FROM THE OFFICE OF PUBLIC AFFAIRS

I’m disappointed that Chairman Thomas isn’t speaking because I really wanted to know what he would say to the world’s preeminent corporate tax officers.  We are fortunate to have Chairman Thomas’ leadership on Ways & Means.  He is smart and a tireless worker, but more importantly, he understands the importance of sound tax policy and is committed to enacting legislation that reflects sound tax policy.

I want to begin today by paying tribute to this organization’s former President, Larry Langdon, who has served so ably as LMSB Commissioner for the past three and a half years.  His departure will mark the end of the beginning of the modern era in tax administration, an era ushered in by Charles Rossotti when he became Commissioner in 1997.

It would be hard to think of a better person to begin the reshaping of tax administration for large and mid-sized business than Larry.  During his more than three years as head of LMSB, he put in place numerous changes in procedure that significantly improved the audit process.  Many of the procedural changes were important not just because they cut days and unnecessary work off the examination, but because the changes themselves required people to work differently and think differently than they had in the past.  They took out the controversy and contention and introduced cooperation and problem-solving.  The changes brought about transformations of relationships and job descriptions.  Across the board, Larry improved relationships between the IRS and corporate taxpayers, stakeholder groups, the tax-writing Committees on the Hill, and Treasury.  His ability to do that stemmed from his incredible people skills and innate appreciation of the positive in life.

The opportunity to work with Larry has been a high point of my time at Treasury.  Former Treasury Secretary Summers once observed that policy design without policy implementation is almost meaningless.  For the last two years, Larry has been a key link in insuring that those of us in the design business fully understand the implementation issues.  The result has been sounder tax policy proposals.  Those of us at Treasury will miss him sorely.

While Larry has excelled at improving the current tax compliance process, in some ways, he has only laid the groundwork for the reexamination of the audit process that will occur as the IRS addresses the challenges that lie ahead.  The possibilities that might flow from reexamining the audit process are reflected in Larry’s last initiative – limited issue focus examinations.  That initiative may well transform tax administration, moving it beyond what Larry and his team have achieved so far.

Still to be fully considered are three important questions:
• Who should be audited?
• How should they be audited?
• What should be audited?

The first question is about the selection process.  The second question is about the scope of the audit.  The third question is about issue identification, and it entails both finding the issues and deciding whether the issues matter – that is, whether the issues are worth the resource commitment.  It remains an unappreciated but enormously significant point that, with limited resources, every decision to devote additional resources to a taxpayer or to an issue means that another taxpayer or another issue will go unexamined.

That is one of the reasons it is so important for Treasury and IRS to work together closely.  We can assist the IRS in the issue identification process through more and better and timely published guidance. 

I would note that we are getting out more published guidance right now.  The process is moving more quickly with B. John Williams and a capable team in place in the IRS Chief Counsel’s Office.  Some of the guidance we have issued in the last two years has been aimed at resolving long-standing issues.  The capitalization regulations are perhaps the most notable example of that.  Other guidance, such as notices listing transactions, warns taxpayers that a transaction is subject to challenge and aids IRS agents in identifying the transaction on a return.  The most significant guidance may be the tax shelter disclosure rules that we recently finalized.

In addition to published guidance, Treasury and IRS are hard at work reconsidering Schedule M to make it a more useful document for the IRS audit team.  We hope the result is something less burdensome for all of you.  Both the disclosure regulations and a revised Schedule M should significantly assist LMSB.

We issued the disclosure regulations together with revenue procedures covering exceptions to the disclosure requirements.  The use of the revenue procedures to list the exceptions was intended to provide us greater flexibility in making necessary adjustments.  I encourage you to review them if you haven’t yet.  We’d like to identify and resolve issues sooner rather than later.

Differences between book and tax reporting have generated considerable interest in recent months. As Yogi Berra has observed, “predictions are hazardous, especially about the future.”  Nevertheless, we predict that the section 6011 disclosure regulations, which require the disclosure of significant book/tax differences outside the predictable, will eliminate some of that mystery. 

I’m going to hazard another prediction.  So long as we have myriad, significant, and difficult to explain book/tax differences, I believe you can expect the public’s questions about the accuracy of both book and tax reporting to linger, the media stories about the discrepancies to continue, and IRS doubts about the correctness of the tax return to persist.

Besides the regulations eliminating some mystery about the differences, we should also carefully consider eliminating some of the differences between book and tax, a point made by former Secretary O’Neill in a letter to Senator Grassley last summer.  Greater conformity between the two reporting systems would introduce a healthy tension that could have positive effects on both.

Commenting last week on the economy, New York Federal Reserve Bank President William McDonough observed that “recovery in the business sector continues to be restrained, not just by geopolitical uncertainty and the need for further restructuring in some key sectors, but by caution on the part of investors and lenders.  They continue to doubt the quality of internal governance and external oversight, as well as the reliability of the information corporations provide – in short, critical issues of investor and lender confidence.”

