FROM THE OFFICE OF PUBLIC AFFAIRS

Good afternoon.  Thank you for the invitation to be with you today.  Speaking here is always a treat because of the unique nature of the Federal Bar Association in bringing together practitioners in government service and in the private sector.  Moreover, those of you in the private sector have more often than not walked a mile in the shoes of those in government service.  That gives you a special appreciation of both the rewards and the difficulties of government service, and this conference provides an opportunity for a valuable dialogue between those of you who have been in government service and those of us who are now.

I am not going to talk about shelters today.  Nor am I going to talk about inversions or a lot of other things I've spoken about at nearly every outing for many months.  That's not because the war on shelters has been won - far from it.  Though I do believe the tide has turned, there is still much to do.  It's not because we've put an effective fence around the inversion swimming hole either, though the fence of public opinion, coupled with the stated intent of Treasury and the tax-writing committees to prevent inversion transactions, one way or another, has prevented others from trying the water.  I'm not going to talk about those topics because today I want to spend some time on basics.

What basics?  The basics I want to talk about are the basic problems undermining our tax system.  Although there are a number of basic problems, I’m going to focus on three:  complexity, the inconsistency of our rules with the values of American society, and the inconsistency of our rules with our economic interests as a nation.

Let's start with complexity.  It's no secret to any of us that our tax laws are extraordinarily complex.  The complexity on the individual side affects all of us, but it particularly affects low and moderate income taxpayers who must grapple with overlapping, inconsistent, and mutually exclusive credits, deductions, and exclusions, and a myriad of phase-outs overlaying it all.  The IRS recently completed an analysis of the burden and cost of complexity to individual taxpayers.  That analysis put the burden on individual taxpayers well in excess of three billion hours per year and the cost well in excess of $60 billion per year.  And that's just the individual side.

The complexity on the business side is even worse.  While large businesses can grapple with it, many small and medium-size businesses cannot.  The challenge for businesses trying to comply with the law - or the IRS trying to administer and enforce it - is enormous.

Last week, we met with folks from the IRS's Large and Mid-Sized Business (LMSB) Division on audit difficulties and later with representatives of a business on compliance difficulties.  At the LMSB meeting, we learned of the difficulties LMSB was encountering in enforcing the law, many of which are caused or exacerbated by the complexity of the rules.  At the meeting with the business, we learned of the rather extraordinary lengths to which the business – and those similarly situated – is going to comply with the complex rules and to avoid creating liabilities for taxes that economically make no sense.

The meetings were striking for their similarities.  Both were about complexity.  The role of the complexity of the laws in creating shadows for the dishonest to hide from their tax responsibilities cannot be overstated.  At the same time, the burden the complexity of the rules places on American businesses and workers struggling to comply cannot be overstated.

The meetings were also striking for their differences.  The LMSB meeting was about the opportunities complexity affords the noncompliant.  The business meeting was about the costs complexity visits on the compliant.  Needless to say, the complexity makes it extremely difficult for the IRS to sort the compliant from the noncompliant.

Last week, an ABA colleague of mine, Bob McKenzie, sent me this quote.  “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.”  I’m not sure to whom the quote should be attributed, but it is worth remembering.

Our income tax system began as a system intended simply to fund the government.  Over the years, successive Congresses and Administrations have proposed and enacted both minor changes and major overhauls.  We have grafted on more and more components to the point that the system is nearing collapse.

To be sure, many of the components reflect an increasingly complicated world.  But many do not.  Often changes have been designed to hit a revenue target or to patch a hole, real or perceived.  Whatever the case, changes have been made too frequently, without coherent or consistent policy design, with insufficient overall consideration of their effect on our country or its relation to the global economy, and without adequate thought to how each of the new components fits with the others.

In the tax world, we have done exactly the opposite of what the business world has done to increase productivity – a key to the incredible economic growth the county has experienced in the recent past.  What is it the business world has done to increase productivity?  Simplify.  A key way that companies have raised productivity is by simplifying.  Take every process down to its constituent parts, and cut out the inefficiencies, the points of friction, the drags that prevent the most streamlined operation and the standardization of transactions.  Instead of simplifying to increase productivity in tax compliance and administration, we keep adding complexity – more rules, more limitations, more terms, more conditions, more qualifiers, more provisos, more exceptions.  The result is that our system gets slower and slower and more inefficient.  We burn more fuel, and emit ever more heat and smoke, and yet with all that burning, there’s less and less light to show for it.

