Compliance of House GOP Tax Plan with WTO Rules Hinges on Labor Deduction Allowance, Analysts Say
The debate surrounding World Trade Organization compliance of border adjustability provisions being discussed by House GOP leaders will likely center on whether any changes would maintain a U.S. tax deduction for labor costs, said tax analysts in recent interviews. There's a growing discussion over border adjustability provisions mentioned in the House GOP tax blueprint and if such tax changes would violate WTO rules for import and export treatment (see 1612140046). The framework would exempt exports from taxes through rebates while making imports taxable. WTO rules prohibit such a system if part of a direct tax, or income-based, framework. The blueprint tries to steer clear of any violation by employing a “consumption-based” tax approach (see 1612010056). Still, outside observers would likely scrutinize whether any U.S. tax reform actually manifests a pure consumption tax in practice, and look beyond any label that government officials might attach to a proposal, analysts said.
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Several tax professionals agreed that the implementation of House Speaker Paul Ryan’s, R-Wis., and House Ways and Means Committee Chairman Kevin Brady’s, R-Texas, tax reform blueprint as proposed would present WTO issues because the plan doesn’t intend to remove U.S. tax deductions allowed for labor costs. Tax Foundation analyst Scott Greenberg, Tax Analysts policy counsel Robert Goulder, and another industry executive said that would keep the U.S. tax framework an income tax, which is a "direct tax" within WTO rules. But Douglas Holtz-Eakin, president of conservative think tank American Action Forum, made the case that the GOP blueprint proposes a consumption tax, even with the labor subsidy. “On the economics, it seems pretty straightforward to me,” he said. “This is a very straightforward tax.”
Others said there are a few caveats to the GOP’s “consumption tax” label. “The answer to your question will depend on who’s asking it and why,” Greenberg said. He called the blueprint a “quasi-consumption tax,” because of the existent deduction allowed on U.S. income taxes for wages and salaries paid. However, Greenberg added that there is a strong case to be made that the character of the “Better Way”-proposed tax wouldn’t deviate all that much from the types of consumption value-added taxes (VATs) employed around the world, as long as the U.S. payroll tax remains in place. “There’s a case to be made that the combination of this House GOP-modified corporate income tax, plus the current U.S. payroll tax, ends up looking awfully like a value-added tax split into two parts,” he said. “A payroll tax plus a corporate cash flow tax equals a value-added tax.” Greenberg also said the GOP proposal would allow companies to deduct the full cost of capital investments from the tax base, which is indicative of a consumption tax framework.
The GOP tax approach wouldn’t measure corporate income, per se, but the U.S. labor tax deduction is an income-based element, Goulder said. This is a major reason why such a law could invite scrutiny from other countries at the WTO, he said. To be sure, the envisioned framework is unlike the credit-invoice method VAT --which taxes all of a business’s sales--used by almost all countries employing a consumption tax. The plan more resembles a subtraction-method VAT, wherein companies calculate tax liability by subtracting cumulative VAT stated on purchase invoices from cumulative VAT stated on sales invoices. Japan is the only developed country with such a VAT. That nation employs a labor cost deduction as part of its VAT, Goulder said, and assesses an 8 percent tax rate. Goulder said no countries have challenged the Japanese VAT at the WTO, but added that may stem from the nation’s “very low” tax rate. “A Better Way” (here) proposes a 20 percent corporate tax rate.
It is a “safe bet” that the EU, which employs a credit-invoice VAT, would bring a WTO challenge against the proposed U.S. framework, Goulder said in an email. Labor composes about two-thirds of a “traditional VAT” tax base, as opposed to the GOP blueprint, University of Michigan law professor Reuven Avi-Yonah wrote in a Dec. 12 article (here). Labor costs are “not deductible” under a subtraction-method VAT, Avi-Yonah said. “Even if the tax paid by the workers may be viewed as a surrogate for a business’s tax on labor, that surrogate tax cannot be accurately measured, and that cost should not enter the tax-inclusive prices of the business’s outputs,” he said. “Giving a full deduction for labor costs would effectively subsidize exports and overtax imports.”
While not calling it a VAT, Capitol Hill staffers working on the issue believe the eventual bill will comply with WTO rules, according to an industry executive close to Hill discussions. But, “there definitely are people around town who say, ‘Whoa, whoa. No. I do not feel comfortable that this is WTO-compliant,’” the executive said. Even some proponents of the Ryan/Brady blueprint believe the planned tax approach would be subject to a WTO challenge, the executive said, adding that some feel that the U.S. could prevail through any such dispute, while opponents dispel that notion. Some businesses are supporting the border adjustability proposal despite the likelihood of a WTO challenge, because the blueprint also proposes a territorial tax system believed by many executives to be more business-friendly than the U.S.’ current system, the executive said. Others believe the U.S. could withstand any WTO challenges, which typically take a long time, the source said. “I think there are mixed views on whether we would win a challenge, and mixed views on whether it really matters,” the executive said.
As for chances that Congress passes the proposal through any legislation in 2017, as the blueprint expresses hope for, the GOP proposal would likely pass the House and be backed by the incoming Trump administration, as Vice President-elect Mike Pence maintains a close relationship with Ryan, Goulder said. But the Ways and Means Committee will likely have to work out the advancement of the border adjustability provisions with Senate Finance Committee Chairman Orrin Hatch, R-Utah, who is drawing up a much less “radical” tax reform proposal, Goulder said. If Senate Republicans climb on board with the House proposal, there is a chance it could be signed into law, most likely in the second half of 2017, Goulder said.
Drafters of the House tax reform legislation hope the proposal can pass within the first 100 days of President-elect Donald Trump’s administration, according to a private-sector source close to Hill discussions. “To me, that seems really, really ambitious, because I can’t emphasize enough how radical a change this is,” that source said. “Viewed from a distance, it looks like you’re just tweaking the corporate tax, but it really is a whole new concept.” Goulder said the House will likely have to convene hearings to confront questions about the proposal, including WTO-related issues.
The National Customs Brokers and Forwarders Association of America (NCBFAA) is following the border adjustability issues in the GOP reform blueprint and will likely join a coalition “as this ripens,” Jon Kent, who lobbies for the NCBFAA, said in an email. The biggest questions for NCBFAA members center around how trade infrastructure will reorganize under such a change and who will absorb the increased costs of imported products expected for products like oil, he said, adding that any supply chain reconstruction would come with substantial risk. “Or is there a realignment that nets us out at even or better?” Kent said. “Very uncertain. We don’t like to bet on…the promise of better times without some strong indications of success.”
Written by Brian Bradley