The Strategist

IMF proposes implementing US tax reform in the entire world

01/18/2019 - 07:11

With all controversies, IMF experts believe that full implementation of principles of the 2017 US tax reform allows the country that implements it to significantly outperform its competitors. Economists of the fund are very cautious but still certain that such a reform, exempt profits abroad from taxes, is most effective for the global economy in all major countries at the same time.

401(K) 2012 via flickr
401(K) 2012 via flickr
The IMF Research Department published a working paper, which simulates effects of transition from a common income tax (CIT) to destination-based cash flow tax (DBCFT) on local and global economies. This is the first work among major international organizations and central banks on this topic. The very appearance of such calculations opened up an internal discussion in the IMF on this issue. Moreover, it shows that the idea of a global transition of the world to DBCFT is considered seriously.

The question oт DBCFT, first discussed in 1997 by the American economist Alan Auerbach, became relevant in 2016. Then, the US Republican Party, as part of its discussion of tax reform, proposed a corporate taxation scheme based on this idea. Ideally, DBCFT looks like domestic taxation of the gross profit of business generated by domestic consumption, with the exemption for export tax. The reform of US President Donald Trump implemented the scheme only partially (CIT reduction in the USA from 35% to 20%, increase in depreciation and capital repatriation benefits). The so-called border adjustment tax (BAT) was not introduced. Nevertheless, even in this form the new tax scheme resulted in reinvesting the funds of American companies in the USA, to a higher rate of GDP growth in the country, to a stronger dollar (with which Donald Trump is dissatisfied and which is the effect of abandoning BAT in many respects). Besides, this started global redistribution of capital and investment flows, as Auerbach and his followers predicted. Apparently, this is a long-term trend.

The IMF calculated several scenarios of possible effect for the world in its new DGSE model, adapted for the 80 largest economies. The first is a one-sided transition of a large economy from the current CIT to taxing the entire cash flow of companies, both export and domestic. To put it simply, they propose CIT abandonment and VAT increase (recall that most countries in the world, unlike the US, charge VAT or similar taxes). The second is replacement of CIT in one country with a full-fledged DBCFT. The third and fourth schemes are different scenarios for complete transition of all large economies to DBCFT.

The main conclusion of the IMF (still very preliminary and debatable) is that it would be the most rational for the world to simultaneously and rapidly abandon CIT and transfer to a full-fledged DBCFT. The first scenario (a single indirect tax or a large VAT) has major disadvantages for all. In the second case, the winners will be those that switch to DBCFT first, that is, exempt exports from income tax and allow its currency to strengthen without protecting its markets. The EU and the PRC, at the time of discussing tax reform in the United States, came out with careful criticism of the ideas of DBCFT and BAT. The implicit “recommendation” of the IMF to switch to DBCFT by the whole world can be considered as a warning to opponents of this scheme.