How a Proposed Cash Flow Tax Could Impact the Finance Industry

The taxation of financial intermediaries has been a perennial problem for the design and administration of VATs. This has required countries around the world to resort to ad hoc solutions that are invariably inefficient and often complex. The House Republican destination-based cash flow tax, which is closely related to a VAT, could be headed down the same uncertain and haphazard path.

Even though banks, insurance companies, and other financial institutions compose a significant share of the U.S. economy, the House blueprint released June 24 left readers with no idea of how finance would be treated under the new plan. The proposal said only that the House Ways and Means Committee would work to develop "special rules" for these taxpayers.

This is why a January 27 paper with special emphasis on financial transactions released by the intellectual godfathers of the destination-based cash flow tax is so important. (See Alan Auerbach, Michael P. Devereux, Michael Keen, and John Vella, "Destination-Based Cash Flow Taxation," Oxford University, Said Business School, Working Paper 17/01, Jan. 27, 2017. The authors, along with Paul W. Oosterhuis and Wolfgang Schön, composed a working group chaired by Devereux that has been studying alternative methods of international corporate taxation for the last three years.) With its focus on financial transactions, the working paper provides a missing piece that is desperately needed if this new approach is going to advance.

In a nutshell, their proposed solution for computation of the cash flow tax base involving financial transactions is to ignore all financial flows (interest, premiums, principal payments, etc.) when financial institutions conduct transactions with other taxable businesses. On the other hand, treatment of financial transactions with individuals and businesses not subject to the tax would be more complicated and use a method unfamiliar to most income tax payers. This latter method would require all financial cash flows, including the disbursement of loans to borrowers and the repayment of principal to lenders, to be included in the computation of the destination cash flow base.

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