any foreign tax credits attributable to the income, which they most definitely do have.  That brings the total, after a rough estimate of tax rates in so called tax haven jurisdictions, to 150 Billion (assuming 15-20% tax in the tax haven, for example, it is roughly 11% in Ireland).  
  

Without going into the details of the Obama tax proposal, which essentially doing a handful of things to raise to revenue: (1) matching deductions with income; (2) eliminating subsidiary deferral; (3) revising the check the box rules, and (4) crack down on offshore bank accounts.

As someone that knows a couple of things about this field, my first thoughts are that Obama needs to consult with a better team of advisors.  I strongly support the President, and understand his needs to raise revenue to fill in the holes in his budget proposal, recession proposals and other plans to be determined.  But, it is clear that he is barking up the wrong tree.  

This plan has shades of Jimmy Carter.  Someone that is worldly respected, but someone that did not grasp the economic implications of his decisions.  Obama, however, is someone that is intelligent enough to change his mind.  If he sees the problems with his plan, he will be able to correct it, that is the consistent pattern he has established during his time in office (at all levels).

Why is the plan wrong?  Simply put, taxing income that is earned overseas is against all principles of International Taxation.  This will decrease any competitive advantage or sink the playing field, by making us one of the very few countries to tax foreign source income.  

That is now the real problem.  The real problem is that taxing this income reduces the coffers of corporations, that are relying on this money for financing, stability and investor confidence.  By reducing billions of dollars in cash on the balance sheets of major corporations, many will feel the need to clamp down on expenses, reduce investment and likely lay off workers.  Which will only increase the unemployment in the United States.  Such a response could either further the recession, or suffocate any growth shown in the near future.  

 

Proposal

 

A better plan would be allowing companies to bring back their foreign source income without being subject to taxation, if they use the money to hire American workers (the workers do not have to be American, but a strong % would be encouraged).  The plan would allow for a deduction of 75,000 (or another number) for each worker hired. 

 

Example: Company X, 100 million dollars of foreign source income.  Company X is allowed to bring the full 100 million back into the United States, and use hiring deductions (75K per employee) to offset the tax rate on the 100 million in income.  Normally, the tax bill without the deduction would be roughly 35 million before tax credits.  Therefore, if Company X hires 665 workers and receives a 75K deduction for each worker, they would have a credit against the 100 million in foreign income of roughly 50 million.  This would reduce the amount taxable to 50 million, still subject to foreign tax credits and allow Company X to reduce their tax bill and increase their work force to generate more income.  

 

This proposal would have a couple of consequences.  (1) It would still allow the United States to receive tax revenue, either from the remaining portion of income not offset with credits/deductions, or if all of the income is offset with employee hiring deductions (75k) and foreign tax credits attributable to taxes paid in the foreign country where the income was earned, the United States could still recoup income from the workers salaries at ordinary income rates.  

Thus, if the 665 employees in aggregate earned 40 million dollars of income (or $60,150 on average), the United States, assuming a 15 % tax rate on ordinary income (tax rate reduced to reflect possible credits, exemptions, deductions, etc) would still have tax revenue of 6 million dollars, instead of the zero they are currently collecting.  Remember the 6 million is on top of the remaining portion of the 100 million that is not used for employee hiring deductions (however, I imagine most of it will be used if foreign tax credits are still available).   

(2) This proposal will increase hiring, possibly even increase hiring over demand, which will result in the need for hyper innovation to find a use for the workers.  This could spur another wave of American revolutions, similar to the industrial revolution, technology changes in the 1990's, and allow for higher GDP and growth.  By decreasing the unemployment rate this will spur demand for consumer products, and decrease pressure on credit card companies and all types of financial institutions worried about collecting from individuals without means (which is taking place currently at Capital One, JP Morgan, Citi, etc).  

(3) Such a proposal will still allow the American government to collect revenue.  Their main concern.  This will also be a proposal that is backed by the American people, helping politicians save face with their constituency and increase their chances for election.  Obviously, everyone will not find this proposal to be beneficial, maybe not even American corporations who do not want to be forced to be engaged in massive hiring.  

Bottom Line: this proposal will increase the productivity of American corporations, increase GDP, raise revenues, raise consumer confidence, and help reduce the national deficit.  It is at least worth a look.