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Testimony on the impact, effectiveness, and fairness of the Tax Reform Act of 1986 before the Committee on Ways and Means U.S. House of Representatives February 7, 1990.

Testimony on The Impact, Effectiveness, and Fairness of the Tax Reform Act of 1986 before the Committee on Ways and Means U.S. House of Representatives February 7, 1990

On February 7, 1990, TEI President William M. Burk testified before the House Committee on Ways and Means on the impact, effectiveness, and fairness of the Tax Reform Act of 1986. Mr Burk focused on the administrative and compliance burdens spawned by the 1986 Act. Mr. Burk's testimony is reprinted below.

Executive Summary

Introductory Comments. Tax Executives Institute recognizes that corporate taxpayers can be expected to devote a reasonable amount of time to their tax affairs. Today, however, U.S. corporations face a tax system so complicated that tax executives are frequently reduced, not to ensuring total compliance - because that may be literally impossible - but to substantially complying with the tax laws.

Types of Complexity. Commissioner Goldberg has identified three types of complexity with which taxpayers must contend: (a) substantive complexity: how difficult is it to discern what the rules are?; (b) transactional complexity: how difficult is it to work with the provision?; and (c) administrative complexity: how difficult is it to create, collate, analyze, and maintain the necessary records and information in respect of the provision? In addition, there is transitional complexity - which encompasses the problems associated with the instability of the tax laws.

The Causes of Administrative Complexity. Complex rules have been developed that, without regard to their merits on conceptual grounds, are impossible for the IRS to administer and for taxpayers to comply with. The burdens generated by many provisions have been markedly disproportionate to their relative policy and even revenue goals.

Measuring the Results of Complexity. TEI conducted a survey to quantify the administrative burden of the Tax Reform Act of 1986 and to identify the particular provisions that contribute the most to that burden. Twenty companies participated in the survey and virtually all major industries were represented. The survey compared the companies' 1987 compliance burden to that in 1986 and specifically tracked the increase in staff time for preparing the return, internal research, and fees to outside advisers. On the whole, large increases in all three categories were reported. The order of the increase for staff time ranged from 10 to 191 percent; for research time, from 30 to 1,025 percent; and for fees paid to outside advisers, from 0 to 3,750 percent.

The major reasons for the increased workload were accounting changes (e.g., uniform capitalization rules), international provisions (e.g., myriad foreign tax credit limitations), and the alternative minimum tax. TEI members anticipated that the workload for preparing the 1988 return would be even worse.

Recommendations. TEI recommends that the complexity issue be addressed by -

* Seeking IRS testimony on the administrability of

proposed tax law changes.

* Making draft legislative language available in advance

of hearings.

* Developing pre-enactment forms and schedules.

Adopting these recommendations would help to make the legislative process more responsive to "real world" limitations and constraints. A reduction in complexity would contribute to increasing corporate productivity and, consequently, would enhance the ability of U.S. business to compete in foreign markets.

Mr. Chairman and Members of the Committee: I am William M. Burk, Director, Domestic Tax and Audits for CPC International Inc. in Englewood Cliffs, New Jersey. I am here today in my capacity as President of Tax Executives Institute to present the Institute's comments on the effect of the Tax Reform Act of 1986. Specifically, I will focus on the administrative burdens and costs faced by corporate taxpayers in complying with the statute.

I. Background

Mr. Chairman, Tax Executives Institute (TEI) is the principal association of corporate tax executives in North America. Our 4,300 members represent approximately 2,000 of the largest companies in the United States and Canada, and are responsible for coping with the tax laws - from both a planning and a compliance perspective - on a day-to-day basis.

TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting uniform and equitable enforcement of tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayer and government alike. As a professional association, TEI is firmly committed to working with the government in developing and maintaining a tax system that works - one that is consistent with solid tax policy, taxpayers can comply with, and the Internal Revenue Service can audit.

