Thank you. It is a pleasure to be here among tax professionals to discuss in greater detail some of the Administration's plans for fiscal 2000. Specifically, I intend to cover two topics this morning: first, the substantial progress we have made over this past year at the IRS, and second, in more detail, our concern over the recent proliferation of abusive corporate tax shelters and our plans to combat them.

I. The IRS: A Successful Period of Reform

Speaking here at the TEI two years ago, I laid out Treasury's five-point plan for building a better IRS. Our goals were: to strengthen leadership; to increase managerial flexibility; to enhance oversight; to improve IRS budgeting; and to work for a simpler, fairer tax code.

Two years on, with the passage of the bipartisan 1998 IRS Restructuring and Reform Act and with the hard work of the IRS, led by its new Commissioner, Charles Rossotti, working closely with the President and with the Vice-President's National Performance Review, we have seen real progress on all five fronts. Most important of all, taxpayers are seeing results, in the form of a more modern, efficient, customer-friendly IRS:

• two years ago, taxpayers dialing the IRS toll-free number had about a 20 percent chance of getting through. Today telephone access rates are running at more than 90 percent. And the filing season help lines have been open 24 hours a day, 7 days a week since January 1.
  

• nonpaper filing methods -- e-file, On-Line and Telefile -- are up 15 percent this year. And about 8 million households who calculate, but do not file their taxes electronically have been invited to join a pilot program for entirely paperless filing in 1999.
  

• "hits" to the IRS homepage have more than doubled, to nearly 500 million. A recent Washington Post article waxed lyrical about its "webby breeziness" and asked: "Who would have thought that the IRS web site would be so thorough, so accessible, so useful and -- can this be true? -- so cool."
  

• and alternative payment methods are on the rise: payment by direct deposit is up 22 percent in 1999. And a number of taxpayers are already taking advantage of the new ability to pay their taxes by credit card.

I am also glad to report that all mission critical systems at the IRS have been made Y2K compliant and placed back into production for the 1999 filing season.

Commissioner Rossotti will be talking to you later on about his plans for the IRS this year. He knows -- as do we all -- that the IRS has a great deal more to do to become the tax collection agency for the 21st century that the country needs and American citizens deserve. But we can surely take pride in the tremendous changes that have already been achieved. For our part, the Administration has complete confidence that Charles and his team will build on these successes in the months and years to come.

II. The Administration's Plans for Corporate Tax Shelters

I would like to spend the rest of my time today discussing the Administration's plans for combating a problem that has been a continuing concern inside and outside the Administration in recent years -- and which Treasury officials have been discussing with the TEI and others for some time. This is the growing problem of abusive corporate tax shelters.

In the past few years alone:

• Congress has been forced to pass two provisions to prevent the abuse for tax purposes of corporate-owned life insurance. As Ken Kies, then Chief of Staff of the Joint Committee on Taxation, stated afterwards, "When you have a corporation wiring out a billion dollars of premium in the morning and then borrowing it back by wire in the afternoon and instantly creating with each year another $35 million of perpetual tax savings, that's a problem.... I think we were looking at a potential for a substantial erosion of the corporate tax base if something hadn't been done."
  

• our Office of Tax Policy has uncovered several tax "products" that would have cost the government tens of billions of dollars if left unchecked. Indeed, the Office of Tax Analysis estimated that legislation last year to eliminate one such product -- liquidating REITs would save the tax system upwards of $30 billion over the next ten years.
  

• most recently, we have brought to light lease-in, lease-out transactions, or so- called "LILO" schemes. Like COLI, these transactions, through circular property and cash flows, offered participants millions in tax benefits with no real economic risk. The notion of a U.S. multinational leasing a town hall from a Swiss municipality and then immediately leasing it back to the municipality is, surely, odd on its face.

Because these transactions are marketed in secret and the main thing we know about them is that there is much that we do not know about them it is difficult to estimate how much they cost the government each year. There seems to be little doubt among the cognoscenti that the transactions we have caught which cost billions a year represent only the tip of the iceberg. Professor Joe Bankman of Stanford University has recently estimated the total cost at more than $10 billion a year. This seems in line with the judgement of other practitioners:

• testifying recently before Congress, the American Bar Association noted 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.
  

• for his part, House Ways and Means Committee Chairman Bill Archer signaled at a hearing a couple of weeks ago that we was willing to join the Administration's efforts in this area, saying that the area of corporate tax shelters "merits review."
  

