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.

About Michael Mandel 127 Articles

Michael Mandel was BusinessWeek's chief economist from 1989-2009, where he helped direct the magazine's coverage of the domestic and global economies.

Since joining BusinessWeek in 1989, he has received multiple awards for his work, including being honored as one of the 100 top U.S. business journalists of the 20th century for his coverage of the New Economy. In 2006 Mandel was named "Best Economic Journalist" by the World Leadership Forum.

Mandel is the author of several books, including Rational Exuberance, The Coming Internet Depression, and The High Risk Society.

Mandel holds a Ph.D. in economics from Harvard University.

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2 Comments on Needed: A ‘Global-Compatible’ Tax System

  1. Tax overhaul, i.e., sweeping tax reform is badly needed, and the tax reform debate should be at the heart of the next presidential campaign. The U.S. is at a competitive disadvantage in world trade by not employing a VAT, as all our trading partners have VATs. Over 150 countries employ VATs to eliminate the burden (cost) of government from the price/value equation in international trade. (The VAT is the sales tax that is border-adjustable and subtracted from exports and added to imports.) Employing a VAT would be stimulative for domestic production. For reference info on VAT, go to http:www.vatinfo.org

    Steve Abramson, publisher
    VATinfo.org

  2. While I agree with the author, it is a mistake to believe that VAT is some sort of import or excise duty, that makes it more difficult for non-US companies to enter the US market. It simply levels the playing field – VAT is the big equalizer. All businesses, resident or non-resident, have to account for the same taxes on domestic supplies of goods and services as well as imports.

    See http://www.us-vat.com/blog/?p=157

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