II. Introductory Comments

Mr. Chairman, in 1913 the modern income tax came into being as part of the Underwood Tariff. Representative Cordell Hull of Tennessee - who chaired the Committee's income tax subcommittee (but who is perhaps best remembered for his subsequent service as Secretary of State) - defended the proposal by stating that -

Every good citizen ... should be willing to devote a

brief time during some one day in the year, when

necessary, to the making up of a listing of his income

for taxes....

"A brief time during some one day." Mr. Chairman, the world in 1990 is far different from, and far more complex than, it was in 1913. TEI (whose members strive to be good citizens) recognizes that large corporate taxpayers can reasonably be expected to devote more than "a brief time during some one day" to their tax affairs. Today, however, we face a tax system so complicated and, in many respects, perverse that tax executives are frequently reduced to performing corporate tax triage: moving from one compliance challenge to another, using band-aid approaches to stop the worst bleeding, and striving not to ensure total compliance - because regrettably that may literally be impossible - but to substantially comply.

Of course, if the tax system were as simple today as Congressman Hull envisioned in 1913, Tax Executives Institute - and the ABA Tax Section and the AICPA Federal Tax Division - might well not exist. We would not need to, and the accountants, lawyers, and other business professionals and their staffs, who now devote themselves to trying to understand, to cope, and to comply with the tax laws, could dedicate themselves to more productive activities - thereby adding value to our economy and making industry and the country as a whole more competitive.

It has frequently been said that each successive tax bill is the latest installment of the "Lawyers and Accountants Relief Act." On behalf of Tax Executives Institute, I am here to say: we have seen complexities that go far beyond the bounds of full employment. Indeed, many of us have crossed over into the realm of sleepless nights. All of us know experienced and talented colleagues who have opted out - who have taken early retirement or switched careers because the costs and pressures of "keeping up" were just not worth it. For the particular individuals involved, the decision to leave taxes could well be the right one, but for the companies and the colleagues they leave behind - who must replace the tested with the inexperienced - the result is troubling: just when the challenge is the greatest, you lose some of your most qualified and productive people.(1)

In sum, TEI members are on the front line - dealing with the consequences of tax reform every day. It is from this perspective that Tax Executives Institute commends the Committee for its recent efforts to simplify specific provisions of the tax law - most notably, the adjusted current earnings (ACE) provisions of the alternative minimum tax and the Code's civil penalties - and for its willingness to explore the general subject of complexity. As the Committee is well aware, some have questioned whether there is a "constituency for simplification." We respectfully suggest that it is here in this room today. For our part, we pledge our continuing support for the Committee's simplification initiatives.

III. The Types of Complexity

Mr. Chairman, complexity comes in all shapes and sizes. Commissioner Goldberg has identified three types of complexity with which taxpayers must contend:

* Substantive Complexity: How difficult is it to discern

what the rules are?

* Transactional Complexity: How difficult is it to work

with the provision - for example, to arrange a transaction

so that it satisfies the requirements of the


* Administrative Complexity: How difficult is it to

create, collect, analyze, and maintain the necessary

records and information in respect of the provision?

Although the three types of complexity overlap, our comments today are directed primarily at administrative complexity. Thus, we have focused on the recordkeeping and audit burdens spawned by tax reform. We note, however, that there is a fourth type of complexity, which affects the other three: transitional complexity, which encompasses the burdens and problems associated with the instability of the tax laws - the veritable churning of legislation, the constant changing of the rules.

Moreover, although the effects of transitional complexity might be thought to dissipate quickly, that simply is not the case. Not only do some provisions have long phase-in periods (e.g., the ACE provisions of the alternative minimum tax), but broad delegations of rule-making authority to the Treasury Department and the IRS postpone the day when taxpayers are provided with meaningful guidance on what a new provision means; only then, of course, can the "transition" from the old law to the new be completed.(2) In addition, during the transition period, taxpayers are frequently compelled to work simultaneously with the new and the old laws. As a result, a given year's tax return can implicate both, multiplying not only the taxpayer's recordkeeping and compliance burdens but, ultimately, the IRS's auditing challenge as well.

