Rep. Devin Nunes (Brendan Hoffman/Getty Images)
Rep. Devin Nunes (Brendan Hoffman/Getty Images)

One can be forgiven if their eyes start to glaze over at the mention of "corporate tax reform." But a forthcoming proposal from Rep. Devin Nunes (R-Calif.) promises to make the topic, if not exciting per se, at least somewhat intriguing.

Nunes is preparing legislation to replace the corporate income tax with one that lets businesses deduct all their investments. If it works, it'll encourage a huge surge in business investment, boosting growth and growing household incomes. If it fails, it'll be a corporate tax break without much economic benefit. Either way, it'll totally change how we tax businesses.

Currently, the corporate income tax targets profits. Companies add all their revenues, subtract expenses (as well as any deductions), and then are taxed on the difference. If they make a big investment, such as purchasing a building, they can deduct that expense, but they have to do it over the life of its use.

For example, office buildings have to be "depreciated" over the course of 39 years. If you're a company and you buy a building that costs $3.9 million, you could claim a deduction of $100,000 every year for 39 years, but you couldn't claim a $3.9 million deduction the first year. That makes it hard for companies to make investments in things like buildings, infrastructure and equipment.

The code as currently structured also makes them more likely to buy those things by borrowing money rather than selling stock. Interest payments to bondholders are deductible under the corporate tax, but dividends paid to shareholders are not. Many observers think Wall Street's over-reliance on debt has contributed to financial instability, and perhaps helped lead to the 2008 crisis. The corporate tax structure helped encourage that behavior by Wall Street.

So how would Nunes change this? Simple: He'd tax net cash flow (the total amount of money coming into the company minus the total amount of money coming out in a given year), not profits. That means that investments like buildings would be deductible in their entirety the year they're made, and dividend payments and interest payments would be treated the same.

Industry, science and technology! Big men putting screwdrivers into things, turning them, and adjusting them! (Scott Eells/Bloomberg)

Nunes introduced the idea in an op-ed in The Post last fall, and says he'll introduce legislation as soon as the Joint Committee on Taxation gets him back a score. That could take a while: "[JCT] had to build an entirely new [tax] model because it's an entirely new system," he says.

But he thinks it's worth the wait, not least because, he argues, it would totally eliminate the need for most corporate tax expenditures. That's because most of those take the form of allowing faster depreciation for, say, solar panels,  to spur businesses to buy them. But if everything is deductible immediately, you don't need any of those. "It encourages businesses to take risks," he says. "You don't need an R&D credit, you don't need green credits, people will take those risks on their own."

Nunes has proposed a 25 percent rate for the tax. That's lower than the current corporate rate, but you can't really compare the two, as they tax totally different bases. In any case, he's not wedded to it. "I don't think, if you move this rate 5 points either way, it really matters to be honest with you," he says. "It's going to create so much revenue." Why's that? "You're going to bring so much money off the sidelines and plow it into the economy," he continues. "You'll have really strong economic growth."

(See Auerbach et al)

The rationale is that a business cash flow tax is a kind of consumption tax, and economists love them some consumption taxes. A simulation by economists Alan Auerbach, David Altig, Lawrence Kotlikoff, Kent Smetters and Jan Walliser found that replacing the personal and corporate income taxes with a flat value-added tax would boost long-run growth by 9.4 percent, and adopting a progressive consumption tax (specifically an "X tax," which combines a payroll tax and a business cash flow tax) would boost long-run growth by 6.4 percent. Evaluating theories like that empirically is tough, but it's worth noting that reliance on consumption taxes over income taxes is correlated with higher economic growth, though there's a chance that's not causal.

This sometimes gets portrayed as a conservative view, but it needn't be so. For example, Auerbach has proposed a tax plan almost exactly identical to Nunes's, and released it under the auspices of the Hamilton Project and the Center for American Progress, two noted progressive think tanks. He notes that the Treasury Department evaluated a business cash flow tax reform plan and found that it would "increas[e] national income by up to 2.4 percent over the 10-year budget window, 3.7 percent over 20 years, and 4.8 percent over the long run."

