FROM THE OFFICE OF PUBLIC AFFAIRS

I want to thank Charles, Mike and Tim for inviting me here this morning. As has become traditional, I am following behind our Deputy Secretary, this year Stu Eizenstat, to discuss issues that are part of the tax policy agenda this year. I will focus first on the Administration's legislative initiatives and then shift to administrative guidance.

As you know, the President's budget calls for about $350 billion in gross tax cuts over ten years -- $250 billion in net tax cuts and about $100 billion in revenue offsets.

The budget includes targeted tax cuts to address several particularly pressing problems -- education, health care, child care, poverty relief and retirement saving. For example, the Budget includes two new initiatives designed to provide a progressive saving incentive. First, the President's Retirement Saving Accounts provide a progressive matching credit for contributions to pension accounts maintained by employers or financial institutions. Second, a new credit would be provided to small businesses that provide automatic contributions to their employees. We are presently meeting with outside groups to discuss comments and concerns regarding these proposals. We have been pleased at the generally favorable response and hope that our conversations will help us refine and improve our proposals, leading to their enactment

In its FY2001 budget proposals, the Administration also seeks to leverage the progress that has already been made in revitalizing America's economically disadvantaged communities through the provision of another $17 billion in targeted tax incentives over the next decade. These measures will allow more communities to benefit from the investment that is so important in a technology-driven economy, while offering an innovative approach to the task of attracting patient equity capital to businesses in economically disadvantaged areas.

LS-485

For example, an important priority is the New Markets Tax Credit, a part of the President's broader New Markets Initiative. This tax incentive would help attract $15 billion in equity capital to community-based financial institutions which, in turn, would invest these funds in their communities, spurring the creation of high-quality jobs and, equally important, building lasting links to the new economy. High technology and service firms at the heart of the new economy have generally sought to locate near other similar enterprises, in places like the Silicon Valley and the Dulles Corridor, so that they may tap a common pool of customers, employees and other resources. Thus these enterprises tend to be highly concentrated geographically, and often not in lower-income areas. The New Market Tax Credit would attract capital, and therefore high-growth industries, to lower-income areas by providing a subsidy to investors. This temporary subsidy will, at least in part, compensate investors for the additional costs involved in establishing operations in locales which have yet to benefit from the strength of the U.S. economy over the past decade and where the presence of other fast-growing firms may therefore be limited.

The New Markets Tax Credit is specifically designed to further the efforts of community-based financial institutions in promoting economic revitalization while encouraging these entities to make the "on the ground" decisions concerning where the need for capital is greatest. Such institutions -- including a wide variety of existing or newly-formed community development banks and venture funds -- would apply to the Treasury Department for authorization to issue stock (or other equity interests) with respect to which the investors could claim a tax credit equal to approximately 25 percent of the investment, in present value terms. The credit would be claimed in five equal installments, each equal to 6 percent of the original investment, during each of the first five years of investment.

The budget also contains an important new tax initiative to encourage the development of vaccines to combat diseases that afflict the third world. These diseases cause over 5 million deaths annually, most in developing countries. The credit would match the efforts of nonprofits, such as UNICEF, to provide a market to purchase these vaccines.

The final budget initiative I would like to focus on addresses a serious concern with the current tax code. The Budget contains a $33 billion proposal to correct serious design flaws in the individual Alternative Minimum Tax (AMT) that are causing the AMT to apply increasingly to middle-income families, thereby complicating their tax preparation and raising their tax bills. The number of taxpayers subject to the AMT is expected to grow, if no change is made, from 1.3 million today to 17 million by 2010. This is due in part because, under current law, the AMT treats personal exemptions and the standard deduction as preference items, in the same category as special tax breaks such as intangible drilling costs and tax shelter losses. Taxpayers subject to the AMT are denied these deductions. As a result, under current law, a couple with five children and $70,000 of income that claims the standard deduction would be subject to the AMT in 2000. The AMT was never intended to affect such families.

The Administration's proposal would address these design flaws in two ways. First, when fully phased in, the proposal would allow taxpayers to deduct all of their dependent exemptions against the AMT, thereby ensuring that no taxpayers would become subject to the AMT simply because they claim personal exemption deductions for their children. This would cut the number of taxpayers on the AMT in 2010 by more than half to 7.6 million. Absent this reform, by 2010, 45 percent of two-child families would be subject to the AMT. The percentage is higher for larger families. Second, the proposal would allow taxpayers to claim the standard deduction for AMT purposes in 2000 and 2001.

