FROM THE OFFICE OF PUBLIC AFFAIRS

Good morning. I am pleased to be here today to discuss what may be the most serious compliance issue threatening the American tax system today: the rapid growth of abusive corporate tax shelters. President Clinton and Vice-President Gore and we at the Treasury and the IRS have felt continuing concern at this growing problem. I want to reflect today on where we are on these crucial issues and where we are going.

Today, the Administration is announcing a series of reforms that, combined with other steps we are taking, will constitute the most comprehensive effort to date to curb abusive corporate tax shelters. These proposals will be the focus of my remarks today. But let me begin by outlining why we in the Administration - and so many others, including the staff of the Joint Committee on Taxation, the American Bar Association, the New York State Bar Association and other bodies - now believe reform to be necessary.

Let me be clear: our aim is to curb illegitimate tax avoidance. We have no quarrel with the natural desire of companies and individuals to minimize their tax burden by legitimate means. We well remember the words of Learned Hand: "There is nothing sinister in arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; for nobody owes any public duty to pay more than the law demands; to demand more in the name of morals is mere cant."

We must, however, draw the line at the pursuit of engineered transactions that are devoid of economic substance. These transactions have no goal other than to reduce a corporation's tax liabilities. In doing so, they undermine the integrity of the tax system.

In the early 1980s, widespread abuse of the tax system by wealthy individuals undermined our tax base and generated cynicism about the fairness of the tax code. Litigation to pursue abusive shelters also consumed large amounts of IRS time and money. Congress responded appropriately by enacting reforms that went a long way towards restoring trust in the integrity of the code.

Today there is growing evidence that abusive corporate tax shelters pose a similar threat to our tax system. Since 1990, the gap between book income and taxable income has more than doubled, in real terms, to more than $90 billion and is now wider than at any time since the mid-1980s. Even in a very good year for the corporate sector, last year corporate tax receipts fell by 2 percent. Although some of this gap can be attributed to other causes, there is no doubt that there has been a striking growth in abusive tax shelters.

As we made clear in the Treasury's White Paper on corporate tax shelters last year, abusive shelters have a number of malign effects:

• Shelters reduce the corporate tax base and thus raise the burden on other taxpayers.
• Shelters undermine the vitality of our voluntary tax system. Companies feel obliged to follow the lead of competitors who abuse the tax code in a "race to the bottom". The New York State Bar recently highlighted the "corrosive effect" of shelters, stating: "The constant promotion of these frequently artificial transactions breeds significant disrespect for the tax system, encouraging responsible corporate taxpayers to follow the lead of other taxpayers who have engaged in tax advantaged transactions."
• Shelters complicate the tax code by forcing legislators to take remedial action. In the past few years alone, nearly 30 narrow statutory provisions have been adopted in response to abuses further complicating the code.
• And shelters divert resources from productive investment in the real economy. As a former tax official, now a leading member of a well-known law firm, has said: "You can't underestimate how many of America's greatest minds are being devoted to what economists would all say is totally useless economic activity."

The Treasury, the IRS, and Congress have already taken aggressive action to curb visible shelters. It is suggestive of the scale of the problem that specific action over the last ten years will save the American taxpayer almost $80 billion over the next decade.

These include:

• Closure of the so-called Lease-In Lease-Out (LILO) shelter whereby companies attempted to avoid tax through circular transactions. In one extreme case, a company leased a town hall from a Swiss municipality and leased it back the same day. This measure saved $10.2 billion.
• Closure of the so-called BOSS shelter where companies would generate an artificial tax loss that can be used to offset other income. This action is also expected to save billions of dollars for the tax system.
• Closure of the liquidating REIT transaction that saved the taxpayer $34 billion. Corporations used the unintended confluence of two unrelated tax provisions to avoid paying taxes on income.
• And today we are issuing guidance to close the so-called "debt straddle". This is a shelter designed to create an artificial tax loss by setting up two debt instruments, the interest rate on one of which resets to zero, generating a loss, while the interest rate on the other doubles. The debt straddle is reminiscent of the old butterfly straddles in the commodity markets and is best described as "heads I win, tails I win".

