Reimagining a U.S. Corporate Tax Increase as a Supplemental Subtraction VAT

Abstract

The U.S. federal government raises tax revenue almost exclusively through income taxes, both corporate and individual, whereas its trading partners and competitors rely for their national revenue on both income taxes and “destination based” value added taxes (VATs), which are not imposed on exports but are imposed on imports. As a result, U.S. corporations, which are subject to U.S. corporate income tax, may be at a serious trade disadvantage to competitor non-U.S. corporations with respect to both U.S. domestic sales and foreign sales, if the U.S. corporate income tax exceeds the foreign country’s income tax imposed on those competitors.

The Biden administration has proposed raising the tax rate on U.S. corporate income from its current 21 percent to 25 percent and perhaps even more likely to 28 percent. The proposed rate increase faces substantial Republican opposition. The opposition to the proposed rate increase argues that such an increase will chase business offshore and put the U.S. at a competitive disadvantage in attracting  business and selling products both in the U.S. and abroad that compete with foreign products. The problem, simply put, is that foreign countries rely on VATs and can afford to maintain lower corporate income tax rates than otherwise, but the U.S. does not have a supplemental source of revenue like a VAT.

The issue of a competitive U.S. corporate income tax is not simply a current Biden/Republican tax rate disagreement about raising the U.S. corporate income tax. Rather, it is an issue about U.S. corporations having to compete with foreign corporations from countries that impose a lower income tax (and no VAT on exports) on those corporations than the U.S. imposes on its domestic corporations, and, further, that the U.S. cannot reciprocate by charging a lower income tax on its exports than on its domestic sales because of international treaty constraints. Thus, the issue reaches well beyond a proposed Biden administration corporate income tax increase, but rather to the structure of the U.S. business tax system of not having a VAT in some form as an integral part.

This Article considers revenue raising alternatives to supplement the current business income taxes and recommends that a subtraction VAT should be added to the corporate income tax as, at the very least, a step in keeping the corporate income tax competitive with the U.S.’s trading partner countries, perhaps as the long-term solution but perhaps as a first step to the adoption of a credit VAT to supplement the corporate income tax. In doing the foregoing, the Article compares the two types of business-level consumption taxes, the credit method VAT and the subtraction method VAT, relating them back to the most basic consumption tax, the retail sales tax. The Article argues that the subtraction method VAT, although not adopted by any other country, should be the choice because it can be added to the corporate income tax as a supplemental tax and can most easily coexist and be coordinated with that tax. It thereby allows for the easiest transition and is likely to be most acceptable to the public, which is well used to the corporate income tax and, as many observers believe, would be unwilling to adopt a credit method VAT, seeing it as a refined retail sales tax, which is a consumption tax imposed on individuals.

The Article then describes the proposed “Supplemental Subtraction VAT” that would supplement the tax on a corporation’s income and how it can be engrafted onto the existing corporate income tax to minimize the disruption to the current corporate income tax collection system. It then argues that the new supplemental subtraction VAT imposed on corporations, which would be destination-based, should be accepted as a VAT by the WTO and the U.S.’s trading partners for international tax and trade treaty purposes.