But that view has its skeptics. "The studies that get big growth impacts from moving to a consumption tax generally come from models of fundamental tax reform completely replacing the individual income tax as well as the corporate income tax with a comprehensive consumption tax, and, further, those results are driven by some pretty problematic assumptions," says Chye-Ching Huang, a tax expert at the Center on Budget and Policy Priorities. Namely, the studies assume that spending from existing savings or wealth will be taxed, which Huang says is "highly efficient but pretty unfair."

Michael Graetz, a tax expert at Columbia Law School, is considerably more keen on consumption taxes than Huang, having proposed a plan to eliminate the income tax for people making under $100,000 and make up the revenue with a value-added tax (VAT). But he points to a potentially bigger problem with Nunes's plan: It may be illegal.

It's weird to think of a law being illegal, but Nunes's plan could run afoul of international treaties, particularly those around the World Trade Organization. "It cannot be border-adjusted under the WTO agreements," Graetz says. That means that, unlike VATs, it's impossible for business cash flow taxes to exempt exports and tax imports. Instead, they can't touch imports for the most part, and have to tax exports, if they're not going to be ruled a trade law violation. That wouldn't be too politically popular. "If we're going to tax consumption, we ought to do it in a way that fits well with international trade and treaty obligations," Graetz elaborates. "It's not clear how this kind of tax would be treated under the hundreds of bilateral income tax treaties."

Auerbach is skeptical of this, though. "I think that at some point, if a country like the U.S., and particularly other countries, want to adopt a tax system like this, then WTO rules can change," he says. "The WTO is set up to protect against certain kinds of activity and it's set up by lawyers who don't understand economics, and sometimes that leads to funny outcomes, and this would be one of those."

Former senator Sam Nunn (D-Ga.), who also supported a business cash flow tax. (Getty Images)

Graetz also thinks the treatment of borrowing could prove tricky. Ideally, you count the money borrowed as income and deduct the investments it funds, but figuring out exactly what counts as income from debt and what can be deducted is tricky. He notes that when former Sens. Sam Nunn and Pete Domenici worked on a business cash flow tax in the late 1980s and 1990s, they couldn't really find a way to resolve that issue satisfactorily.

"I remember talking to Paul O'Neill, Bush's first secretary of the treasury, who was on a commission advising Nunn and Domenici, and his response was that it just wouldn't work," Graetz says. Auerbach notes that simply ignoring financial transactions would be simpler (and that's what VATs do), but that leaves financial companies off the hook.

One part of the plan Graetz does like is that it eliminates so-called "pass through" entities, or businesses such as partnerships where money is not taxed at the firm level and instead passed along to individuals. That leads to very different tax treatment of partnerships and other corporations, even when the partnerships are companies like Blackstone, the private equity giant. Nunes would have all businesses use the same tax code, rather than reserving the corporate code for only some businesses. Graetz thinks that's a step in the right direction, if a politically tough one. "The current system makes no sense but moving to a unified regime is going to be tricky," he says.

For now, Nunes is crossing his fingers and hoping for a good JCT score. "The best thing that could happen is if it comes back revenue neutral at [a] 25 percent [rate]," he says.
"Then it's got real legs. Then it can go directly to [House Ways and Means] Chairman Camp, [Senate Finance Committee chair Max] Baucus, and Obama and Harry Reid and Boehner. Revenue neutral at 25 percent, and it'll get done."

That may be a little optimistic. Camp and the White House are having enough trouble trying to reform the existing corporate tax, lowering rates while eliminating deductions and credits. Adopting something totally new could be harder still.

And Auerbach and Huang both doubt that the Nunes plan could be revenue-neutral at a 25 percent rate. "Taking the rate down to 25 percent would lose revenue," Huang says. "And then, Rep. Nunes’s proposal would cost even more than that, because he’d be levying 25 percent not on a (broad base of) of corporate income, but on a much narrower corporate tax base that allows upfront deductions for things that can’t be completely expensed now."

But there's no question that Nunes is thinking bigger than your typical congressman on how we should be getting tax revenue from businesses. "This system would be much better than what we have today," he says. "Even if we get what Chairman Camp's trying to do, this is a step beyond that."