IV. The Causes of Administrative Complexity

Mr. Chairman, what are the causes of complexity in the Internal Revenue Code? They are as varied as the taxpayers to whom the provisions apply. Many provisions are complicated because they address complex industries or transactions. Other provisions concededly become complex because individual taxpayers or industries successfully urge Congress to enact special transitional rules affecting them. We suggest, however, that administrative complexity has as its primary causes not "special interest lobbying" but rather neglect and expediency.

There can be no doubt that complexity is a byproduct of the budget process that in recent years has compelled Congress to adopt a hit-and-run, band-aid approach to tax legislation. We submit, however, that budget exigencies should not be permitted to mask, or excuse, the tendency to exalt theoretical purity over practical realities. In an effort to close a relatively few "tax pinholes," labyrinthine sets of rules have been conjured up that - without regard to their merits on conceptual grounds - are impossible for the IRS to administer and for taxpayers to follow. The problems, moreover, have been exacerbated by essentially "no tolerance" drafting - the practice of crafting extraordinarily complicated statutes in an effort to foreclose potential, inchoate abuses. Such complexity, moreover, often begets more complexity as taxpayers endeavor to understand and creatively use complicated provisions to lawfully minimize their respective tax burden. Each transaction that is ruled out of bounds spawns another that is legitimate; each time another line is drawn or another hair is split, simplicity is sacrificed for what is often an unworthy goal.

Obviously, there are legitimate policies to be served through the tax system and some provisions will unavoidably impose substantial compliance burdens. We submit, however, that the burdens generated by many provisions have been markedly disproportionate to the relative policy and revenue goals underlying the statutory provisions. Until its repeal, section 89 stood as a prime example of this. On the international side of the ledger, we can point in particular to the separate "baskets" required in respect of non-controlled section 902 companies, the application of uniform capitalization rules in the foreign context, the multiple changes to Subpart F, and the affiliated group method of allocating interest and other expenses.

The choice between policy and complexity is not an absolute one. It is one that should be informed and open. In the past, the "constituency for simplification" has had no mechanism for effectively voicing its concern. There has been no adequate means of gauging the administrability of particular proposals within the time constraints of the legislative process. There has been no "administrability estimates" to counteract, or complement, the revenue estimates. In short, there has been little or no accountability. We hope that this hearing signals the Committee's commitment to elevate administrability and compliance concerns to their rightful position in the tax legislative process.

V. Measuring the Results of Complexity

Although there was never any doubt that the Tax Reform Act of 1986 imposed substantial new compliance burdens on business taxpayers, the magnitude of the burdens - most particularly, the consequences of administrative complexity inherent in the foreign tax credit changes, the uniform capitalization rules, and the complex alternative minimum tax regime - received scant attention in 1986. In 1988, TEI undertook to quantify the burden and to identify the particular provisions that contribute the most to it. We did so because we believed such an effort could lay the foundation for remedial action.

A. Methodology. Thus, in late September 1988 - shortly after the time calendar-year corporations were required to file their first post-tax reform (1987) return - TEI sent a questionnaire to companies in the major industry groupings represented by the Institute's membership. We concentrated on companies with substantial operations or sales overseas because the 1986 Act's foreign provisions seem to be among the worst offenders on the simplicity/complexity continuum.

Twenty companies participated in TEI's survey, and virtually all major industry groupings are represented by the responding companies: food processing, pharmaceuticals, electronics, industrial products manufacturing, telecommunications, automobile manufacturing, financial services, transportation, media communications, and several resource industries (oil and gas, metals, and forest products).

