AICPA addresses unanswered questions on tax reform.

The American Institute of CPAs has published a comprehensive analysis of the major alternatives to the current federal income tax system. The report, Flat Taxes and Consumption Taxes: A Guide to the Debate, was released in January and is the result of a two-year effort by the AICPA tax division. The report provides policy makers and the public with an indepth look at the policy issues and economic consequences of tax reform for both individuals and businesses. It was distributed to all members of Congress, key congressional and administration staff and other key individuals involved in the tax reform debate.

"Radical changes in the tax system are going to fundamentally change the U.S. economy and the way we do business," said Deborah Walker, chair of the AICPA tax executive committee. "We needed a fair and objective assessment of the proposals on the table, and that is what we have produced." AICPA president Barry C. Melancon said the public needed to be better informed about the potential benefits, as well as about the unintended consequences if major reforms were to be enacted. "This report focuses on the many unanswered questions that need to be answered as the debate continues," said Melancon. The report does not endorse any particular proposal, nor does it defend the current tax system.

A look at some alternatives The report examines four types of consumption taxes critical to understanding election-year debates:

* Retail sales tax. Levied by most states.

* Value added tax. Used by every major industrialized country except the United States and Australia.

* Flat tax. Proposed by House majority leader Richard K. Armey (R-Tex.).

* Consumed income tax, such as the unlimited savings allowance (USA) tax. Proposed by Senators Sam Nunn (D-Ga.) and Pete V. Domenici (R-N.M.).

(For more information on the various proposals, see "Tax Reform: Two Perspectives," JofA, Nov. 95, page 38.)

"All of these proposals are consumption taxes and thus have tremendous potential to improve our economy by increasing savings," said Martin A. Sullivan, author of the AICPA guide and former staff member of the Joint Committee on Taxation and the U.S. Treasury Department. But Sullivan said consumption taxes would be more regressive than the current system, and to correct that they would need to become more complex, rendering them less economically efficient and less appealing. "These are the kind of issues Congress will have to grapple with if we are going to move forward with this debate" said Sullivan. "If any of these tax proposals are enacted, it will make the changes caused by the Tax Reform Act of 1986 look like small potatoes."

The major issues

The report discusses how businesses would be affected, as well as issues such as the proposals' impact on savings and economic growth, simplification and transition. "There would be major redistribution of the tax burden from the corporate to the noncorporate sector," said Sullivan. The report also explains that a flat or LISA tax would be less of a tax burden on capital-intensive industries, such as communications and public utilities, and more of a burden on labor-intensive sectors, such as construction, service and transportation.

The report addresses whether consumption taxes should be levied on domestic production or domestic sales. "The consumption tax debate would create a battle between the exporters and importers, who have huge stakes resting on the outcome," said Byrle M. Abbin, chair of the AICPA consumption taxation task force. Abbin said there were potentially many other unintended consequences on international competitiveness if a consumption tax is passed. For example, said Abbin, the United States could become a tax haven for foreign concerns looking to benefit from low tax rates. "This could bring retaliation by countries where U.S. companies have operations" said Abbin.

Simplicity and efficiency

The report says the consumption tax proposals have tremendous potential for simplification. However, new tax systems may create unexpected compliance requirements that add complexity. For example, according to the report, the USA tax needs complicated rules to determine "new" savings that are eligible for deductions. With the flat tax, businesses must be able to differentiate between deductible expenses and nondeductible fringe benefits. "It is likely that any new consumption tax will lead to substantial complexity--at the outset as well as in subsequent legislation--as Congress finds it necessary to provide tax relief for a variety of taxpayers," says the report.

Transition

Without special transition rules, the replacement of an income tax with a consumption tax will subject many individuals and businesses to large tax penalties. Abbin told reporters that corporate equity and assets, as they appear on financial statements, could be dramatically affected as a result of adopting a consumption tax system. Without appropriate transition rules U.S. companies could experience a $1.5 trillion to $3 trillion loss in shareholder equity. "Even if there is a transition rule, this loss is a strong possibility" said Abbin. He said the Financial Accounting Standards Board, the Securities and Exchange Commission and Congress would need to establish certain rules to avoid this equity loss.

The impact is not clear

Sullivan said there were many unanswered questions about the economic impact of a new tax system. "There might be a short-term negative impact on the economy that would be outweighed by long-term benefits," said Sullivan. "There is a lot of confusion out there and we want to help people understand what is going on."

The report lists a number of questions that deserve further attention, such as

* Who will administer the new tax?

* What will be the business recordkeeping and reporting requirements?

* How should financial planning be adjusted in anticipation of the tax?

"It is clear there are far more ramifications with each of the proposals than simply collecting revenue," said Abbin. "These proposals affect our whole financial system--its structure and resulting impact on lenders, borrowers and investors."

Those interested in ordering copies of Flat Taxes and Consumption Taxes: A Guide to the Debate can call toll-free [phone], menu #1, and request product no. 061045JA. The cost for AICPA members is $25.50 and for nonmembers, $29.95. There is a separate executive summary (product no. 024018JA) that costs $5 for both members and non-members.