IF YOU WANTED TO ... (A TAX EQUIVALENCE) 

Peter Merrill is a principal and senior advisor in the National Economics and Statistics group at PricewaterhouseCoopers (PwC), part of the group's Washington National Tax Service. He is also a former chief economist for the Congressional Joint Committee on Taxation. Last Wednesday, Mr. Merrill was the first panelist at the GBD colloquium on Border Taxes: The Background, A Proposal, and the Challenges. This was our first attempt to highlight and discuss the Ways and Means Committee's Blueprint for tax reform, especially its likely effects on U.S. trade and America's trading partners.

The fact that the United States is one of the few countries that does not use a value added tax or equivalent -- some 167 countries do -- seemed to us a logical starting point for any discussion of border taxes, and so we asked Mr. Merrill to talk about VAT systems and how they work. He did so with great clarity, and a good portion of this entry is taken up with an extended quote from his remarks on VATs. Today's quote is, in fact, something Mr. Merrill said in the Question and Answer portion of the program. We highlight it not because Mr. Merrill was arguing for doing away with the corporate income tax--he wasn't--but because in that short remark he put a spotlight on the two kinds of taxes that are the now at the center of debate over American tax policy, namely value added taxes and corporate income taxes.

About the VAT. But let's back up a bit. What is a value added tax and how does it work? Here is Peter Merrill's description of how VATs work and their importance in national economies.

PETER MERRILL on How VAT Works:
I do want to say now a little bit about, just a very high level, how the VAT works, the economic perspective, that's what I am. So I won't give you the detailed view. But very high level, the VAT is intended to be a tax on domestic consumption of goods and services. So, of course, if your goal is to tax domestic consumption of goods and services, you have to tax imports, or you would miss a lot of consumption. And, of course, you should exempt exports from that tax, because they're not consumed in the country.

So every VAT has a border adjustment for goods. Goods are taxed typically as part of customs formalities, when the goods enter the country's trade territory, and tax is not assessed on exports - called "zero-rated."

For services the story is a little bit more complicated because there aren't border frontiers for services. Historically, the VATs, which date back to the '50s, taxed services at source, like the income tax. But over time, they have moved to a destination basis. And one example of that is, if you live in the EU and you buy software, games, books, anything electronically over the Internet from a company that is not based in the EU, that company, say it's a U.S. company, has to actually register for the VAT in one of the 28 EU countries, and collect that tax.

So the mechanism for collecting tax on cross-border services is complicated, but it's moved to a destination base, where the consumption occurs, not at origin.

The mechanism for collecting this domestic consumption tax is different than a retail sales tax. Obviously, a retail sales tax, you just try to, hopefully, collect the tax once, in sales to consumers of goods. It doesn't quite work that way in practice.

But with the VAT it's different, because every business registers for VAT, not just the seller to the ultimate consumer. And to prevent the tax from being collected multiple times on the same value added, each business gets a credit for the VAT on the things that it buys. So if you have a supply chain, each company in the domestic supply chain is charging VAT; each business buyer is getting an offsetting credit. So you can see, the tax and credit cancels all the way through the supply chain until you get to a sale to a final consumer, someone that's not a business, that doesn't get a credit for their purchases. At the end of the day, you collect the same amount of tax as the retail sales tax, but you're collecting it through the supply chain. ...

And on Some Advantages, Peter Merrill:
There are a lot of advantages to a VAT over an income tax system: VATs do not impose taxes on savings and investment. They tend to be much more pro-growth than corporate income taxes - the OECD itself concluded that from econometric analysis. But it's much less distortive of the economy. A VAT is neutral between the methods of finance - between debt and equity, [and] between businesses operating as corporations or pass-throughs. There's no incentive in a VAT to shift your income abroad, since source of income doesn't matter. There's no incentive to move your activities abroad, again, because that doesn't matter; only the place of consumption matters. ... 

[On the other hand,] it is much more regressive than the corporate income tax. It has a compliance burden if you require these VAT invoices. [There is] no incentive to move your corporate domicile abroad to repatriate, or expatriate. There is no disincentive to bring your foreign cash back as there is in the U.S. So it has a lot of great neutrality.

The audience last week would have been very disappointed if Mr. Merrill had not offered some thoughts on the Destination-Based Cash Flow Tax of the House Ways and Means Committee's blueprint. He did not disappoint. We, however, are going to save the discussion of the proposed new tax for a later entry. In this one we shall stick to taxes on the books in one place or another.

Again, today's featured quote refers to two kinds of taxes, valued added taxes and corporate income taxes. This comment section is devoted to an exchange in the Question and Answer session that, for us at least, was an eye-opener. It went this way.

QUESTION: On this point about the corporate income tax not being that big a deal or that big a share of what our government takes in. So Chairman Brady is telling every reporter he talks to that our businesses are staggering around under the weight of this enormous made-in-America tax. ... As I understand it, our corporate income tax as a share of GDP is below OECD average, so that our peer countries' companies have a higher burden of non-border adjusted taxes than our companies do. So, how are we to sort ... this out and understand what's real?

MR MERRILL: Let me say something quickly about that. Where the U.S. differs dramatically from other OECD countries is that most business income in the U.S. is not earned in C-corporate form. It is earned in partnerships and S-corps. So, the U.S. looks totally different than the rest of the world, and it makes sense. When you look at the rest of the world, they have very low corporate income tax rates compared to the U.S. 17 percent in the UK. The OECD average is 24 percent, okay? They have fairly high individual income rates in other countries. So in other countries around the world, being a corporation is a tax shelter. You do not want to be an unincorporated business and pay taxes 40-45 percent. You want to be a regular corporation and pay taxes at 15 or 20 or whatever. The U.S. is a very different world. In the U.S. everyone that can is getting out of corporate form .... So, we have, depending what year you look, 50, 60 percent of our business income outside of corporate form, and the rest of the world is totally different.

As Mr. Merrill also explained, however, there is a limit to the number companies that can avoid C-corporation status. That's because, "Companies that go to public equity markets have to operate in C-corp form." Another point worth mentioning here is that businesses in other forms are increasingly able to operate in the realm of limited liability. 

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On a personal note, when your editor joined the staff of the National Association of Manufacturers in 1980, the vice president for tax was the very memorable Paul Huard. Paul generally greeted you with an aphorism -- "Buy low, sell high!" -- and liberally punctuated his conversation with others. The one that comes to mind today would seem to have some relevance to the topic at hand. Like an old preacher Paul would say again and again, "Corporations don't pay taxes; people do." And repetition never spoiled the prayer.