Daily Tax Update - March 1, 2011: Senate Finance Committee's Tax Reform Hearing: "How Did We Get Here?"

SENATE FINANCE COMMITTEE’S TAX REFORM HEARING: "HOW DID WE GET HERE?":  Today, the Senate Finance Committee held a hearing titled, "How Did We Get Here? Changes in the Law and Tax Environment Since the Tax Reform Act of 1986."  The hearing examined how changes since the Tax Reform Act of 1986 have affected the tax code, including the globalization of the economy, innovations in technology, advancements in the financial services industry and growth of tax planning practices, and how the tax code has and has not responded.  Five former Assistant Secretaries for Tax Policy testified: Fred Goldberg, Jon Talisman, Mark Weinberger, Eric Solomon, and Pam Olson. 

  • In his opening remarks, Committee Chairman Max Baucus said, "Today, we will look at how the tax code has changed, and whether it has adapted to these changes.  We will look at how the tax environment is different since we last revamped the code in the 1986 Tax Reform Act.  And we will consider how globalization affects the central issues we face in tax reform. We have made 15,000 changes to the tax code since 1986, but many of these changes have stretched the code in different directions.  Have these changes left us with a tax code that is more efficient, competitive and fair?  How have these changes affected average Americans?  Today’s panel of distinguished witnesses allows us to look back on the last 25 years of tax policy.  We will hear more about the reasons behind many of those 15,000 changes.  We will hear about what challenges they faced and how things have changed. The Assistant Secretary for Tax Policy sits at the intersection of tax policy and tax administration.  In this position, our witnesses have been uniquely situated to see all sides of the tax policy debate. One major change we must consider is how doing business has evolved since 1986.  Changes in the foundation of conducting business have had a significant impact on how we collect revenue."
    • Baucus added, "Today, many US businesses pass their income through to shareholders and pay the same tax rate as individuals.  For that reason, this business structure is often called a 'pass-through.'   Since 1986, we've seen the number of pass-throughs double and today, over 94 percent of all businesses are now organized as pass-through entities.  Additionally, two-thirds of our large businesses are pass-throughs, which is more than twice the level of the next-highest developed country. We receive more revenue from pass-through businesses every year than we do from businesses with traditional corporate structures, called C-corporations.  We must consider how efficiently we tax business income, given that so much of it is taxed on an individual basis today. Given our increasingly global economy, we must also consider how other countries’ tax laws affect our system." 
  • Goldberg said, "In many respects the emerging discussion of tax reform is, in the immortal words of Yogi Berra, déjà vu all over again.  The Tax Reform Act of 1986 was premised on the notion of lowering rates and broadening the base.  The stated goals were the timeless tax policy themes of simplification, fairness, efficiency and competitiveness.  The Act did indeed broaden the base and lower rates, and was an improvement over prior law in important respects.  But whatever those gains may have been, they were transitory at best.  The tax system today is grotesquely complicated.  It is perceived as unfair from every point on the political spectrum – from the most liberal Democrat to the most conservative Republican.  It has caused gross distortions in the allocation of resources and has played a significant role in eroding our competitive position in a global economy." 
    • Goldberg added, "I also take issue with those who maintain that corporate tax reform must be 'revenue neutral' (or, worse yet, those who maintain that corporate tax reform should raise additional revenue). This is backwards.  As noted above, corporations never have and never will pay taxes – people do.  And the folks being taxed are workers and middle class savers.  Tax policy in recent years has been characterized by a sentiment that we should increase the tax burden on companies, and a 'better-not-leave-or-else' view of the world.  These policies have been and will remain a dismal failure.  Our country would be far better off if we took advantage of our unique strengths to become a 21st century tax haven – a country where stable tax policy, with relatively low marginal tax rates and tax burdens on enterprise and capital income, help induce businesses, mobile capital and highly productive individuals to locate their job-creating activities in the United States.  This approach is doable – and can be accomplished within a framework that maintains or enhances the all-in progessivity of the tax system."
    • Goldberg concluded, "To a large extent, the ’86 Act was driven by tax 'experts' in the public and private sector.  This approach had its benefits, and succeeded in important respects.  But it also had significant downsides. It meant that reforms would retain the basic structure of the current system.  It also meant an unhealthy obsession with 'closing loopholes' and adherence to tax theory that was wholly at odds with reality.  This time around, tax reform should be driven by a broader community of public and private stakeholders with a clear perspective on what kind of corporate tax reform is best for the country."
  • Talisman said, "Over the past several years, we have been facing a ‘perfect storm’ that many policymakers believe compel the need for tax reform. Because of structural defects, the AMT (absent patches) is exploding and reaching deep into the middle class.  We have well over 100 structural extenders that will expire later this year or next year, including the 2001 and 2003 tax cuts.  It is unsustainable for much of our tax code to exist on a temporary basis.  The US will soon have the highest corporate tax rate and is one of a handful of remaining countries with a worldwide tax system.  The combination is giving rise to competitiveness concerns.  And, unfortunately, we’re facing all of this when we have record near-term deficits, and projected expanding long-term deficits from the impending demographic surge in entitlement programs."