Let me move from the initiatives and briefly discuss a few other issues of importance to us at Treasury: corporate tax shelters, and our 2000 priority business guidance plan.

As you all are well aware (and as discussed by Deputy Secretary Eizenstat yesterday), we have been seeking to address the recent proliferation of corporate tax shelters. In fact, I first spoke to you about this problem in St Louis in the fall of 1998. This is a problem, we believe, that affects the integrity of the tax system and therefore warrants great concern and merits concerted action, both legislative and administrative. When we started working on our "White Paper" on corporate tax shelters at the end of 1998, our first goal was to raise awareness that there was a problem and to explore the nature of the problem. Now, it is clear that there is widespread agreement and concern among tax professionals that the corporate tax shelter problem is large and growing.

Earlier this year, the American Bar Association testified about its "growing alarm [at] the aggressive use by large corporate taxpayers of tax 'products' that have little or no purpose other than the reduction of Federal income taxes," and its concern at the "blatant, yet secretive marketing" of such products. The staff of the Joint Committee on Taxation, the New York State Bar Association, the Tax Executives Institute, and others have echoed these comments. The dialogue we have received to date on this topic has been invaluable.

Our budget proposals include a number of targeted provisions aimed at specific shelters of which we were aware. What we have found over time, however, is that addressing tax shelters transaction-by-transaction is a losing proposition. As one participant has remarked, "it is like the arcade game of 'whack-a-mole'". You kill off one over here and two or three more appear over there. Already, last year, we shut down so-called "chutzpah trusts" which were similar to a structure shut down by Congress in 1997. The "BOSS" transaction that we curbed recently by notice is a derivation on the section 357(c) product. Promoters will continue to search for defects in the code to exploit, and taxpayers with an appetite for tax shelters will simply move from those transactions that are specifically prohibited by the new legislation to other transactions the treatment of which has not been definitively proscribed.

To curtail the development, marketing, and purchase of corporate tax shelters, we must change the tax shelter cost/benefit analysis in a manner sufficient to deter these artificial transactions.

Last month, we announced new tax disclosure regulations designed to increase disclosure and access to information regarding corporate tax shelters. Greater disclosure will help the IRS to identify these shelters and assist enforcement in curbing these shelters. Also, requiring disclosure will inhibit corporate taxpayers from engaging in questionable transactions

• Corporate taxpayers would be required to attach a disclosure statement to their return regarding transactions that have certain identified characteristics common to corporate tax shelters. Also, any transaction that is substantially similar to a transaction previously identified by Treasury and the IRS as a tax shelter would need to be disclosed.
• These characteristics include: book ax differences above $5 million, certain fees paid to a promoter in excess of $100,000, use of a tax-indifferent party to provide tax benefits, conditions of confidentiality, contractual protection against the fact that the tax benefits would not be realized, and inconsistent treatment for U.S. and foreign tax purposes.
• To aim at larger transactions, the reporting obligation would be limited to transactions above certain dollar thresholds.
• Also, to avoid impact on legitimate transactions, several exceptions are provided in the regulations. For example, transactions in the ordinary course of a taxpayer's business would not be disclosed if they were consistent with customary commercial practice and the taxpayer can demonstrate it would have participated in the transaction on substantially the same terms absent the tax benefits.
• Promoters would be required to register certain confidential corporate tax shelters under section 6111(d). Disclosure is required for any transaction that (1) has a significant purpose of tax avoidance or evasion, (2) is offered under conditions of confidentiality, and (3) has promoter fees in excess of $100,000.
• This hopefully will enhance IRS notification of tax shelters either through actual registration of shelters or removal of conditions of confidentiality.
• Promoters would be required to maintain lists of investors and other pertinent information regarding potentially abusive tax shelters.
• This will allow cross-checking. Once a shelter is identified as having been promoted, we will be able to locate all of the taxpayers to whom it was marketed.
• This information must be available for inspection by the IRS generally for a period of seven years.