These and other steps have produced important progress. But they have been - necessarily - ad hoc. Treasury and the IRS have come to understand new tax shelters only by capturing them on audit, picking up reports in the trade press, receiving anonymous tips and finding irregularities on tax returns. What we see, we can act upon. What we cannot see, by definition, we cannot act upon. But what we fear is that visible corporate tax shelters are only the tip of a very large iceberg.

And there are now clear signs that abuse of the corporate tax code is becoming more sophisticated and harder to detect: companies are demanding "black box" features in their transactions that are structured to be impenetrable to all but those who designed it. As one tax promoter said recently: "You can have the greatest shelter in the world, and clients won't pay for it if it is too simple. I've rejected a lot of great ideas for that reason." For these reasons, we believe the traditional ad hoc approach to this problem is no longer tenable.

Our comprehensive strategy for combating abusive corporate tax shelters contains three elements that are mutually reinforcing:

• First, new regulations to improve disclosure of corporate shelters effective today.
• Second, administrative reforms within the IRS and strengthened rules governing the practice of accountants and lawyers before the IRS.
• Third, new legislation to increase penalties for abusive transactions and to codify the economic substance doctrine.

Deputy Secretary Eizenstat, Commissioner Rossotti, Chief Counsel Brown, Acting Assistant Secretary Talisman, and myself are all committed to pursuing these reforms. And we look forward to working with Congress, the tax community, the legal profession and others in achieving these goals.

1. New Regulations to Combat the Proliferation of Shelters.

A central element of our approach in curbing tax shelters is bringing these transactions to light and taking remedial action where appropriate. To this end, Treasury and the IRS are today issuing three new regulations to bring more corporate shelters into the open. By requiring companies to disclose any transactions that significantly reduce their liabilities, these guidelines will enhance disclosure and deter abusive shelters. They will not impose a burden on taxpayers engaging in legitimate transactions.

• First, taxpayers will be required to attach a statement to their return providing information on any transactions with multiple characteristics common to tax shelters. These include situations where there is a significant difference between book and tax income; where there are fees of more than $100,000 to a promoter; where there is use of a tax indifferent party to provide tax benefits; and where there is insurance against benefits that do not materialize.
• Second, promoters must disclose any transaction that has a "significant purpose" of tax avoidance or evasion, that is offered under conditions of confidentiality, and that has promoter fees above $100,000.
• Third, in order to facilitate cross-checking of tax reporting by investors in promoted products we are requiring promoters of tax shelters to maintain lists of investors and other relevant information that must be supplied on request to the IRS.

These are temporary and proposed regulations that will have an impact on taxpayers from this point forward.

1. Administrative Reforms.

As we increase disclosure, we must also increase the capacity of the IRS to act on this crucial issue and enhance the capacity for self-regulation. Commissioner Rossotti has rightly made customer service a central priority for the IRS. However part of serving the citizenry is ensuring the fairness of the tax system for all.

The reforms comprise two elements: internal change at the IRS, and enhancing the incentive and capacity for self-regulation within the industry.

Under the leadership of Commissioner Rossotti, the IRS is undergoing a substantial restructuring to re-focus the IRS along functional as opposed to geographic lines. One of the benefits of this will be that officials will acquire the expertise to detect complex tax shelter abuses more easily.

In addition, the IRS is establishing a central office for tax shelter analysis to coordinate and guide the IRS's efforts in combating abusive shelters. The central tax office will be included in the mid-size businesses division overseen by Larry Langdon, former head of corporate tax affairs at Hewlett Packard. As a result of recent efforts to combat tax shelters, there are already an increasing number of abusive tax shelter cases in various stages of examination, appeal or litigation at the IRS.

At the same time, we are mindful of the fact that it can sometimes be hard to distinguish zealous pursuit of duty from over-stepping the boundaries of the law. That is why we are putting in place proper safeguards to prevent that line from being crossed. For example, Treasury and the IRS are looking at whether to allow taxpayers to pre-file future transactions for IRS approval so that the new regulations and proposed legislative reforms do not interrupt legitimate economic transactions. The IRS is also exploring the possibility of establishing a fast-track procedure at the request of taxpayers under investigation.