    • Talisman added, "First, it will be important to agree on the goals and intended benefits of tax reform.  The establishment and marketing of goals will determine whether any significant tax reform is accomplished, and how it is judged politically…Second, revenue-neutral tax reform will, by definition, create winners and losers…Third, while simplification is desirable, some of the complexity of the code is unavoidable, and would be necessary in any tax system that is adopted.  We have a complex economy and society that requires special rules to take into account different or unique circumstances in order to be fair or to prevent abuse. Another factor is our political dynamic.  Since the early 1980s, there has been pressure not to increase spending; however, the political desire for new programs did not disappear.  Accordingly, many new programs are being run through the tax code.  Finally, much of the complexity and current instability in the code is caused by legislative efforts to meet our budget rules."
  • Solomon and Weinberger said, "This year will mark the 25th anniversary of the Tax Reform Act of 1986 (the 1986 Act). The 1986 Act — building on reforms from the early 1980s — significantly lowered marginal tax rates while broadening the income tax base. It was the last comprehensive reform of the Code.  Since that time, we have witnessed numerous and material changes in our tax laws.  The changes in our economy, demographics, business environment and global landscape over this period have been even more dramatic.  In 1986, our nation’s principal political rival was the Soviet Union, there was no European Union or Euros, no concept of BRIC2 countries, no smart phones, nor the wide use of cell phones.  Clearly, the world is very different than it was in 1986.  As the world has changed, businesses and other governments have rethought their business models and revenue policies and adopted strategies in order to compete successfully.  The United States too needs a tax code that reflects this changed landscape." 
    • Their statement added, "The fundamental elements of our current tax system are the product of events and vigorous debate that have taken place over a long period of time.  The Code has been augmented, patched, clarified, and otherwise tweaked.  It has been amended to provide additional incentives, to address inequities and unintended consequences, or simply to raise revenue.  As a result, the system has developed into an overly complicated set of rules that has evolved largely without sufficient analysis or debate regarding the long-term competitive effect or alignment with worldwide tax policy trends.  This observation is not intended as a criticism of the process, but merely a recognition of the practical and political realities.  Throughout the evolution of our tax system, the way the world does business has been changing at an extraordinary pace. New industries have been created.  New markets have opened.  The flow of capital has shifted. New economic powers have arisen.  These developments are transforming the landscape for business in the United States and around the world.  As a result, US tax policy decisions which have historically been made without great concern about what has been happening beyond our borders, can no longer be made in a vacuum.  Recently, the principal discussion of tax reform has been about the corporate tax system.  Corporate tax reform has significant ramifications for US businesses, American workers and the US economy that must be fully debated and understood.  Increasingly it is being recognized that with such a large percentage of US business income being earned by flow-through entities and sole proprietorships, that the tax reform debate cannot be limited to corporate taxes." 
    • Their statement concluded, "We believe that tax reform needs to take account of the changing way American businesses operate and the impact foreign competition increasingly plays in their success here and abroad.  One thing taxpayers and policymakers of both political parties can agree on is that tax laws should not disadvantage American workers, businesses or consumers.  As we embark on the tax reform debate, it is important that the discussion not be overtaken by rhetoric.  Some may suggest that the current preferences are loopholes.  They are by and large not loopholes.  To meaningfully reduce statutory tax rates without significant budget. consequences, it would require addressing preferences that have been included in the Code with deliberation and intention.  They are some of the primary instruments we use to influence social and economic policy — including, for example, education, savings, income redistribution and investment in certain areas or industries.  Our unprecedented fiscal deficits and national debt require us to comprehensively re-evaluate our spending and tax priorities.  We must not ignore that.  Since so many policy objectives are implemented through both spending and tax policies, each should be considered in conjunction with each other.  The imperative of attaining a more pro-growth and efficient tax system is even greater in the face of our long-term fiscal situation.  Finally, we would like to commend the Chairman for the approach he has laid out for addressing comprehensive tax reform in this Committee.  The thorough process you have laid out — to assess current state, consider changes, involve stakeholders, and then proceed with comprehensive reform — is the appropriate approach to construct tax policy.  Over the years, the budget and legislative processes have played significant roles in how tax policy has evolved.  They undoubtedly will play a role here.  The tax reform process will need to be navigated and well orchestrated in order to ensure that the end result is a stable, long-term reform that can respond to the changed environment and withstand the test of time."
  • Olson said, "I commend the Committee’s efforts in exploring much-needed reforms to the US tax system.  These efforts are timely, particularly in light of our country’s pressing fiscal concerns and the changing global landscape.  The velocity of change in the global economy makes swift action imperative.  Our tax system and the manner in which it is interwoven with economic activity is complicated, however, and reforming the tax system is even more so.  As a consequence, reforms must be carefully considered before they are enacted."
    • Olson stressed the need for careful consideration of timing for major changes to the tax code.  Olson also urged that sound policy be the primary objective and "that the Committee consider the addition of an alternative tax base, coupled with lower rates on existing tax bases, as part of tax reform."
  • Testimony can be accessed here.
  • For additional information, contact Philip R. West at pwest@steptoe.com.