For some time, we have looked at greater conformity between the book and tax reporting rules as a means of achieving some tax simplification.  I know that Commissioner Rossotti firmly believed it would ease tax administration.  The continuing consternation over corporate accountability suggests another potential benefit to an exercise aimed at reducing book-tax disparities.

Greater conformity wouldn’t mean the end of provisions in the Code intended to promote investment – such as accelerated depreciation.  But fewer special tax accounting rules, coupled with a simpler and more comprehensible set of differences, could go a long way to fostering greater confidence in the numbers and respect for the tax system.

At a recent conference, SEC Chairman William Donaldson issued a challenge.  He asked that “corporate America look beyond rules, regulations and laws and look to the principles upon which sound business is based.”  He added, “In order to restore their trust, American investors must see businesses shift from constantly searching for loopholes and skating up to the line of legally acceptable behavior.  They must see a new respect for honesty, integrity, transparency, accountability, and for the good of shareholders, not only an obsession with the bottom line at any cost.”

I believe that is what we must be about, both with respect to corporate governance and with respect to the tax system.

Despite the continuing concerns about corporate America, I believe there are changes afoot.   Changes for the better.  But I think that one of the things lost in the headlines is the strength of the base from which that change for the better begins. 

In the past three years we have seen the pendulum of public opinion swing from lionizing American corporations and business leaders to the opposite: widespread public skepticism toward the notion that businesses can be a force for good, and a general doubt that businesspeople can rise to serve causes higher than their personal enrichment.  The American businessman has gone from hero to zero in nothing flat. 

Perhaps American business leaders should never have been so lionized - we all have feet of clay - but neither should they be demonized.  Above all, we must remember that much of what has happened was caused by the outrageous acts of a few.  It would be foolhardy for us to judge the many on the basis of the acts of a few.

Even Enron, a name now synonymous with greed, financial chicanery, and the new economy’s fall from grace, was comprised of thousands of dedicated, idealistic and enthusiastic employees, who saw their plans, their dreams, and their life’s savings go down with the company.  The actual perpetrators were a small but crooked band, operating at the top of the pyramid.  Yet the shadow of the few at the top has fallen over the many good people below them, and over firms large and small across our nation.

Though stories of corporate criminality still dominate business magazine covers and headlines - just as the haloed portraits of those same men now indicted once graced the same glossy sheets - the truth is that American businessmen and women have upheld and will continue to uphold the great strengths and virtues of American society.

If you look, I believe you’ll find that in the business world, ordinary people show extraordinary character every day.  Let me give you two examples of TEI members.

A few years back, I was working with a client that had just wrapped up a lengthy and somewhat contentious audit.  The client’s quick review of the IRS’s calculation of the additional tax due indicated several million dollars had been left out of the calculation.  After a more careful review confirmed the mistake, the client picked up the phone and called the IRS to advise of the mistake.

Another client, similarly following a lengthy and somewhat contentious audit, received a refund check for millions of dollars more than had been anticipated.  After a careful review of the computations, the client determined the IRS had made a mistake in its interest calculation and returned the overpayment.

Those examples are not unusual.  I’d wager that most of you in this room hand the IRS in the course of an audit changes to your company’s tax return that increase tax liability.

American companies are a force for good because they share American values.  That is the case at home and abroad.  Integrity shows up in everyday business conduct as American companies do business around the globe.  In effect, we are exporting ethical business practices along with investments of capital and know-how.

My favorite example of this export of ethical business practices involves an investment by U.S. Steel in Slovakia.  U.S. companies are subject to various restrictions on their business practices abroad, including the Foreign Corrupt Practices Act, which can make doing business in countries accustomed to graft a challenge.  But U.S. Steel took ethical practices a step further on its own.

When U.S. Steel acquired a large plant in Slovakia, it ran a full-page ad making clear that it would neither pay nor accept any corrupt payments and that any suppliers or employees making or accepting such payments would be terminated or dismissed.  The knock on effect changed the culture for business investment in Slovakia, for the benefit of all Slovakians.

Besides exporting ethical business practices, we have exported high standards for transparency in the financial sector.  In the summer of 2001, Former Treasury Secretary Paul O’Neill challenged Treasury staff to increase the number of tax information exchange agreements we have with other countries. These agreements help us gain access to the information we need to enforce our tax laws. Many significant offshore financial centers were reluctant to enter into these agreements fearing they would lose business. But the Cayman Islands, the largest financial center in the Caribbean -- and a partner with us in the financial war on terror -- stepped up to the plate and signed a tax information exchange agreement with us. It was the first agreement the U.S. had concluded in more than a decade.  Since then several other significant financial centers have entered into such agreements with us and we are hopeful that other countries, including some of our major trading partners, will follow their lead so we can improve our tax information exchange relationships with them.