The numerous savings vehicles we have in the Code are a prime example of this.  Two decades ago – before the ’86 Tax Reform Act fixed all sorts of things that weren’t broken – there was one kind of IRA and it worked for everyone.  As Matt Fink of the Investment Company Institute has noted, from 1980 to 1986, contributions to IRAs rose nearly ten-fold, from $4 billion to $38 billion.  Even more significant, however, is that the median income of contributing workers declined from $41,000 in 1982 to $29,000 in 1986.  The ’86 Act added provisos to the simple IRA that limited its availability.  Provisos based on income and pension plan availability.  The result: participation dropped particularly among those still eligible to participate.  Confusion over eligibility, deductibility, and the benefits of continuing to contribute sidelined many former participants. 

The complexity also sidelined our financial institutions whose marketing abilities – coupled with the convenience of payroll deductions or automatic transfers – had made the IRA popular and successful.  The limitations, qualifiers, and provisos made it impossible for them to standardize transactions.  In short, we told simplicity – and  the efficiency and productivity simplicity brings – to take a hike.  It has never returned.  Instead of going back to basics to fix the decline in participation, we have added more complexity.  We now have three versions of the IRA – traditional, nondeductible, and Roth.  All operate differently, including with different limitations, qualifiers, and provisos – and, of course, they are mutually exclusive.

Recognizing that more people would be willing to set aside cash for retirement if they knew they could withdraw it in certain circumstances, we made exceptions for certain kinds of withdrawals in certain situations and added more complexity.

As the list of sympathetic withdrawals lengthened, we added new savings accounts for the new purposes.  ESAs, QSTPs, MSAs.  Hardly a month goes by that someone doesn’t propose yet another account for yet another purpose. 

And so the complexity grows, the inability to standardize transactions grows, the cost of administration grows, and the confusion multiplies! 

Implicit in all of these complicated provisions are two important points.  First, we don’t trust the American taxpayer to make the right decisions for him- or herself and his or her family.  If we did, we wouldn’t need the long list of qualifiers, provisos, and exceptions, backed up by penalties.  (Penalties, incidentally, that particularly discourage participation by lower and moderate income families.) 

Second, we recognize that our system penalizes those who save their money instead of spending it, even though we will only reduce the penalty for those who agree to save, and in fact do save, for the purposes dictated by us here in Washington.

We need to go back to the drawing board – back to the drawing board with faith in the American people to do the right thing.  The President’s budget proposals for retirement and lifetime savings accounts would do just that.

The proposed simplification of the retirement savings accounts and the addition of a lifetime savings account accessible to all Americans would bring other simplification benefits.  In a matter of less than a decade, the proposed retirement and lifetime savings accounts would permit all lower and moderate income Americans to enjoy the benefits of tax-free compounding and freedom from the complexity of Schedule B and Schedule D.

Let me turn to another basic problem with our tax system.  It is filled with rules that contradict our values.

Many of these contradictions are familiar to you.  We tax you more if you marry.  We tax your family when you die.  I’ve helped some very wealthy families – and some not that wealthy families – as they try to sort out what happens to the assets on the death of the parent.  I’ve watched businesses shrink, life-long employees lose their jobs, and debts mount, while the family grieves not just over the loss of their loved one, but over the demise of stability as they struggle to pay the estate tax.  And the estate tax doesn’t just take the assets of the elderly.  It hits young families who have been planning for their future, but not for an untimely death.  These experiences have left me with the firm view that the occasion of someone’s death is a lousy reason for society to help itself to the property left behind.

Some of the features of our tax system that contradict our values have become such an engrained part of our system that they’ve become second nature to us – we don’t realize the effect they’re having.  I’ve already mentioned one of them – we tax those who save more than those who spend.

Take a simplistic example.  Two families – identical except that one of them spends everything and the other saves some – to buy a new home, for continuing education, for a rainy day, for unexpected emergencies, for their children’s future, for their own retirement security.  Over time, the family that saves will see its tax bill increase relative to the family that spends everything.  We justify that on the basis that the family that saved has more income and a greater ability to pay.  But the reason they have more income is because they chose to do the right thing.  Virtue may be its own reward, but we’re going to get less of it if we attach penalties to it.  And mind you, the additional taxes aren’t limited to the tax owed on the savings income.  Nor are the penalties for this virtue limited to the tax code.

Let me turn to one more problem with our tax system.  We’ve designed a system that is inconsistent with America’s best interests because it distorts economic decision-making.  In doing so, it gets in the way of taxpayers making the right decisions.

