Selected International Aspects of Fundamental Tax Reform Proposals

Abstract

Over the past several years, there have been a series of proposals to replace the U.S. income tax. The 1996 presidential primaries saw one major candidate, Steve Forbes, espouse the virtues of a flat tax. Another candidate, Senator Richard Lugar, favored a national retail sales tax. A year earlier, Senators Nunn and Domenici introduced their "Unlimited Savings Account" tax. Each of these proposals involves substituting a consumption-based tax for the current income tax.

Proponents of fundamental tax reform generally hope that shifting to a consumption tax base will bring about increased savings and invest­ment and will simplify compliance and enforcement. Except for an occasional obligatory bow to the assertedly positive effects of these reforms on U.S. "international competitiveness," the public debate about tax reform rarely addresses international implications of the tax reform proposals. Yet these proposals would dramatically alter the international as well as the domestic tax landscape. Moreover, the open nature of the U.S. economy would fundamentally affect any impact of the tax reform.

This paper evaluates selected international aspects of three leading fundamental tax reform proposals; the Schaefer-Tauzin-Chrysler national retail sales tax, the Nunn-Domenici "Unlimited Savings Account" tax (the "USA" tax), and the Armey-Shelby "flat tax" (the "Flat Tax"). A threshold problem is simply to understand how these three proposals work, both as taxes generally and with respect to cross­border transactions in particular. In order to understand the effects of each of the three proposals, Part II begins with a discussion of consump­tion as a tax base and the usual approaches to taxing consumption at the business or personal level, as well as the usual approach to determining the geographic reach of the tax. Each of the three proposals is then described, with particular reference to its treatment of cross-border activity.

Part III considers decisions made in the proposals to tax on a desti­nation or origin basis, and compares the forms of consumption taxes proposed to the standard credit-invoice method value-added tax ("VAT') adopted by most other developed countries. The differences between these three proposals and the internationally accepted credit­ invoice method VAT have ramifications affecting interaction with the VA Ts of other countries. Part III also evaluates differences in the approaches taken under the three tax reform proposals with respect to the GATT rules proscribing export subsidies for sales of goods, as well as the advantages and disadvantages of origin- or destination-based taxes.

Part IV discusses the problems associated with consumption taxa­tion of cross-border services generally, as well as taxation of financial services. This discussion identifies some of the practical problems of a consumption tax in an international environment.

Part V considers the international implications of replacing the fed­eral income tax, including in particular the interaction of a reformed U.S. system with other countries' tax systems. In this section, and throughout the paper, it must be remembered that we are examining a consumption tax, not an income tax. Thus, the principal implications of Part V relate to the proposals' expressed objective that the United States have no income tax. The resulting "mix" of income and consumption taxes (i.e., all consumption and no income taxes) would be different from that of any other major developed country. We also consider the implications of such a dramatic change in the international tax landscape for and likely "first order" responses by U.S. and foreign investors and foreign governments.

The principal objective of this paper is to explain and to help the reader achieve some understanding of the three tax reform proposals as they would apply to international transactions. Where possible, the pro­posals are evaluated using the tax policy criteria of impact on economic efficiency, equity in distribution of tax burden, and the administrative burden of compliance with and enforcement of the tax. 5 As tax lawyers, not economists, any economic observations are based on our attempts to understand and apply the relevant economic principles.

Finally, the proposals are discussed as they have been proposed. There is no attempt to evaluate the likelihood of modifications to the proposals, or to predict the ultimate shape of any consumption tax regime which might be adopted.