FROM THE OFFICE OF PUBLIC AFFAIRS

Good morning. 

Washington is always an interesting place to work.  That is never more so than now, and particularly for those of us who labor in the tax area.

The President抯 Jobs and Growth Package

Earlier this year, the President proposed a package of tax changes aimed at improving economic growth and providing more jobs.  Although there is much positive to be said about the economy, it is clear the economy is not running on all cylinders.  The President抯 jobs and growth proposal is intended to put the economy on a path to long-term stable growth.

The big picture on the economy is complicated, and the pieces can be hard to fit together, so it may be helpful to begin by putting things in perspective.

We had a communications seminar awhile back and I learned you lose the audience as soon as you start talking about numbers.  No wonder my audiences always look lost!   The advice was to stop using numbers.  Hello?  I抦 a tax lawyer.  So I抣l begin by breaking the communications rules.

The economy experienced historic events during the �s, some of them contributing to the stock market bubble of the �s, some of them laying the foundation for longer term prosperity for ourselves and those around the globe.  The Fed engineered the first ever soft landing to the business cycle, China joined the global marketplace, and the telecom revolution changed forever the way that we do business.  The bursting of the stock market bubble in March of 2000 meant the destruction of over $7 trillion of wealth, and that抯 just here in the U.S.  Stock markets have fallen dramatically around the globe.  It was followed by the country falling into recession, the September 11 attacks, and continuing corporate accountability concerns.  Our neighbors aren抰 likely to be able to help much.  By and large, growth prospects around the globe are weaker than here in the U.S.  Based on everything we抳e been through, we抮e not doing that badly.  The problem is that we抮e not doing well enough.  We need a higher growth path for the economy to create enough jobs.

The President concluded we needed a package of tax relief of sufficient size to move the needle on the economy.  Tinkering around the edges won抰 do that.  Small won抰 do that.

The President抯 package was scored by the Joint Committee at $726 billion over 10 years.  Sounds like a large number.  Let抯 put it in perspective.  Over that same 10 year period, we project GDP to be over $140 trillion.  So the President抯 tax relief totals roughly half a percent of GDP.  Over that same 10 year period, we project taxes collected by the federal government to total around $27 trillion.  So the tax relief totals roughly two and a half percent of total revenues.  We need what the President proposed to help get the economy rolling again.

The House passed its budget resolution with room for tax relief of $726 billion over the next 10 years.  That permits the enactment of the President抯 jobs and growth package.

The Senate is still working on the budget resolution.  There was an interesting vote yesterday.  Although the press reports have been about the vote to cut the size of tax relief, more interesting is that in that vote 47 Democrats voted for tax relief of $350 billion.

When all is said and done, we hope to see a final budget resolution that encompasses the President抯 jobs and growth package.

There are two pillars to the foundation of America's greatness and its well-being:  national security and economic security.  We cannot let our economic security sink while our troops fight for our national security.  The risk is not in doing too much, but in doing too little.

There are three parts to the President抯 tax proposals intended to provide both demand side and supply side support to the economy - an acceleration of the 2001 Tax Cuts that were delayed until as long as the end of the decade.  These include an expansion of the size of the 10% bracket, a reduction in rates from 27% to 38.6% to 25% to 35%, elimination of the marriage penalty for lower and moderate income families, and an increase in the child credit from $600 to $1000. 

The second part is a tripling of the amount of capital investment that can be expensed by small businesses. 

The third part is the end of the double tax on corporate earnings.

The effect of the double tax on corporate earnings is familiar to most of us in this room.  In fact, it抯 how a lot of us make a living.  And you抮e familiar with the math.  A tax as high as 60% on earnings paid out as dividends and as high as 48% on earnings retained.  But it抯 instructive to pause to consider those effects because they抳e grown more perverse as the years have passed.

With our corporate tax rules, we抳e designed a system that is at odds with America抯 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抮e going to have less of it if we attach significant financial penalties to its practice.  I don抰 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抯 nothing wrong with debt, retaining earnings, or repurchasing shares, but there抯 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抰 fudge cash.  Moreover, as Secretary Snow likes to point out since he joined the Treasury, 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抳e 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抯 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抰 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抯 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.

The goal of the President抯 proposal is to end the double tax.  The basic mechanism is an exclusion for shareholders of dividends paid out of earnings on which the corporation has paid tax.  To avoid a new bias against retaining earnings, the President抯 proposal includes an adjustment to shareholders� stock basis that reflects retained earnings.

The tax free dividend is determined by the company on the basis of the tax liability it reports on its tax return.   The earnings on which the company has paid tax are determined on the basis of a 35% tax rate.  That amount less the tax paid is the amount that a company can distribute to shareholders tax free, and it is distributed on a proportionate basis.  If the company chooses to retain some of the taxed earnings, the company will advise shareholders of the amount by which they may adjust their stock basis.

The calculation of the previously taxed earnings will be based on the most recent tax return filed by the company before the year begins.  Any subsequent adjustments to the tax return will be reflected in the calculation of taxed earnings at the time of the adjustment, and not retroactively.  This will give companies and shareholders certainty about the tax free status of the dividends at the time the dividend is paid.

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.

Complexity of Our International Tax Rules

A couple of weeks ago, Bob McKenzie, sent me this observation:  揑t 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.�SPAN style="mso-spacerun: yes">  To be sure, the complexity of the tax laws has kept all of us in this room in lucrative employment.  But that doesn抰 mean it抯 a good thing!

That is nowhere more evident than in the international area. The rules are antiquated and out of synch with our participation in the global economy.

Some � perhaps a lot � of the complexity in our rules comes from the design of rules around revenue estimates.  Although some have criticized the revenue estimating process, I don抰 believe that is the issue.  The problem, in my view, lies in our having substituted reliance on estimated revenue costs or savings for sound tax policy judgment.  While it is critical that we carefully consider all the information available in making decisions about tax policy, particularly revenue estimates, it is time we considered the limitations of some of the information on which we rely.  Many times, the objectives we seek cannot be measured in the numbers on which we rely.

For example, the costs of compliance are not measured in the information we gather.  Neither is the cost to the system of the lost respect caused by the complexity.  Nor the opportunities for gaming the system that complexity creates.  Nor are the effects on the larger economy.

It appears the sum of the parts is often less than the whole in terms of benefits to the economy and greater than the whole in terms of perceived cost.

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抰 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抰 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抰 understand these relationships.  They seem to believe that rules harming American companies aren抰 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.

Ending Tax Shelters

At the end of last month, we issued final tax shelter disclosure regulations.  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抰 yet.  We抎 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, 損redictions are hazardous, especially about the future.�SPAN style="mso-spacerun: yes">  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抦 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抯 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扤eill 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 搑ecovery 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.�/P>

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抰 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 揷orporate America look beyond rules, regulations and laws and look to the principles upon which sound business is based.�SPAN style="mso-spacerun: yes">  He added, 揑n 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.�/P>

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.  One of the things lost in the headlines is the strength of the base from which that change for the better begins.

Though stories of Enron still dominate business magazine covers and headlines, the truth is that 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, obscuring the reality that American businessmen and women have upheld and will continue to uphold the great strengths and virtues of American society.  It would be foolhardy for us to judge the many on the basis of the acts of a few.  That is what we must remember as we go forward.

Thank you.