The Treasury Department has identified a number of ways in which our international rules harm American companies.  What is particularly troubling is that some seem to believe that rules harming American companies aren’t a problem – as though the companies were somehow disconnected from the rest of society.  But that’s wrong.  What we must recognize is that rules that harm American companies harm their employees, their shareholders, their creditors, their suppliers, and their customers.
In the international area, 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. where it may mean a job or higher productivity for an American worker.  The rules are antiquated and poorly reflect our participation in the global economy today.  We must redesign those rules and do so taking into account the practical effects of the rules on American companies and American workers.

Perhaps the most obvious example today of the way in which our tax system distorts economic decision-making is our corporate tax system.  It 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.

Think about how different the '90s might have been had dividends not been disdained as "tax inefficient."  The President's dividend exclusion proposal is a powerful corporate accountability package.  Think about what might have happened with corporate tax shelters if the President's proposal, which makes corporate tax payments an asset to shareholders, were already law.

Virtue may be its own reward, but we’re going to have less of it if we attach significant financial penalties to its exercise.  As American businesses align themselves as never before with the interests of their shareholders, creditors, employees, customers, and suppliers, it is time for us to align our corporate tax system with the best interests of America.  It is time for Congress to bring to an end the economic distortions in our corporate tax rules.

Like the Chinese curse, we live in interesting times.  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 those 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.

In the late ‘70s, I subscribed to Quest – a magazine dedicated to reporting on “the pursuit of excellence in all fields.”  With catastrophes and misdeeds well-covered in other periodicals, Quest set itself apart with stories accentuating the positive – successes and human conquests and victories.

One of the stories I remember from Quest was about a local San Francisco brewery, founded in the 1860s and about to go bust in 1965.  The quality of the beer was inconsistent and it was available only on tap – customers had to come to the brewery to pick up the kegs themselves.

Fritz Maytag – yes, of the Maytag appliance family – had fallen in love with the beer, and although he had no experience in brewing, he bought the brewery. Maytag, serving as president and brew master, made it his mission to save the old brewery and preserve the art of classical brewing.  He succeeded.  Maybe you’ve heard of that old brewery – Anchor – or had one of the beers – Anchor Steam.  Not only do customers not need to go to the brewery to pick up a keg anymore, you can usually find an Anchor Steam at my house.

A story about the revival of a local brewery might seem a curious one, especially when offered as an antidote to allegations of corporate graft on a billion-dollar scale.  But it’s the kind of everyday story of American businessmen and women making a huge difference in a community.

Since Quest is no longer around to deliver a pollyanna message, it’s also my starting point for telling you that, in my experience, business in itself is a force for good, and most businesspeople go above and beyond their obligations to contribute to their communities.

Let me give you a few of my favorite examples.

William J. Bennett, in a recent speech about teaching virtues, remarked on the negative stereotype that businessmen have been given: "American businessmen traveling across the country with their laptops." Yet, on that fateful day of September 11th, 2001, it was American businessmen on American Airlines Flight 93 who waited until they were over a rural area and then rushed the cockpit.

Ordinary American businessmen, but what those men did on September 11th was anything but. 

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 from the tax world.

A few years back, I was working with a client for whom I 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.

Besides integrity, if you look, you’ll find that American businesses are also known for extraordinary generosity.  In fact, our charitable giving practices make the U.S. the envy of some of our major trading partners.  Consider Ford Motor Company, which not only opened automotive plants in Mexico, but, in 1966, launched a school construction program, an initiative to increase the possibilities for development and economic well-being for Mexican children.  Ford schools serve more than 60,000 students across Mexico and have served more than 1.5 million children since their inception.

Or consider the Youth Automotive Training Center, a school founded by a Florida businessman that takes each year a crop of about 20 young men, who have committed some of the most serious crimes, and turns them around.  At the school, the young men’s physical and emotional needs are attended to, they work towards completing their high school diploma, and they learn a trade that allows them to leave a year later with gainful employment awaiting them.

American companies are a force for good at home and abroad because they share American values.  In effect, they are exporting ethical business practices along with investments of capital and know-how.  One of my favorite examples 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, 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. 

Let me close by reminding you of the three basic problems we should all be working to fix –

(1) Complexity.
(2) Inconsistency with our values.
(3) Inconsistency with our best interests as a nation.

Finally, don’t forget to look for the good in those around you.  There’s a lot more of it than the headlines would lead you to believe.

Thank you.