Needed: A ‘Global-Compatible’ Tax System

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.

Comments

  1. I know very little about the details of a VAT tax. With that in mind, the single, most important attribute of any tax is that every voter knows how much of his/her money goes to the gov’t. Without that, we lose an absolutely fundamental and critical feedback loop.

    So much of our debate today rests on misinformation caused by the opaqueness of the current tax code. If VAT means I know I paid $20k in taxes this year, great. If VAT is hidden in the “costs” of goods, gov’t will have no checks and balances, will be the sole expert on what the tax rates should be, and will grow exponentially.

  2. a vat/gst hurts the poorer the country

  3. The main problem I have with the VAT is that countries will never give up income taxes in exchange for the VAT. They just throw the VAT on top of an existing tax scheme.

  4. VAT systems work well providing that neighbouring contries have roughly a similar level of taxation. It is also a relatively complicated system (require a certain degree of development).
    Proceeds are however not sufficient to finance a modern Western society. So you also need other taxes or drastically would have to cut government spending.
    To make other taxes (income) compatible seems unrealistic. The EU has now discussed for 40 years a set up for corporate tax similar to the one for VAT and almost got nowhere.
    Doing this on an even wider scale is in my opinion a dead end street. And with these non-compatible taxes the main competition is going on.
    Probably governments will have to live with the fact that it gets easier and easier to migrate tax-revenue in one way or another. Leading to lower tax revenues for high tax countries. Which will mean live with lower state income and subsequently lower state expenditure.
    Which might be bad news for people who like government to do more or a more equal society and will certainly give rise to a lot of social tensions especially in the Western world. And more in Europe tahn the US because of the higher tax rates and costs of aging which will eat up more and more of the budget.

Trackbacks

  1. […] This post was mentioned on Twitter by Ashwin Parameswaran, Robert Went. Robert Went said: Needed: A ‘Global-Compatible’ Tax System – Mandel on Innovation and Growth – http://j.mp/g8H4VW […]

  2. […] This piece is cross-posted at Mandel on Innovation and Growth […]

  3. […] On the merits of a global-compatible tax […]

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