The IRS cannot be asked to shoulder the entire burden of compliance. If we are serious in our intention of curbing abusive shelters then we need to place more emphasis on professional conduct of those who participate in the industry, including accountants, lawyers and other related professions. The dilemmas of this area have been exemplified by the recent remark of a tax practitioner, that "writing tax opinions is a choice between eating and sleeping. I like to eat." We would prefer that he get some rest.

To enhance self-regulation and compliance within the industry, we are planning within the next six months to issue an updated version of Circular 230, the professional guidelines on conduct for those who practice before the IRS. This may include sanctions on firms that issue opinions on tax shelters, limits on contingent fee arrangements and heightened opinion standards. In extreme cases, we would contemplate suspending individuals or even whole firms from practicing before the IRS.

I recognize that these issues will require discussion. To this end, we expect to organize a series of meetings with key figures in the legal, accounting, investment banking and wider corporate community to discuss how we can work together to meet our common obligations.

The action we are taking today on disclosure and our efforts to raise standards are important and necessary steps. But they are not sufficient. Disclosure only deters if abuse has consequences. It is right that we require companies to disclose tax shelters in their IRS statements. But companies also need a good reason to comply with the new guidelines in the first place.

That is why we are also proposing legislation in the FY2001 budget that would give us the ability to pursue the abusive shelters that are hidden from view. Formally we estimate that these proposals would save the taxpayer $23 billion over the next decade. But in practice are more likely to reach tens of billions of dollars. I also want to thank Congressman Doggett for advancing similar legislation. We look forward to working with him and the tax-writing committees to advance these changes.

There must be effective disincentives to stop companies from violating reasonable standards of disclosure. These must also be sufficiently tough to confront the underlying problem: the spread of abusive tax shelters. The proposals include:

• A penalty of $100,000 for each failure to disclose a transaction with features common to tax shelters.
• Raising the penalty for substantial understatement from 20 to 40 percent where a taxpayer's statement does not disclose a corporate tax shelter. Also, we would reduce the dollar thresholds on the understatement penalty for large corporations.

The creation of abusive tax shelters is a sophisticated process that encompasses a broad range of interested parties beyond the companies themselves. These include tax-indifferent entities, such as foreign corporations, the promoters of shelters, and entities that profit from providing advice. Our proposals must therefore include measures to deter third parties from involvement in abusive shelters. These include:

• A 25 percent excise tax on fees received in connection with the promotion and implementation of corporate tax shelters.
• The imposition of tax consequences on otherwise tax indifferent entities that enable shelter deals to go ahead by absorbing otherwise taxable income in exchange for a fee.

More fundamental, yet surely more difficult is the need to codify the doctrine of economic substance so that we can combat abusive shelters. There are countless instances where specific action targeted at one type of tax shelter unintentionally leads to the creation of another. As I mentioned earlier, last year, we shut down LILOs; yet already we are hearing about "Son of LILO" transactions. The "BOSS" shelters we had to respond to last year were little different to a structure closed down by several months before. And so on.

We propose to cut through this problem by codifying the economic substance doctrine into law.

The guiding principle of economic substance is that taxpayers should not be allowed to derive benefits from transactions that have no meaningful economic purpose - where the tax benefits from a transaction significantly outweigh any pre-tax profits. The proposal would bring a number of improvements:

• Codification would combat abusive tax shelters on a universal rather than a case-by-case basis.
• It would attack tax shelters before they arose by requiring taxpayers to apply this doctrine to transactions to determine whether the tax benefits would be allowable.
• And it would remove much of the need for and burden of tax litigation from the judicial system.

4. Conclusion.

The specific action we took today; the three new regulations; the ongoing administrative changes; and the legislation we are proposing, each reflect different aspects of what we believe is a comprehensive strategy.

I want to emphasize that these elements build on each other. Without progress on each, it will not be possible to protect the tax system. We are prepared to debate, discuss and to compromise as to the details. But I am convinced it is a matter of national importance that we implement each of these changes as rapidly as possible. We look forward to working with all of you towards this objective. Thank you.