The optimal Relationship between taxable income and financial accounting income: Analysis and a proposal

Georgetown Law Journal

Volumn 97, Issue 2, 2009, Pages 423-484

  Shaviro, Daniel ^a  

^a NEW YORK UNIVERSITY SCHOOL OF LAW   (United States)

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EID: 60449118160     PISSN: 00168092     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (191)

1. On the "Enron era" in corporate governance, see, for example, Kurt Eichenwald & Alexei Barrionuevo, Tough Justice for Executives in Enron Era, N.Y. TIMES, May 27, 2006, at Al.
2. The growing book-tax gap has been cited as one of the challenges in tax administration. A Tune-Up on Corporate Tax Issues: What's Going on Under the Hood? Hearing on Compliance Concerns Relative to Large and Mid-Size Businesses Before the S. Comm. on Finance, 109th Cong. (2006) (written testimony of Mark Everson, Comm'r, IRS).
3. Joann M. Weiner, Closing the Other Tax Gap: The Book-Tax Income Gap, 115 TAX NOTES 849, 850 tbl.1 (2007). The 2003 book-tax gap was unusually high, however. Over the preceding five years, aggregate net taxable income was just under 70% of aggregate book income ($2.114 trillion as compared to $3.024 trillion). See id.
4. See generally Mihir A. Desai, The Divergence Between Book Income and Tax Income, in 17 TAX POLICY AND THE ECONOMY 169 (James M. Poterba ed., 2003); Michelle Hanlon et al., Evidence for the Possible Information Loss of Conforming Book Income and Taxable Income, 48 J.L. & ECON. 407 (2005); Gil B. Manzon, Jr. & George A. Plesko, The Relation Between Financial and Tax Reporting Measures of Income, 55 TAX L. REV. 175 (2002); George A. Plesko & Lillian Mills, Bridging the Reporting Gap: A Proposal for More Informative Reconciling of Book and Tax Income (MIT Sloan, Working Paper No. 4289-03, 2003).
5. See, e.g., Joshua Ronen et al., The Effect of Directors' Equity Incentives on Earnings Management, 25 J. ACCT. & PUB. POL'Y 359, 380 (2006). Privately held companies may also seek to over-measure their earnings-for example, to impress prospective buyers or investors-but are not subject to the same legal requirements as publicly traded companies with regard to the preparation of earnings statements. See, e.g., Symposium on Bebchuck & Fried's Pay Without Performance-Pay for Short-Term Performance: Executive Compensation in Speculative Markets, 30 J. CORP. L. 721, 725 (2005) (noting incentives to manipulate earnings in privately held firms).
6. See Joseph Bankman, The New Market in Corporate Tax Shelters, 83 TAX NOTES 1775, 1777 (1999) (including among the definitional characteristics of a corporate tax shelter that "[it] is likely to be shut down by legislative or administrative change soon after it is detected").
7. See Ronen et al., supra note 5, at 380.
8. See generally Mihir A. Desai, The Degradation of Reported Corporate Profits, 19 J. ECON. PERSPECTIVES 171 (2005). On the nexus between tax avoidance and corporate governance internationally, see Mihir A. Desai et al., Theft and Taxes (Nat'l Bureau of Econ. Research, Working Paper No. 10978, 2004). On the link between tax avoidance and high-powered incentives, see Mihir A. Desai & Dhammika Dharmapala, Corporate Tax Avoidance and High Powered Incentives (Nat'l Bureau of Econ. Research, Working Paper No. W10471, 2004). For a fascinating case study of the interaction between tax sheltering and misleading accounting, see STAFF OF J. COMM. ON TAXATION, 108th Cong., REPORT OF INVESTIGATION OF ENRON CORPORATION AND RELATED ENTITIES REGARDING FEDERAL TAX AND COMPENSATION ISSUES, AND POLICY RECOMMENDATIONS (Comm. Print 2003).
9. See Rev. Proc. 2004-45, 2004-2 C.B. 140.
10. See, e.g., Peter C. Canellos & Edward D. Kleinbard, Disclosing Book-Tax Differences, 96 TAX NOTES 999 (2002).
