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Making the Case for Tax Neutrality

Posted by  Mike Huthwaite

As someone who is passionate about Cash Flow, I often find that the single most frustrating impediment stopping companies from implementing optimal management practices centered around Cash Flow is without a doubt the tax system. 

The tax system, whether it be corporate or personal, is often a complex system that is based on rules-based accounting, which often has little to do with the actual health and well being of the taxable entity. 

For the record, I’m not a tax expert, but I am an ardent believer in Cash Flow, and it irks me that we can’t build a tax system that is logical and straightforward.  A system that aligns the collection of tax with the creation of personal wealth or shareholder value. 

Why can’t we build a system where business decisions are made irrespective of tax?  Where loopholes and creative tax accounting aren’t rewarded?  Where business decisions are made purely on the ability to create value for the shareholder and not on how to manipulate the tax system. 

This is the world I want to live in… and here is a blueprint for how it could happen. 

Disclaimer
Before I go on, it’s important to point out that I’m not trying to make a political nor social economic argument for why someone should pay more or less tax than someone else.  Nor am I concerned with how governments spend tax revenue.  I will leave that up to the politicians. 

What I want is a tax system that is more transparent, simple and efficient for everyone whether that’s an organization or an individual. 

But, in order for this to occur, underlying tax calculations must be simple to understand and easy to forecast.  The tax rules have to be so straightforward that it doesn’t require a tax accountant or a series of forms to fill out.  And finally, it has to leverage modern technology so that it can operate efficiently without the need for the IRS, Inland Revenue or any other government tax agency. 

Tax Based on Cash Flow
The easiest way to tax is based on Cash Flows.  In other words, if you receive more cash then you disperse in a given period then you pay tax, otherwise you don’t.  That’s essentially it.  Under this approach, every cash inflow and every cash outflow is counted equally, hence the name “tax neutrality”.  This is true if you are a company or an individual.

Depreciation, Amortization and other non-cash activities are completely irrelevant in this cash-based system.  As a result, individuals and companies don’t need to worry about maintaining tax schedules or applying complex and often arbitrary rules that benefit some, but not all.  

Treat all Cash Flows the Same
It should not be up to the government to decide what is a taxable expense or not.  If you have a mortgage or pay rent, you can deduct the outflow of Cash.  If you invest in your business, then that should reduce your tax payment in exactly the same way as taking a customer out to lunch. 

In short, it should not be up to the government or any other agency to decide what is a tax-deductible outflow.  If you want to make money, then you as a business must decide what expenses are necessary and which aren’t.  After all, a company that can’t manage cash flow on their own will ultimately go out of business. 

Alternative ways to Stimulate the Economy
The truth is, a tax paying entity that spends money actually stimulates the economy.  This is beneficial to the economy even if it means that the company or individual pays less tax.  It’s also likely to increase the velocity of cash through the economy.  As money flows faster, it brings down interest rates.  This phenomenon benefits the economy even if it doesn’t result in direct tax revenue. 

Tax Authorities
When governments stop policing what expenses are taxable and nontaxable, the need for government tax authorities, tax accountants and tax lawyers reduces significantly.

This not only saves everyone the agony of added expenses; it also eliminates the underlying incentive for trying to game the tax system in the first place. 

Use Technology to Manage Cash Flow
Let’s face it, we live in a digital world.  Tracking flows of Cash is becoming easier and easier.  This is especially true as we become less dependent on physical cash.  Tracing the flow of cash and even consolidating that cash flow across multiple accounts is not a big ask these days. 

Pushing the tax collection burden away from employers in favor of the banks enables financial institutions to track not only the sources, but also the uses of Cash. 

Open for Discussion
What should the tax rate be?  Should we have graduated tax rates based on Cash Flow levels?  How often should taxes be collected? Should we allow losses to be carryforward? 

These are all good questions for debate, but my only thought here is that we should keep it as simple as possible.  Doing so, will lower the rate for all and reduce the amount of overhead required to manage the tax system. 

When everyone is sharing in the creation of wealth, I don’t see why the tax rates couldn’t reach the single digits. 

Conclusion
Tax Reform based on Cash Flow, not only ties value creation to tax, it also radically simplifies the system reducing bureaucracy and reducing a ton of waste (time and resources).  The result is a streamlined system that would be far easier to track and plan, justifying economic growth and reducing costs for everyone.

 

Mike Huthwaite

Passionate advisor and thought leader in the area of Strategic Finance. A seasoned consultant with 20 years of experience, Mike has advised numerous mid-market and large multi-national organizations enhance their strategic planning capabilities.

Mike is an advocate for Cash Flow and Discounted Cash Flow (DCF) analytics. He is a regular speaker and blogger on the topics of uncertainty, Real Options (advanced scenario analysis) and various financial modeling technologies.