IRS SEEKS NEW ISSUES FOR INDUSTRY ISSUE RESOLUTION PROGRAM:  Today, the IRS announced that it is encouraging business taxpayers, associations and other interested parties to submit to the Industry Issue Resolution (IIR) Program tax issues for resolution involving a controversy, a dispute or a potentially unnecessary burden on business taxpayers.  According to the IRS, "The objective of the IIR program is to resolve business tax issues common to significant numbers of taxpayers through new and improved guidance. In past years, issues have been submitted by associations and others representing both small and large business taxpayers, resulting in tax guidance that has affected thousands of taxpayers."  Requests for guidance on tax issues under the IIR program can be submitted at any time to IIR@irs.gov.  Submissions received are reviewed semi-annually with selections next being made from issues submitted by March 31, 2011.

  • Additional information can be accessed here

MISCELLANEOUS GUIDANCE RELEASED TODAY:
Revenue Procedure 2011-21 provides the depreciation deduction limitations for owners of passenger automobiles (including trucks and vans) first placed in service during calendar year 2011 and the amount to be included in income by lessees of passenger automobiles first leased during calendar year 2011.  These depreciation deduction limitations and income inclusion amounts are updated annually pursuant to section 280F to reflect the automobile price inflation adjustments.  Rev. Proc. 2011-21 also modifies Rev. Proc. 2010-18, to increase the depreciation limitations and lessee inclusion amounts for passenger automobiles first placed in service or leased in 2010 by taxpayers claiming the section 168(k) additional first year depreciation deduction pursuant to the Small Business Jobs Act of 2010.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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