11. Possible expansions to current disclosure rules might include requiring companies to make public their federal-income-tax returns, their Schedule M-3 computations, or their financial accounting reserves for federal-income-tax adjustments under Financial Accounting Standards Board Interpretation 48, FASB Interpretation No. 48: Accounting for Uncertainty in Income Taxes-An Interpretation of Financial Accounting Standards Board Statement No. 109, FIN. ACCT. SERIES (Fin. Acct. Standards Bd., Norwalk, Conn.), June 2006, at 27. ¶B22 [hereinafter FASB Interpretation No. 48].
12. See, e.g., Desai, supra note 8, at 189.
13. See Wolfgang Schön, The Odd Couple: A Common Future for Financial and Tax Accounting?, 58 TAX L. REV. 111, 115-16 (2005) (noting that, while Germany for more than a century primarily used the one-book approach, "[i]n recent years, we find a growing tendency in Germany to abolish the principle of [such] dependence altogether"). Other countries that have recently moved away from a one-book system or are considering doing so include Austria, Belgium, and France. See id. at 117-18.
14. See, e.g., 26 U.S.C. § 472(c) (2000) (conditioning use of last-in, first-out (LIFO) inventory accounting on its being used for financial accounting purposes); I.R.S. Notice 94-47, 1994-1 C.B. 357 (treating financial accounting classification of an instrument as debt or equity as relevant to its tax classification).
15. See THE FEDERALIST No. 51, at 291 (James Madison) (Clinton Rossiter ed., 1961).
16. As I discuss below, financial accounting income sometimes has direct substantive significance in corporate contracts, such as executive compensation arrangements that treat it as an input to determining the amount due. See Robert W. Holthausen & Richard W. Leftwich, The Economic Consequences of Accounting Choice, 51. ACCT. & ECON. 77, 84-88 (1983) (discussing significance of financial accounting income on management compensation, government regulations, and lending agreements); David I. Walker, Financial Accounting and Corporate Behavior, 64 WASH. & LEE L. REV. 927, 940-41 (2007).
17. Douglas A. Shackleford et al., A Unifying Model of How the Tax System and Generally Accepted Accounting Principles Affect Corporate Behavior 3 (Nat'l Bureau of Econ. Research, Working Paper No. 12873, 2007).
18. On the basic tradeoff between efficiency and distributional goals, see, for example, LOUIS KAPLOW, THE THEORY OF TAXATION AND PUBLIC ECONOMICS 1 (2008).
19. Shackleford et al., supra note 17.
20. See Daniel Shaviro, Beyond the Pro-Consumption Tax Consensus, 60 STAN. L. REV. 745, 753-55 (2007) [hereinafter Shaviro, Beyond the Pro-Consumption Tax Consensus]; Daniel Shaviro, Endowment and Inequality, in TAX JUSTICE RECONSIDERED: THE MORAL AND ETHICAL BASES OF TAXATION 123, 126-27 (Joseph J. Thorndike & Dennis J. Ventry, Jr. eds., 2002).
21. See HENRY C. SIMONS, PERSONAL INCOME TAXATION 50 (1938). The other leading measure is consumption, that is,' the first term in the Haig-Simons measure without regard to changes in net worth.
22. See WILLIAM A. KLEIN ET AL., FEDERAL INCOME TAXATION 8, 38 (14th ed. 2006).
23. See Shaviro, Beyond the Pro-Consumption Tax Consensus, supra note 20, at 746-47.
24. See id. at 787.
25. See generally Joseph Bankman & David A. Weisbach, The Superiority of an Ideal Consumption Tax over an Ideal Income Tax, 58 STAN. L. REV. 1413 (2006).
26. See DANIEL SHAVIRO, WHEN RULES CHANGE: AN ECONOMIC AND POLITICAL ANALYSIS OF TRANSITION RELIEF AND RETROACTIVITY 97-98 (2000).
27. See DAVID F. BRADFORD, TAXATION, WEALTH, AND SAVING 180 (2000) (noting that American and Canadian officials had examined potential implementation of Haig-Simons-like income tax on shareholders as replacement for corporate income tax).
28. The risk profile of a company's expected future earnings may also affect the value of its stock.
29. Cf. Louis Kaplow, Human Capital Under an Ideal Income Tax, 80 VA. L. REV. 1477, 1478-79 (1994) (discussing the importance of human capital and the benefits and drawbacks to taxing gains in human capital).