B. Basic Results: Increased Workload. In our survey, we focused on several aspects of the return-preparation process. Companies were asked to compare what they did in preparing their 1986 federal returns to what they did for 1987. To the extent possible, the companies adjusted their findings to reflect only increases (or decreases) attributable to tax law changes. We asked for several comparisons:

* The amount of staff time devoted to preparing the

return, other than research ("staff time").

* The amount of staff time devoted to substantive research

in connection with preparation of the return

("research time").

* The amount of fees paid to outside tax advisers on

current tax-compliance matters, relating to the

current year's liability ("use of outside advisers").

Although the results varied widely from company to company, none of the companies reported a decrease in its tax-compliance burden.

The order of the increase for staff time ranged from 10 to 191 percent; for research time, from 30 to 1,025 percent; for fees paid to outside advisers, from 0 to 3,750 percent. As might be expected, the three types of increases were related: companies that witnessed a very large increase in the amount of fees paid to outside tax advisers saw a comparatively smaller increase in internal research time, and vice versa. For example, one company reported a nearly 35-percent increase in internal research time but a 121-percent increase in outside fees. On the other hand, another company responded that its outside fees on current year tax-compliance matters had not increased but that its internal research time had increased by more than 1,000 percent. On the whole, however, large increases in all three categories were seen.

For illustration purposes, the survey responses made by 11 companies are summarized below.(3) Specifically, the following tax reform-related increases were noted in the amount of staff time, internal research time, and fees paid to outside advisers:
 Percent Percent Percent
 Increase in Increase Increase in
 Staff Time in Fees to
 for Preparing Internal Outside
Company Return Research Advisers
CPC International 20 360 0
Eagle-Picher 20 33 0
Harris Trust 18 500 N.A.
Hewlett-Packard 114 500 0
Household Int'l 18 35 121
Mobil Corp. 132 125 100
Pfizer Inc. 40 260 20
Phillips Petroleum 191 30 20
Southwestern Bell 35 60 30
Times Mirror Co. 22 66 N.A.
Weyerhaeuser Co. 75 180 180

Mr. Chairman, as dramatic as these figures are, they do not tell the whole story. For one thing, some of the responding companies had other than December 31 year-ends. Consequently, those companies did not feel the full brunt of the 1986 Act changes in completing the returns they filed in 1988.

In addition, the Institute's survey did not capture information on the number and cost of system changes that have been required. Companies have had to design and implement new information-gathering systems, acquire new computer hardware and software, and otherwise divert resources from other, arguably more productive tasks.

Furthermore, percentages alone often mask the magnitude of the increasing compliance burden. For example one member who works for a large multinational corporation reported a percentage increase in staff time of more than 130 percent. That's an impressive figure. It's even more impressive, however, when you consider that it reflects an increase from 1,442 staff weeks to 3,351 staff weeks. Similarly, the company's internal research increased from 99 staff weeks to 223 staff weeks - an increase of 125 percent.

That company also provided information on the materials prepared in connection with its 1987 tax return. The length of the return did not change that much from 1986 to 1987 - approximately 13,000 pages. What did increase, however, was the required back-up material - which increased by 19,000 pages. The company also reported that it incurred expenses of almost $2 million in making 1986 Act-related changes to its internal recordkeeping systems.

Finally, some companies have had their compliance burdens in respect of their 1987 returns grow as a result of subsequent events. Most notably, the IRS's 1989 change and retroactive application of its interpretation of the 1986 Act's interest sourcing rules has necessitated that some companies file amended 1987 returns, which obviously required substantial time and effort.

The point, Mr. Chairman, is not that Company A reported a 50-, or 500-, or even 5,000-percent increase in compliance costs or that Company B was able to muddle through with a 5-percent increase. The point is that, across the board - regardless of industry - U.S. companies have seen an incredible increase in what it takes to get their returns out the door.(4)

C. Reasons for Increase. Respondents were asked to identify the major causes of the increased workload. The results were not particularly startling, with nearly all responding companies listing -

* accounting changes - e.g., uniform capitalization

rules, completed contract method changes, installment

sales provisions, vacation pay accruals;

* international provisions - e.g., myriad foreign tax

credit separate limitations, Subpart F changes,

uniform capitalization in the foreign context, currency

rules, interest allocation rules; and

* the alternative minimum tax.

