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Tax Overhaul Great in Theory. Here’s Why It’s So Hard in Practice | ASHARQ AL-AWSAT English Archive 2005 -2017
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U.S. 100 dollar notes are seen at a bank in this picture illustration in Seoul September 20, 2011. REUTERS/Lee Jae-Won

New York- House Republicans have an ambitious plan for overhauling the way American businesses are taxed.

A short list of the plan’s potential benefits looks awesome: It would give companies more incentive to keep jobs in the United States, less to overextend themselves on borrowed money and provide vast savings by reducing what companies spend on tax lawyers, who help them game the current system.

Yet these changes could also set off a cascade of more harmful effects. The plan could shift trillions of dollars of wealth from Americans to foreigners; set off an emerging markets financial crisis; wreak havoc in global oil markets; and cause sustained harm to the American higher education and tourism industries (including, as it happens, luxury hotels with President Trump’s name on them).

Welcome to the real world. The tax code has been flawed and inefficient for a very long time, precisely because fixing it could be so terribly disruptive. In a nutshell, the corporate tax issue provides an excellent case study of the problem of “path dependency” in public policy.

The United States might well have a better, more efficient tax code today if, starting a century ago, lawmakers had designed it so that businesses were taxed on where their sales and expenses take place, as the Republicans’ plan calls for.

But that is not what happened. Instead, lawmakers took what seemed to be a logical approach: They focused on taxing businesses on their profits. Today, that choice shapes arrangements in every corner of the economy. It affects the values of currencies and financial assets. Every business has devised its structure and organization to maximize its advantage within the existing system.

Given all that, any fundamental change in the corporate tax code will create powerful ripples — some quite predictable, others less so — across the business and financial landscape. Essentially, for a politician trying to decide whether to support the new legislation, the question boils down to whether you think the potential long-term gains are big enough to justify the probable short- and medium-term disruptions.

A closer look at the disruptions that moving toward a “destination-based cash flow tax” would create makes clear why it would be no small event.

The tax has a feature called “border adjustment,” under which exports are not taxed but imports are. That, at first glance, may seem to penalize companies that import goods, like retailers, and subsidize those that export, like makers of jumbo jets. But economists believe the change in the tax code would lead to shifts in the currency markets that offset those moves, namely to a sharp rise in the value of the dollar compared with other currencies.

The most vigorous opponents of the plan include retailers and consumer goods companies, which worry that currency adjustments won’t fully offset the damage they will suffer (they have a newly formed group fighting it, Americans for Affordable Products).

But beyond the obvious problems, the proposed change in the tax code would cascade through the economy in many other ways.

A 25 percent rise in the value of the dollar, the most widely used currency on the planet, would have enormous consequences. Supporters think the dollar will rise that much if the plan is enacted — indeed, it must happen, to avoid sticking Americans with much higher prices for imported consumer goods.

But according to calculations by Michael J. Graetz, a Columbia law professor, a currency shift of that scale implies that Americans who hold foreign assets would lose $6.1 trillion, and foreign holders of assets in the United States would gain as much as $8.1 trillion. Meanwhile, because the dollar is the world’s benchmark currency, many businesses and governments outside the United States borrow in it, especially in emerging-market countries where confidence in the domestic currency is low.

That means that a steep run-up in the value of the dollar generally makes those debts more onerous, and causes big trouble for countries including China, South Korea and Turkey. Consider that the Asian financial crisis in 1998, the Latin American crisis in 2001 and an emerging markets slump in 2015 all had their roots in debt problems and a spike in the dollar.

What’s more, global markets in oil and other commodities are priced in dollars, so a dollar spike could unleash hard-to-predict reactions from commodity producers. Oil would become much more expensive, and oil price shocks have helped set off recessions in the not-too-distant past.

Perhaps the most irony-rich consequence of such a tax overhaul — which would, presumably, be signed by President Trump — would be the damage to the tourism and education sectors in the United States. These businesses would have a serious problem, unlike conventional exporters — companies that ship things overseas, say.

For the exporters, the disadvantages caused by a run-up in the dollar would just cancel out the advantage received from changes in the tax system. But businesses that are not exporting anything across the border would suffer from the damage of a more expensive dollar without receiving advantages from border adjustment.

As Stan Veuger of the American Enterprise Institute has noted, that applies to any organization that serves a large number of foreign customers within the United States’ borders. Think of, say, a Trump international hotel, or amusement parks like Disney World, or any American university that bolsters its finances with foreign enrollment at full-price tuition.

All of these sectors would see their prices rise because of the dollar run-up, without any countervailing tax benefit.

Lest any of these ripple effects seem like academic abstractions, keep in mind that tax changes can have powerful spillover effects. Some obscure provisions around depreciation rules in the 1986 tax reform act set off a downturn in the commercial real estate industry that, in turn, was a major factor in the 1990 recession.

The problem of policy path dependency isn’t limited to the tax system, of course. The Obama administration faced it when it began to overhaul the health care system eight years ago. Many liberals argued that the United States should move toward a Canadian-style system in which the government pays for all health care, called a single-payer system. The Obama team saw that approach as appealing in theory, but too disruptive in practice; so many Americans had become accustomed to receiving health insurance through their employer that it didn’t seem feasible to make a wholesale shift to a new and, perhaps, more efficient system.

In other words, decisions that lawmakers made decades or even a century ago have essentially locked us into ways of doing things, as the cost of changing looms more heavily than the potential benefits of trying something different.

And people who have much to fear from a change tend to be louder than those who have something to gain, a central dynamic that tilts policy in the United States toward small-c conservatism.

All of this is frustrating for anyone who believes that the existing system, whether for corporate taxes or health care, is broken and needs radical reform. But the bigger the change, the bigger the side effects.

New York Times