• a recent cover story in Forbes magazine was devoted to the "thriving industry of hustling corporate tax shelters." This quoted a partner in a major accounting firm describing the development and highly selective marketing of "black box" strategies for tax avoidance that can save its purchasers -- and cost US taxpayers -- anything from tens of millions, to hundreds of millions of dollars.
  

• in that same article, John "Buck" Chapoton, the Assistant Secretary for Tax Policy in the Reagan Administration, said that he, were he still at the Treasury, would be making a speech every week about the problem of corporate tax shelters.

Members of the TEI, and others in the corporate community have come to us complaining, generically, of these developments and concerned about the growing pressure they feel themselves to be under to purchase such products in order to stay competitive with others. Many have asked for the help of the Treasury Department -- help that we very much intend to provide.

1. Defining the Problem

Let me assure you at the outset that we, at Treasury, understand the difficulty of our task. The line between legitimate and illegitimate efforts to minimize taxes can be a very fine line indeed. We well remember the words of Learned Hand: "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."

Also, we are well aware that the vast majority of taxpayers are honest. When we go after abusive corporate tax shelters our aim is not merely to protect revenues, but also to protect those who willingly pay their fair share. Otherwise, competitive pressures that come from the suspicion that others are avoiding their share of tax may force a "race to the bottom." One is reminded of the proverbial situation in which everyone is better off sitting in a football game than standing -- but the fact that some are standing obliges others to do the same.

Provisions which provide certain incentives and confer certain benefits on taxpayers will always be debatable as will the proper measurement of economic income. But there should be little doubt about transactions with no real content whose only objective is to reduce tax liabilities. It is these transactions we have in mind when we speak of corporate tax shelters.

Common characteristics that are often indicative of a tax shelter include:

• major discrepancies between "book" profits and taxable profits.
  

• the use of non-taxpaying parties -- such as foreign or tax-exempt entities who participate in the transaction solely to absorb taxable income or otherwise deflect tax liability from the taxable party;
  

• the use of contingent fees, unwind clauses, or other contractual conditions such that the transaction is insulated from an adverse judgment by the IRS.

2. The Limits of Past Approaches

Of course, corporate tax shelters have long been a concern for Treasury and we have not been idle these past years in seeking to combat them. When we have identified corporate tax shelters we have acted and will continue to act to address them using all appropriate legal and regulatory means at our disposal. However, experience is increasingly pointing up the problems with this ad hoc -- and necessarily piecemeal approach. .

First, perhaps inevitably, it leaves us barely scratching the surface of the problem. One is reminded of painting the Brooklyn Bridge: no sooner is one section painted over, than another appears needing work. Taxpayers with an appetite for corporate tax shelters will simply move from those transactions that are specifically prohibited by the new legislation to other transactions the treatment of which is less clear.

Second, piecemeal legislation ends up silting up the code and, almost by definition, calls into question the viability of common law tax doctrines. In the past few years alone, Ken Kies notes, in his recent testimony, that 29 provisions have been adopted responding to perceived abuses.

Third, a transaction-by-transaction approach to corporate tax shelters risks encouraging some of the promoters of -- and participants in -- tax shelter products to rush them on to the market, on the grounds that any reactive legislation will be applied on a prospective basis only, long after the product has been sold and put to use.

It is noteworthy that Administrations of both parties encountered some of the same problems in working to reverse the growth of individual tax shelters which threatened the efficacy of the individual income tax system in the 1970s and 1980s. To stifle the growth of these shelters, the IRS and Justice Department aggressively sought out tax-shelter promoters and their clients, and challenged questionable cases. But enforcement efforts eventually turned to a more global approach, which culminated in success in the Tax Reform Act of 1986 with passage of the passive loss rules.

For similar reasons, we believe it is time for us to turn our attention to finding a more global solution to corporate tax shelters in the United States today.

3. The Administration's Approach

You may take it as a given that Treasury will continue to work to take steps to combat particular tax shelters as and when these are discovered. Our proposals for this year's budget contain a number of such specific proposals aimed at addressing particular tax shelters of which we are aware. But the concerns mentioned above have convinced us of the need for a new approach -- an approach that we hope will ultimately make the vast majority of these piecemeal efforts unnecessary.

Treasury's work in the corporate tax shelter area will henceforth have as its main priority the cultivation of a more general culture of compliance in which tax shelters are more seldom created.