These regulations are an essential part of our comprehensive strategy for curbing corporate tax shelters. Other aspects of this multi-faceted approach to tackling the problem of corporate tax shelters include legislative proposals to halt the sale and marketing of shelters, tightening practitioner standards, regulatory action to clamp down on specific shelters as they come to light, and IRS steps to better identify and address abusive transactions.

Legislative action is necessary in order to curb the further growth of corporate tax shelters. The main elements of the proposed legislation include:

• creating incentives for disclosure by providing penalties for nondisclosure and modifying the substantial understatement penalty,
• codifying the judicially-created economic substance doctrine, and
• providing consequences to all parties to the transaction (including promoters, advisors, and tax-indifferent, accommodating parties).

The centerpiece of the substantive law proposal is not a new standard, but rather is intended as a coherent articulation of the economic substance doctrine first found in seminal case law such as Gregory v. Helvering and most recently utilized in ACM, Compaq, IES and Winn Dixie. The economic substance doctrine requires a comparison of the expected pre-tax profits and expected tax benefits. Codification of the doctrine would create a consistent standard so that taxpayers may not pick and choose between conflicting decisions to support their position. Codification also would isolate the doctrine from the facts of the cases so that taxpayers could not simply distinguish the cases based on the facts.

Of course, we will continue to combat corporate tax shelters with the tools we have available under current law. The Administration has worked with Congress in enacting legislation that shut down specific abusive schemes that have come to light. In the last year, the Treasury and the IRS issued various notices, revenue rulings and regulations stopping several tax shelters including so-called "BOSS" transactions, "lease-in/lease-out" or "LILO" transactions, fast-pay stock issuances, and "chutzpah" trusts. Also, the IRS has won several significant court victories, successfully arguing that various shelter transactions lacked economic substance.

The restructuring of the IRS into business units will enhance the ability of the IRS to address the corporate tax shelter problem by facilitating the centralization and coordination of its efforts. This will help provide additional taxpayer safeguards, while at the same time allowing the IRS to identify and address transactions more quickly and efficiently.

We will be releasing our year 2000 business plan imminently. It is very ambitious, including several more items than last year's plan -- a year in which we released a record amount of formal guidance. This year's guidance plan reflects greater formal input from taxpayers, tax practitioners and industry groups. Suggestions were carefully considered by the newly formed Published Guidance Advisory Committee. This, we believe, will result in a comprehensive plan that is extremely responsive to taxpayer needs.

One area that taxpayers are clamoring for guidance relates to the issue of whether certain costs must be capitalized or can be expensed - the so-called "INDOPCO issue." This issue has been present since the beginning of the income tax. The Treasury and the IRS take this issue very seriously. In 1996, we issued Notice 96-7, asking for comments on how this issue can be best addressed in the guidance process. Not unexpectedly, many of the comments can be summarized as "Fix my problem, and by the way, the answer is current deductibility."

Thus, for the last several years, Treasury and the IRS have embarked on a guidance process that attempted to analyze and provide guidance in the framework of specific fact patterns, generally in the form of revenue rulings. Although a revenue ruling appears to be short and simple, let me assure you that its development is not. Providing such guidance is extremely resource intensive, both from the government's and taxpayer's standpoint, as there needs to be (1) a complete understanding, analysis, and agreements as to the facts, (2) an application of the law to such facts, and (3) consideration of the implications of the holding of one ruling to the fact patterns of other cases.

Although Treasury and IRS have consistently made capitalization guidance a high priority in the last several years and have issued a significant amount of fact-specific guidance, demand continues to outpace supply. For this reason, we believe we must go broader and deeper. Unfortunately, no single "magic bullet" has enabled us to resolve all capitalization issues for once and for all. However, we can and will consider broader topics as (1) whether workable rules can be provided for self-created assets, (2) whether the "plan of rehabilitation" doctrine" can be defined, (3) whether workable rules can be developed for repairs generally, and (4) in what cases de minimis rules are appropriate. We will continue to consider traditional case-specific guidance. However, we should also consider whether new forms of guidance, such as industry settlements and the pre-filing agreements launched by the IRS's Large and Mid-Sized Business division, can be brought to bear.

We welcome your comments and suggestions on how to best proceed. We at Treasury and the IRS realize the importance of the issue and pledge to continue to provide prompt and useful guidance in this area.

I want to thank you again for the opportunity to appear this morning. It is always a pleasure to speak before TEI.