Proposed border tax adjustments risk violating WTO rules

24 January 2017

The author of this column argues that the corporate “destination-based cash-flow tax” proposed by House Republicans could provoke WTO lawsuits against the United States in the same way that new high tariffs would. He concludes that a better corporate tax option legal under international law would be to cut tax rates, curb tax shelters, broaden the tax base, and work for globally agreed rules on the use of tax havens. Alternatively, the United States could consider enacting a value-added tax.

 

Fearful that the punitive tariffs threatened by President Donald Trump would prompt a global backlash against US trade, including a flood of successful lawsuits against the United States in the World Trade Organization, many are urging the new President to support instead the border tax adjustments that House Republicans are reportedly moving ahead aggressively to try to enact.

Speaker Paul Ryan has said that imposing border adjustments as a part of corporate tax reform is a better way than tariffs of countering alleged unfair trade practices by other countries. He foresees his alternative approach as “levelling the playing field without starting trade wars.” Another leading House Republican, Rep. Devin Nunes of California, has added, “Once people familiarise themselves with border adjustability, it becomes easy to understand. It’s much better than going a tariff route.”

To date, the President seems less than persuaded by the House Republicans, saying their alternative is “too complicated.” Also unpersuaded are an unknown number of Members of Congress in both parties. Beyond these imposing political hurdles looms a high legal hurdle: the corporate border tax adjustments the House GOP leaders and others are supporting, if not altered, could be every bit as inconsistent with US international legal obligations under the WTO treaty as would the steep new duties the President-elect has suggested on Chinese imports, Mexican imports, and, indeed, all imports.

As an alternative to these new tariffs, the House GOP tax plan would exempt income generated from exports from US corporate taxes while denying tax deductions for the costs of imported inputs into US production. The proposed corporate “destination-based cash-flow tax” could discriminate against imported products by denying them an equal competitive opportunity with like domestic products in the US market. Also, this tax could subsidise exports by conditioning tax exemptions on using domestic instead of imported goods in US production.

This suggested new tax scheme could threaten the income and the competitiveness of US workers, consumers, and producers. In addition, it could provoke WTO lawsuits against the United States in the same way that new, high tariffs would. It could lead, too, to a slew of retaliatory actions against US exports of goods and services. This, in turn, could lead to still more trade restrictions by the United States, and to still more politically explosive lawsuits in the WTO.

The import and export distortions in the GOP plan would be illegal under WTO law – unless the proposed “cash-flow tax” is eligible for exceptions from what would otherwise be WTO obligations. On imports, an exception exists for “border tax adjustments.” On exports, a full or partial exemption, remission, or deferral from an “indirect tax” is not an export subsidy. House leaders say their proposed tax would fit into these legal categories, and, thus, their plan would be consistent with WTO law.

To this legal point, in asserting the consistency of their plan with WTO law, the authors of the House GOP tax “Blueprint” explain that their proposed corporate “cash-flow tax” would be exempt from what would otherwise be WTO obligations because it would not be a tax on income, but would, instead, be a tax on consumption. They go on to say that WTO rules permit border adjustments “with respect to consumption-based taxes” but not “with respect to income taxes….”

This is incorrect. This assertion is a fundamental misstatement of WTO law.

Under WTO law, the issue is not whether a tax is a tax on income or on consumption. The issue is whether a tax is, or is not, a tax on a product. It is well established in WTO law that a tax such as a sales tax or an excise tax is an indirect tax on a product that is eligible for border tax adjustment as an exception to the general WTO rules on trade in goods, and that may be reduced without creating export subsidies. It is equally well established that an income tax is a direct tax that is not a tax on a product, but rather a tax on a producer, and thus is not eligible for these legal exceptions.

There is not yet draft legislation, but the Nunes bill proposed in the past Congress on which the GOP plan seems to have been modelled would have created a corporate tax based on the difference between taxable receipts and deductible amounts. The GOP “Blueprint” would permit businesses a deduction for domestic wages and salaries. The tax on labour would be collected from individuals instead of from businesses, which could deduct their labour costs.

As apparently envisaged, the proposed “cash-flow tax” does not look enough like an indirect tax on a product. The proposed tax looks too much like a direct tax akin to an income tax – which could keep it from fitting within the legal definitions of the legal exceptions from WTO obligations. If these aspects of the proposed tax are not changed, the United States could well lose the lawsuits that would contest the “cash-flow tax” in the WTO.

Then, if the United States chose to ignore these WTO verdicts, and not eliminate the illegalities in the “cash-flow tax,” the price could be lawful worldwide retaliation against a vast array of US goods and services that could total billions and billions of dollars in lost trade benefits to which US businesses and workers are currently entitled – annually.

A better corporate tax option that would be legal under international law would be simply to cut tax rates, curb tax shelters, broaden the tax base, and work for globally agreed rules on the use of tax havens. Still another option would be to join 160 other countries in enacting a value-added tax – an indirect tax on products for which border tax adjustments are clearly legal under the WTO treaty.

 

This opinion piece first appeared in the Huffington Post.

James Bacchus is Chair of Global Practice at Greenberg Traurig. He is a former Chairman of the Appellate Body of the World Trade Organization and a former Member of Congress, from Florida. He was one of the WTO judges in the Foreign Sales Corporation tax rulings against the United States in 2000 and 2002, when the WTO ruled that the FSCs were prohibited export subsidies.