The House Republican business tax reform plan may be heading for political defeat. Senate support is absent, House Republicans are divided, and Democrats oppose it.

However, the border-adjustability feature of the tax plan is an important goal to preserve because it would neutralize foreign border taxes and improve the United States trade deficit. There are better ways to achieve this trade competitive result that Ways and Means Chairman Kevin Brady should consider. Accordingly, we would like to propose a business tax reform plan replacing the existing system with a border adjustable consumption tax and a border adjustable profit tax.

The current House GOP plan, called a Destination Based Cash Flow Tax (DBCFT) would hit net importing companies aggressively because they would not be able to deduct their import costs from their pretax profits. Net exporting companies would face lower taxes because revenue from export sales is not recognized as income for tax purposes. But this plan has wildly inconsistent tax results among net importing, net exporting, and purely domestic businesses which will cause strange company behavior to avoid taxation.

Opponents charge that consumers will be harmed by higher import prices. They exaggerate because consumer prices do not closely track fluctuations in import prices.

Supporters of the House GOP plan have created confusion with the claim that the harsh treatment of importers would be 100 percent offset by a rise in the dollar exchange rate. They are incorrect.

With 46 years of data since the US ended the gold standard, we know that a country’s tax changes do not cause its currency exchange rates to fully counter any benefits. Former Citigroup Chief Economist William Lee, who has done a detailed study of historical exchange rate movements, wrote:

“it takes many years for the real effective exchange rate to adjust fully to changes in the balance of payments caused by changes such as those caused by border tax adjustments.” [quoted from Lee’s unpublished 2017 paper, Border Taxes Require Slow Exchange Rate Adjustments to Boost Trump’s Economic Agenda]

The better solution is to combine: (1) a border adjustable consumption tax to offset the payroll tax burden and (2) a border adjustable profit tax to replace the current corporate income tax.

Border Adjustable Consumption Tax

A value-added tax (VAT) is used by almost every other country in the world and it is legal under international trade rules. Some have opposed it as a new tax, which would be true if we did not offset other taxes to be revenue neutral. The most competitive VAT would offset the US payroll tax and thus reduce the cost of labor.

Jim Nunns and Joseph Rosenberg of the Tax Policy Center proposed a plan last year to create a broad-based VAT of 4.1 percent and completely eliminate the employer portion of the payroll tax (7.65 percent of payroll). Consumption taxes do not distort business decision-making and they are likely to increase investment by encouraging household saving.

Professor Michael Graetz proposed a 12.9-percent VAT with a narrower base that would raise $1.2 trillion to $1.4 trillion a year. The optimal consumption tax rate would enable the offset of both the employee and employer portion of the payroll tax (15.3 percent of wages), giving all workers an immediate raise and reducing costs for many businesses. Exported goods would be cheaper because they would be VAT and payroll-tax free. Imported goods would pay our VAT just as our exported goods have foreign VATs applied today.

Border Adjustable Profit Tax

At the same time, a border adjustable profit tax, known as formulary or sales factor apportionment (SFA), would enable business tax simplification, lower statutory rates, nearly eliminate tax haven abuse and further improve trade competitiveness.

Under SFA tax, a business would pay taxes on global profits only in proportion to its US sales. If ACME Company sold 80 percent of its products in the US, then only 80 percent of its total profits would taxed here. It is a territorial income tax system in which the destination of sales determines where profits are taxed. Virtually all state-level corporate tax regimes use a version of formulary apportionment.

Tax economists Reuven Avi-Yonah and Kimberly Clausing show that the statutory rate can be lowered at least to 25 percent because SFA would eliminate multinational corporations’ abilities to hide their income in tax havens like Bermuda. Professor Clausing estimated that $111 billion, or nearly one-third, of corporate profits were untaxed in 2012 because the companies used complex transfer pricing arrangements with tax haven subsidiaries to avoid taxes. SFA is the best way to address tax haven abuse by multinationals like Apple and GE.

Conclusion

If the House GOP plan is unable to muster the votes to pass, Congress can use these proposals to better meet their goals of a fairer, simpler tax system that will make it attractive to produce and hire workers in the US rather than offshoring.

Michael Stumo, is CEO and Jeff Ferry is research director of the Coalition for a Prosperous America.