Other provisions of the 1986 Act cited by more than one company include the following: depreciation and investment credit changes (especially the transitional rules); corporate tax changes (the repeal of General Utilities; amendments to sections 382 and 384; section 1060); the 80-percent limitation on meal and entertainment deductions; and a host of industry specific provisions.

D. Is There Light at the End of the Tunnel? Mr. Chairman, the final question on the TEI survey was whether 1988 will be better or worse than 1987. The answer was universally "worse." Thus, even though a substantial portion of the compliance burden is attributable to transitional complexity, the "transition" is far from over - even three years after the Tax Reform Act became law. Two examples that our respondents cited were the interest sourcing rules and the 1990 effective date of the ACE provisions - and Mr. Chairman, as gratified as taxpayers may be about the changes in ACE that were enacted last year, there should be no illusions that the transition from the book earnings concept will be simple. In addition, some provisions become increasingly complex over time - for example, the earnings and profits pooling rules for purposes of sections 902 and 960 - even though they become immediately effective.

Mr. Chairman, we acknowledge that our sample was not scientifically derived and that the results of the survey may not be statistically sound. We believe, however, that the findings should not be dismissed as being merely anecdotal.

VI. Recommendations

Mr. Chairman, the Committee is well aware that complexity is very much like the weather: exceptionally easy to complain about, but difficult to remedy. We also acknowledge the charge that "no one complains about complexity that benefits him" and that in many instances policy concerns legitimately outweigh, or should at least temper, the desire for simplicity. Such a choice, however, should be an informed one. In other words, although taxpayers sometimes engage in hyperbole in lamenting the complex nature of a tax provision - although they may resort to a Chicken Little ("the sky is falling") defense, the proper response should not be to put one's head in the sand.

Rather, the complexity issue should be addressed forthrightly. TEI has long maintained that greater emphasis should be placed on the administrability of particular proposals during the legislative process. Thus, although a hearing like today's can prove beneficial, long-range, systemic solutions are necessary. For example, the Oversight Subcommittee might hold routine hearings on tax law administrability and complexity, inviting testimony from both the IRS and individual and corporate taxpayers.

Safeguards must be built into the system. To our mind's eye, the most effective safeguard would be the time to analyze and focus on specific provisions and on their administrability. Furthermore, a renewed effort should be made to bring administrative concerns to the legislative table on a day-to-day basis.

A. Seek IRS Testimony on Administrability of Proposed Tax Law Changes. To this end, the Institute recommends that the Internal Revenue Service be asked to testify before the House and Senate tax-writing committees specifically to address the administrability of proposed tax legislation. The IRS's testimony would be designed to ensure that clear, administrable, and cost-sensitive rules are enacted into law. The testimony should specifically address the following issues:

* the ability of the IRS to administer the provision

and the estimated cost to the IRS of doing so; and

* the ability of taxpayers to comply with the provision

and the estimated cost to taxpayers of doing so.(5)

TEI believes that the IRS's more active participation in the legislative process - on the sole question of administrability - is critical to reducing the complexity of the tax laws.

B. Availability of Draft Legislative Language. TEI also recommends that a greater effort should be made to prepare draft legislative language in advance of hearings and mark-up sessions. If the Members of the tax-writing committees and their staffs, the Treasury Department, and the IRS (to say nothing of the affected taxpayers) had draft legislation in front of them before they consider the merits of the legislation, the administrative flaws could be discovered and acted upon before the legislation becomes law.

One benefit of releasing legislative language in advance of committee action would be to facilitate the integration of different provisions - through so-called horizontal drafting - and to minimize the enactment of redundant provisions. Another would be to substantially reduce the number of errors that require attention in technical corrections legislation.

