Waiting on the sidelines, however, is a comprehensive business and trade tax concept that potentially could address all of those issues. While some who loathe anything that might lower any corporation’s taxes might disagree, it’s a sensible idea that has come up in one form or another before. If it were to gain enough traction among this year’s federal tax writers to make it into law, states would be likely to see mixed but notable impacts on their own tax structures.
Even as state officials scurry to navigate through all the administration’s spending cuts and freezes already in play, what they are not ready for is a completely new federal tax structure that would alter their economic development strategies — and their own sales and business income tax revenue streams — if Uncle Sam crowds them out with a pre-emptive global tax policy that cuts into several revenue sources. Trade tax policy is therefore a noteworthy topic for governors, legislators, and state treasurers and tax administrators.
Besides watching for local fallout from presidential tariffs, their political and fiscal radar should be tracking two somewhat obscure proposals that surfaced back in 2016 before the tax-cut law under the first Trump presidency was enacted. One goes by the name of ”destination-based cash flow tax,” a garbled mouthful that clearly needs a simpler and catchier title. A related version that resurfaced recently is called a “border adjustment tax.” They are really two sides of the same coin. For the sake of shorthand simplicity, let’s just call the whole concept a “fair trade business tax” (FTB).
Somewhat like today’s federal corporate income tax — and in place of it — an FTB tax would be paid by businesses on the basis of their sales revenues minus their costs of goods and services. But that’s where the similarities end. Capital expenditures would be immediately tax-deductible — a strong, reliable and irreversible investment incentive for building new facilities. Foreign labor costs could be non-deductible, to discourage offshoring. An FTB tax would apply only to sales within the U.S. and not to exports. Imports would be taxed, but with stable, predictable rates set by Congress, not erratically on and off or up and down by White House whim. As with tariffs, FTB tax rates could be reduced reciprocally by statutory formula for imports from VAT- and tariff-free nations, which would promote long-term, mutually beneficial international trade. That is, after all, the ostensible goal of today’s trade-war rhetoric, but without the melodrama.
This global tax model answers the nagging problem that domestic companies cannot build costly new industrial infrastructure such as aluminum smelters here in the U.S. merely on the hopes that a petulant presidential tariff will last more than a year or two. Large-scale onshore capital investments by multinational corporations are incompatible with a temperamental White House.
An FTB tax could solve that problem by establishing a durable, reliable tax regime that wouldn’t change weekly. A future Congress might revise the general tax rates but not abandon the basic policy. Unlike with tariffs, future presidents with opposing views could not unilaterally erase the embedded statutory pricing advantages for domestic companies just by executive order.
The domestic versus foreign labor-cost and capital-investment deductions would uniquely favor U.S.-based manufacturers and tech companies by reducing their taxes relative to overseas competitors. That could cement American leadership in artificial intelligence and advanced robotic manufacturing for years to come. CEOs and corporate directors could make capital investment plans based on a stable tax structure. This makes the FTB concept attractive as something of a hybrid of a VAT (value-added tax), tariff and corporate income tax regime.
For governors and municipal leaders who depend on sales tax revenues, the implications of such a profound change are mixed at best. States that promote manufacturing for international markets could benefit from expanded production facilities and the ensuing state and local tax revenues. But as with tariffs, the macro impacts at the national level would likely be crowding out a sliver of their sales tax revenues, because consumers on a budget will buy less at higher prices under either method.
States, therefore, could rightfully lobby Congress for a sliver of the federal FTB revenue to offset their lost sales taxes, just like American farmers who received a cut of the first Trump China tariffs in 2017. States that tax corporate income would have to adjust how they piggyback on federal tax returns. On the positive side, public pension fund stock portfolios should perform better with an FTB tax, which is likely to be more business-friendly in the long run.
The whole concept is still a long shot, but it’s been taken seriously enough to gain the attention of the International Monetary Fund. It certainly fits the “America First” mindset. Key flaws: The actual revenue intake is both uncertain and cyclical; the impact on foreign exchange markets is unknown; advocates are weak on implementation details, such as how to fairly tax overseas sales of U.S. corporate subsidiaries’ offshore products; and it might bend or break the current World Trade Organization Agreement rules.
For now, I don’t give this idea more than a subjective 15 percent chance of actually advancing to the point of serious House Ways and Means Committee deliberations. But that’s not nothing, and those odds could improve quickly if advocates can gin up some rosy growth-based revenue projections to offset the swelling of federal deficits from all the promised and pending income tax cuts. An FTB tax would be far easier and more realistic for the Congressional Budget Office to model out for 10 years than quicksilver presidential tariffs. The White House could still declare victory for clearing the beachhead with its furious salvo of presidential tariffs, to then be followed by “permanent solutions” enacted by Congress to codify their legacy for years to come.
In any event, it never hurts for state and local leaders to think through the implications of possible outcomes that nobody even considered to be imaginable prior to last November’s election and this year’s tariff tantrums. Forewarned is forearmed.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