This new approach has four core elements:

First, to reduce the incentive to create new tax shelters whenever an old one is blocked and simplify anti-avoidance efforts in the future, we are proposing new penalties to ensure that the search carries real financial risks for all involved. We have seen repeatedly in the financial sphere in this country -- and, more recently, in Asia -- the damage that can come from situations where businesses can operate on a basis where they gamble and win if things turn out their way, but don't lose anything if things go wrong. Without an improved penalty regime the temptation for taxpayers to play the audit lottery is too great.

We are proposing to change the dynamics on both the supply and demand side of this 'market' making it a less attractive one for all participants -- 'merchants' of abusive tax shelters, their customers, and those who facilitate the transactions. As the ABA put it in its recent testimony: "all essential parties to a tax-driven transaction should have an incentive to make certain that the transaction is within the law."

Our proposed penalties include:

• increased, strict liability penalties for substantial understatement where it is found that tax shelters have been used.
  

• excise taxes on "tax-indifferent" parties in tax shelters.
  

• a 25 percent excise tax on promoter and lawyer fees so that they, too, pay a non-negligible price for their activities.
  

• new excise taxes on contingent fees, unwind provisions or tax indemnity clauses that make a positive ruling by the IRS a condition for the transaction itself.

Second, we will issue administrative guidance which, as exigencies demand, looks to the past as well as the future. In recent years -- in cases where, to put it frankly, those involved should have known better -- we have issued guidance with retroactive effect; for example, in the case of step-down preferred stock and the recent LILO revenue ruling. Many have seen these decisions as setting a precedent. They were right. That was the intent. Going forward we will continue to issue additional administrative guidance to address specific transactions as appropriate. And these will have retroactive effect if this is judged necessary for the rulings to have their desired effect.

As Fred Goldberg, former Assistant Secretary for Tax Policy in the Bush Administration, pointed out several years ago, without the ability to issue guidance retroactively, without that threat, some taxpayers, and their "well-heeled" advisors might "simply write down as many zeroes as they wish on a page" effectively printing money through use of corporate tax shelters.

Third, we will work with the IRS to step up compliance efforts -- because all the guidance in the world will not reduce avoidance if IRS agents themselves do not follow it up on the ground. The IRS has had some important victories in the courts recently, with judges upholding its allegations of abusive transactions in the recent ACM & ASA cases. Commissioner Rossotti will later be describing his plans for reorganizing the IRS. Let me just note here that I expect that the move away from a geographical basis to a more functional approach -- including divisions focused on particular subsets of corporate activities -- will make for a better understanding of these businesses on the part of IRS agents, and, I am confident, more effective enforcement of the provisions of the tax code that pertain to them.

Fourth, I spoke earlier of the importance of building a culture of compliance. The Secretary, Don Lubick, Jon Talisman and I intend an intensive and extensive dialogue with practitioner groups -- the tax bar, the accounting profession, and corporate tax executives such as yourselves - - so that we can come to common understandings of the norms of appropriate behavior in this area.

Among the issues that can be considered in this effort are the professional rules of conduct that presently guide such groups in their interactions with the IRS. For our part Secretary Rubin and I have asked the Office of Tax Policy and IRS to consider whether or not any changes in its standards of conduct in these areas may be appropriate.

Any tax administration system in confronting shelters can be imperfect in two different ways. It can allow abusive transactions to go undetected, or it can mislabel legitimate transactions as shelters and unfairly go after them. We want a system that makes neither of these mistakes -- that, as the IRS mission statement makes clear, "applies the tax law with integrity and fairness to all". And that is what we will seek to create. We will only succeed if we can count on the advice and cooperation of the tax community in working through these difficult problems.

As you may already know, in order to carry the debate forward we are in the process of developing a White Paper on corporate tax shelters -- which I expect to be released within the next month or so. Let me underline that we view it more as a discussion draft. With the help of interested members of Congress, practitioners such as yourselves, and other groups we look forward to refining our proposals to ensure that they rise to the challenge they are intended to meet.

III. Concluding Remarks

We have long seen great debates about the importance of tax compliance versus service to taxpayers. People talk about the pendulum swinging from one to the other. I believe that the distinction is ill-drawn.

Rational businessmen recognize that the apparent trade-off between maximizing profits and making high quality products is illusory. Rather, the successful company is successful because it achieves both. Similarly, at the Treasury and the IRS we are convinced that treating in a fair and appropriate way all taxpayers -- those who pay their fair share and those who reach for advantage beyond the law -- is right for all Americans and right for the nation's revenue service.

That is our objective. And it is not an objective that the public sector can ever fulfill alone. That is why I am so grateful for having this opportunity to discuss our proposals with groups such as this one and why we will continue to seek your help and support as much as possible in the months ahead. Thank you.