We recognize that such an approach would not be a panacea and that time may not always permit the release of draft language before the scheduling of hearings. We suggest, however, that the system would be well served if all the affected taxpayers worked together toward that goal. The imposition of this type of discipline on the legislative process - and accountability for tax policymakers - would disadvantage no one.

C. Development of Pre-Enactment Forms and Schedules. A related recommendation is that the IRS undertake in appropriate cases to develop necessary tax forms and schedules before a proposal is enacted. Administrability can be measured in many ways, but perhaps the most vivid and immediate picture is painted by the forms and schedules required to "translate" a statutory provision into the real world. If substantive provisions were not added to the Code until the IRS developed any necessary forms, those provisions could be made more administrable and Congress could make an informed decision whether the policy underlying the proposal was sufficiently important to justify the imposition of the attendant compliance burdens.

In this regard, we understand that pre-enactment forms have been developed by the IRS in the past and that some modifications have been made to the relevant statutory proposals to address concerns brought to light by the draft forms. We similarly understand that the IRS has undertaken to develop an "administrability impact statement" in respect of certain pending legislative proposals. The wider use of both these approaches should be encouraged.

In making the foregoing recommendations, TEI's goal is simple: to make the tax legislative process more sensitive to "real world" limitations and constraints. This can be done by bringing into the process, on a systematic basis, individuals who are responsible for the preparation of corporate tax returns (and all they entail): those who can attest from experience that compliance cannot be achieved - instantaneously - by a flip of a computer switch (especially if the implementing regulations have not yet been issued or have just been amended retroactively). TEI fervently hopes that by subjecting future proposals to scrutiny on grounds of administrability, compliance nightmares such as those spawned by numerous provisions of the Tax Reform Act of 1986 can be minimized.

VII. Conclusion

Mr. Chairman, administrative tax law complexity has increased markedly since the Tax Reform Act of 1986. The true cost of such complexity cannot be measured simply in terms of the increased time and resources devoted to recordkeeping and return preparation. From a policy perspective, the fundamental significance of complexity, especially in the Code's international provisions, may well be its effect on the competitive posture of U.S. business. Foreign-based multinationals do not face the same complications and workload burdens that U.S. companies do. A reduction in complexity will contribute to increased corporate productivity and, consequently, enhance the ability of U.S. business to compete in foreign markets.

Tax Executives Institute appreciates the opportunity to present our views on the effect of the Tax Reform Act of 1986 on the complexity of the tax law and the compliance burdens that the Act poses for the corporate community. We look forward to working with the Committee as the process moves forward, and would be pleased to respond to any questions you or other members of the Committee might have.

(1) This, of course, is the same situation that confronts the Internal Revenue Service, though concededly, for somewhat different reasons, as it attempts to implement and ensure compliance with the Tax Reform Act. (2) This is to not say that TEI opposes the delegation of regulatory authority to the Treasury Department and IRS, only that such delegations prolong the period of transitional complexity since the operative rules will remain uncertain until administrative guidance is issued. Indeed, TEI believes that many issues can be more properly dealt with in regulations (with less attendant complexity and uncertainty) than they can in statutory provisions. (3) Other companies participating in the survey but requesting that their individual results not be disclosed were American Home Products Corporation, BellSouth Corporation, CSX Corp., General Motors Corporation, Martin Marietta Corp., Monsanto Company, Procter & Gamble Company, Reynolds Metals Company, and USAir. (4) The increased compliance burdens have coincided with management programs to freeze or even reduce corporate staffs. Thus, although the increasing workload may objectively justify an expansion of the tax staff, many companies have not had that "luxury." (5) The IRS might also be asked to address when implementing regulations could be expected to be issued, so that Congress can properly gauge the possible effects of transitional complexity.
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Author:Burk, William M.
Publication:Tax Executive
Date:Mar 1, 1990
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