Our tax system faces enormous challenges.  One of them is its sheer complexity.  A couple of weeks ago, Bob McKenzie, sent me this observation:  “It is difficult to predict the future of an economy in which it takes more brains to figure out the tax on our income than it does to earn it.”  To be sure, the complexity of the tax laws has kept all of us in this room in lucrative employment.  But that doesn’t mean it’s a good thing!

Even more serious than the problem of complexity is that we’ve designed a system that is at odds with America’s best interests.  We have rules that distort economic decision-making, rules that get in the way of taxpayers making the best decisions.  Virtue may be its own reward, but we’re going to have less of it if we attach significant financial penalties to its practice.  I don’t think there can be any doubt that our tax rules contributed to the corporate accountability problems we are working through.  It is time for Congress to end the economic distortions in our tax rules.

Our corporate tax system favors debt over equity, retained earnings over dividends, and distributions of earnings via complicated transactions like share repurchases over simple dividend checks.  There’s nothing wrong with debt, retaining earnings, or repurchasing shares, but there’s no reason for the tax code to prefer them either.  Debt can cause instability, particularly during an economic downturn.  Projects financed with retained earnings may be subject to a lower hurdle and avoid public scrutiny.  And the share repurchase, which tends to occur when the stock price is attractive – read low – is like a cheap date while the dividend means commitment.

For too long now, it has been convenient to disdain the dividend as "tax inefficient."  But having the cash to make dividend payments is a powerful indicator of the health of a company.  As Secretary Snow has observed, you can fudge earnings, but you can’t fudge cash.  Moreover, counterfeiting the cash is clearly illegal.  The President's dividend exclusion proposal offers a potent corporate accountability package.

Besides the adverse effect on corporate accountability, the current system has left the desirability of reducing corporate tax liability unbridled.  The crisis with corporate tax shelters might not have occurred if the President's proposal, which makes corporate tax payments an asset to shareholders, had been the law.

Some have argued that we should have taken a simpler approach to ending the double tax on corporate earnings, that we are complicating the Code we’ve said we want to simplify.  A dividends paid deduction at the corporate level might have been administratively simpler for all of you to implement.  But it would have been a different proposal in key respects from the plan the President put on the table.  The neutrality achieved by the President’s proposal between retaining earnings and paying dividends would have been lost.  So too would the transparency regarding corporate tax payments have been lost.  To be perfectly frank, I don’t think what the economy needs right now is another corporate tax deduction.

Some of the assertions of complexity have come from quarters not directly affected by the proposal.  The President’s proposal reduces many of the tax advantages and distortions of current law.  That leveling of the playing field changes the math, and while people sort out what it means, things look complicated.  Some assertions of complexity are really objections to the diminution of a relative tax advantage.  Dare I point out that the protection of those tax advantages keeps many folks in Washington fully employed?  Other complexity concerns are based on misunderstandings.  As many are finding, however, the proposal can be implemented without that much difficulty, and concerns about complexity have waned considerably as people have become more familiar with the proposal.

We are continuing to work with industry groups with concerns on administrative issues.  We aim to make the proposal as simple to administer as possible.  We look forward, in particular, to any input from TEI.  We know we can always count on you to identify key issues and propose sensible solutions.

We believe that freeing our tax system from decision-distorting rules is an important undertaking for us and for our neighbors around the globe.  Beyond the double tax on corporate earnings, our international rules are in need of reform.  They are antiquated and out of synch with our participation in the global economy.

The Treasury Department has identified a number of ways in which our international rules harm American companies and American workers.  We have rules that increase taxes for organizing foreign marketing operations more efficiently and rules that make it more expensive to reinvest profits in the U.S.  That means we have rules that put up barriers to American companies reinvesting their profits in the U.S. where it may mean a job or higher productivity for an American worker.

Discussing the need for changes to the rules can yield some amazing comments from those who don’t understand the practical consequences of the rules, comments that suggest a view of the global economy that is several decades out of date.  American companies invest abroad because the resources and customers are there.  The easiest way to sell goods or services in a foreign market is to have the employees and the facilities there.  U.S. companies’ foreign direct investment adds to our wealth, it doesn’t detract from it.  Foreign direct investment brings the relationships and creates the supply chains that mean more opportunities for other American companies and more American jobs.

Some folks don’t understand these relationships.  They seem to believe that rules harming American companies aren’t a problem - as though the companies were entities disconnected somehow from their shareholders and employees and the rest of society.  But that is wrong.  Rules that harm American companies harm their employees, their shareholders, their creditors, their suppliers, and their customers. It is time for us to redesign those rules taking into account the practical effects of the rules on American companies and American workers.

Let me close by saluting TEI and its members.  So many of you contribute so much to sound tax administration and the development of sound tax policy.  Your comments are thoughtful, balanced, and practical.  You make the job of those of us in government much easier than it would otherwise be.

Thank you.