Clinton budget proposals raise fundamental issues of tax policy and administration.

On December 13, 1995, Tax Executives Institute filed the following comments with the budget negotiators from the White House, Senate, and House of Representatives, concerning certain of the Clinton Administration's budget "counterproposals." TEI'S comments were prepared under the aegis of its Federal and International Tax Committees.

As Congress and the Clinton Administration work together to craft a budget agreement, Tax Executives Institute is concerned that the Administration's counterproposal raises major issues concerning the process by which laws are enacted. The Administration's 11th-hour proposals would work fundamental changes in the tax system, disrupt myriad business relationships, and impose tremendous costs on the business community. TEI has grave reservations about the hurried, almost slap-dash, manner in which the proposals have been presented.

Background

Tax Executives Institute is a volunteer association of nearly 5,000 professionals who are responsible for managing the tax affairs of their companies. TEI's members represent more than 2,700 of the leading corporations in the United States and Canada, all of which must contend daily with business tax laws, from both planning and compliance perspectives.

Discussion

On December 7, 1995 -- one week before the deadline for passing a budget agreement -- the Clinton Administration unveiled its counterproposal to H.R. 2491. Included in that proposal are several untried, even radical, changes in the way in which corporations are taxed. Many of these proposals -- which range from a denial of an interest deduction on certain debt instruments, to a reduction in the dividends-received deduction, to a modification of the loss carryover rules, to an increase in the penalties for failure to file information returns -- have not been subject to public scrutiny.

Indeed, the Administration's need to "clarify" several provisions within days of their announcement -- and the unavailability of legislative language to scrutinize for oversights and mis-steps -- speaks volumes about the policy and administrative problems caused by a rush to enact hastily conceived ideas. In an area where reasonable people counsel restraint and caution, the proponents too often speak in sound bites and offer up unsubstantiated claims. If ever the axiom "marry in haste, repent at leisure" had application in the legislative sector, it is here -- and we fear that it is the economy as a whole that will be called to repent.

Public meetings, public hearings, and public discussions are important, even necessary, to the development of reasonable and administrable tax laws and regulations. The process -- and tax administration as a whole -- profits from an open review of proposed changes by all interested parties. Here, in contrast, no hearings have been held, no comments solicited, no thoughtful discourse pursued. The Administration's proposals suffer greatly from this lack of public scrutiny, especially where longstanding practices or rules are being contemplated. To be sure, some proposals have surfaced in the past -- for example, the accounting method changes relating to the components-of-cost and lower-of-cost-or-market methods were offered up in 1994 to fund the Uruguay Round GATT accord. In most cases, however, when those proposals were exposed to the sunlight, they withered and were wisely rejected as imposing too great a tax or compliance cost without serving any valid policy goal.

In addition to these general comments, consider the following comments on specific proposals:

* Denial of Interest Deduction for Certain Debt Instruments. The Administration's proposal would deny interest deductions on debt instruments with a term in excess of 40 years. So-called supermaturity debt instruments are issued by corporate treasurers primarily to "lock in" attractive interest rates on long-term debt financing. The term of a financial instrument alone does not confer undue tax or financial reporting advantages nor does it vitiate the traditional tax law distinctions between debt and equity financing. Indeed, both the issuer and holder understand well that what they have is a long-term debt obligation that provides the holder legal rights in bankruptcy that are superior to all classes of equity.

More than 25 years ago, Congress enacted section 385 of the Internal Revenue Code, which gave the Department of the Treasury authority to address debt/equity interests. Treasury's inability to issue regulations under that provision clearly demonstrates that the issues should not be addressed in a hasty, haphazard fashion. We urge that the proposal be rejected.

* Limitation of the Dividends-received Deduction. The proposal to decrease the dividends-received deduction from 70 percent to 50 percent of the amount received is nothing less than an assault on longstanding corporate tax policy. Although disingenuously labeled a "loophole" by the Administration, the dividends-received deduction is merely a mechanism to mitigate multiple taxation of income distributed through a chain of corporations. That is to say, where one corporation, P, claims the dividend-received deduction for amounts received as a dividend from another corporation, S, there is no evasion of the corporate tax by P. S has already paid corporate income tax on the earnings before it paid out the cash dividend to P. Moreover, should P pay out the cash received from S as a further dividend to P's shareholders, P's shareholders will pay yet another level of tax on the business income generated by S. Thus, for every tier of corporate shareholder in the chain of income-producing corporations, the dividends-received deduction serves as a check against multiple taxation.

In addition, should the Administration's ill-conceived proposal be enacted, even greater pressure will be added to the trend to "disincorporate" U.S. businesses. Finally, we note that the proposal will exacerbate the difference between U.S. corporate income tax policy and that of much of the rest of the world. Most of our trading partners provide full or partial integration of their corporate-shareholder income tax regimes to mitigate multiple taxation. Indeed, in the past, the Treasury Department has acknowledged that the current system of double (or multiple) taxation of corporate income is economically inefficient. Although Treasury has suggested that the United States would achieve greater competitiveness globally by moving toward an integrated tax system, the Administration's proposal clearly represents a step backwards. TEI urges that the proposal to reduce the dividends-received deduction be rejected.

* Modification of the Loss Carryover Rules. The proposal to modify the corporate net operating loss (NOL) deduction carryover provisions is nothing short of budgetary legerdemain. By proposing to reduce the corporate loss carryback provision from 3 years to 1 and increasing the carry-forward provision from 15 to 20 years, the Administration is resorting to the very budget gimmickry that it itself recently decried. Moreover, the deficit reduction induced by the reduction in corporate tax refunds paid out within the government's 7-year budget window will likely prove counterproductive. Tax refunds paid to companies experiencing temporary business reversals provide a vital infusion of cash when a company needs it most: following a substantial loss of up to the amount of the company's three previous years' taxable income. That refund will often prove decisive in forestalling the company's bankruptcy, thereby preserving employee jobs and future tax revenues from both the company and its employees. As a result, TEI urges that the proposal be rejected. In our view, the only justifiable use of the revenue generated from the proposal to revise the corporate net operating loss carryover rules is to provide a single, uniform set of carryover rules for corporate tax credits (including foreign taxes and research and development) and losses (including capital losses).

* Increase in Penalties for Failure to File Correct Information Returns. The Administration's counter-proposal would increase the general penalty for the failure to file correct information returns to the greater of $50 or 5 percent of the total amount required to be reported. The proposal thus lifts the maximum cap ($250,000) on the amount of any penalties during a calendar year. The Administration contends that this increase in the information-reporting penalty is needed because the "general penalty provisions may not be sufficient to encourage timely and accurate reporting." Other than this general bromide, no evidence has been offered to show that the current provisions are inadequate to ensure compliant behavior. The proposal constitutes an abandonment of the principle that penalties should not be enacted or increased simply to raise revenue. It should be rejected.

Conclusion

TEI regrets that the Administration's proposals seem driven more by a desire for revenue rather than any tax policy concerns. This concern, moreover, is not limited to the four proposals addressed in this letter, but rather extends to virtually all aspects of the President's proposals. Although TEI appreciates that the question of revenue is of paramount concern, we reject the implication that sound tax policy and open public debate must be sacrificed at the altar of budgetary expediency.

If you have any questions, please do not hesitate to call either me at 214-978-2675 or Timothy J. McCormally of the Institute's professional staff at [phone].

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