Reforming the Corporate Income Tax: The Case for a Hybrid Cash-flow Tax

Summary This paper argues for the adoption of a hybrid cash-flow tax on corporations that, on the one hand, taxes only corporate rents as they accrue, and, on the other hand, treats real and financial transactions neutrally. It is, therefore, a superior tax compared to the conventional corporate income tax – on both economic and administrative grounds. Its design also addresses the usual concerns associated with cash-flow taxation. The base of this hybrid cash-flow tax is the aggregate net cash inflow of combined real and financial transactions excluding capital expenditures, for which conventional depreciation allowances are retained with interest as compensation for the opportunity cost of equity capital. Furthermore, it is argued that it should be implemented on a destination basis that would render transfer pricing and thin capitalization moot. This paper is a revised version of an IMF working paper (WP/06/117) previously circulated under the title “A Superior Hybrid Cash-Flow Tax on Corporations.” The views expressed herein are those of the author; they do not necessarily reflect IMF policy and should not be reported as representing the views of the IMF. Helpful comments from Richard Bird, Isaias Coelho, John Isaac, Michael Keen, Russell Krelove, Alan Macnaughton, Peter Mullins, and two anonymous referees are gratefully acknowledged. Discussions with John Isaac have been particularly valuable. The usual disclaimer applies.