Setting aside the issue of border adjustability, the cash-flow tax on domestic producers would replace the current CIT’s tax on total corporate equity income with a business tax on so-called “excess” returns. To see this, consider expensing of business investment is similar to a traditional Individual Retirement Account (IRA) deduction. A traditional IRA provides an immediate tax benefit that is equivalent to exempting the expected “normal” return on the retirement savings. The present value of the immediate tax savings offsets the expected present value of the future taxes on the payouts of both the principal and expected investment return. But since all future payouts are subject to tax, any “excess” capital returns would be taxed in the future. Unlike a Roth IRA that provides no upfront deduction but exempts all future payouts, the traditional IRA (expensing) taxes “excess" returns.
Expensing eliminates the so-called “normal” return to capital, but a recent US Treasury empirical study found that three-quarters of corporate income was "excess" returns. (See Nov. 21, 2016 blog on "normal" and "excess" returns.) Businesses and investors aren’t taking risks and exerting significant efforts to earn “normal” returns, which often are equated to government bond rates. Businesses and investors are still concerned about taxes on "excess" returns. Taxes on “excess” returns can reduce the expected return below their high hurdles rates that reflect risk and entrepreneurial effort.
The return may be "excess" but it isn't necessarily "infra-marginal" to investors and entrepreneurs. That is why many corporations were more interested in a lower corporate tax rate than expensing after a similar tax reform proposal was made in 2005.
Tom Neubig