30. Indeed, there have been several proposals to replace the existing corporate-level tax, at least for publicly traded companies, with a shareholder-level tax that looks simply to the change in stock price during the year. See, e.g., Joseph Bankman, A Market-Value Based Corporate Income Tax, 68 TAX NOTES 1347, 1349 (1995) (stating that market value tax (MVT) could be used to implement proposals calling for " 'integration' of the corporate- and shareholder-level taxes"); Joseph M. Dodge, A Combined Mark-to-Market and Pass Through Corporate Integration Proposal, 50 TAX L. REV. 265, 266-67 (1995) (discussing author's proposal to integrate corporate and shareholder taxes by eliminating corporate income tax and taxing shareholders for unrealized appreciation and deducting unrealized losses of stock); Daniel Halperin, Fundamental Tax Reform, 48 EMORY L.J. 809, 820, 822 (1999); Michael S. Knoll, An Accretion Corporate Income Tax, 49 STAN. L. REV. 1 (1996) (discussing David Slawson's proposal for taxation of individual investors, rather than corporations, in advancing author's proposal for accretion corporate income tax); Anthony P. Polito, Note, A Proposal for an Integrated Income Tax, 12 HARV. J.L. & PUB. POL'Y 1009 (1989).
31. I.R.C. * 162(c)(1) (2000).
32. Tax expenditures may be defined "as mainly allocative rules that, as a formal matter, are found within the (ostensibly mainly distributional) tax system." Daniel Shaviro, Rethinking Tax Expenditures and Fiscal Language, 57 TAX L. REV. 187, 188 (2004).
33. See, e.g., OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES, BUDGET OF THE UNITED STATES GOVERNMENT: FISCAL YEAR 2008, 113-16 (2007). On the case for estimating tax penalties, see Shaviro, supra note 32.
34. See Shaviro, supra note 32 at 207-10.
35. Cf. David A. Weisbach & Jacob Nussim, The Integration of Tax and Spending Proposals, 113 YALE L.J. 955, 962-63 (2004).
36. See Hugh J. Ault & David F. Bradford, Taxing International Income: An Analysis of the U.S. System and Its Economic Premises, in TAXATION IN THE GLOBAL ECONOMY 11, 31 (Assaf Razin & Joel Slemrod eds., 2002).
37. See, e.g., PEGGY B. MUSGRAVE, UNITED STATES TAXATION OF FOREIGN INVESTMENT INCOME: ISSUES AND ARGUMENTS 134 (1969).
38. See Daniel Shaviro, Why Worldwide Welfare as a Normative Standard in U.S. Tax Policy?, 60 TAX L. REV. 155, 159-60 (2007).
39. Foreign tax credits are generally permitted to offset only the domestic tax liability that would otherwise have been due against foreign-source income. See I.R.C. * 904 (2004). Thus, in a foreign tax credit system like that in the U.S., one must determine whether income is domestic-source or foreign-source even though both are includable in income.
40. U.S.-source income of U.S. companies' foreign subsidiaries is taxable in the United States on a source basis like that of any other foreign person. See id. * 882(a).
41. Id. * 1501.
42. Id. * 1504(b)(3).
43. See id. * 83.
44. Id. * 274(n) (2000).
45. Id. * 275(a)(1)..
46. Thus, suppose pre-tax income is $100. A 20% tax on this income yields a liability of $20, leaving the taxpayer with $80. So does a 25% tax on this after-tax income. Algebraically, if x is the tax rate on pre-tax income and y is the tax rate on after-tax income, the two are equivalent if y = x1(1 - x).
47. On the risk-return tradeoff, see, for example, DANIEL SHAVKO, MAKING SENSE OF SOCIAL SECURITY REFORM 35-38 (2000).
48. See infra section III.B for a fuller account of FASB's institutional setting and historical performance.
49. See, e.g., Eugene F. Fama, Efficient Capital Markets II, 46 J. FIN. 1575, 1575 (1991) ("[T]he market efficiency hypothesis [is] the simple statement that security prices fully reflect all available information.").
50. An alternative consumption-base methodology that provides equivalent results to expensing would use income-tax accounting but deduct interest on an as yet unrecovered basis to create deductions with the same present value as under expensing. See David F. Bradford, Transition to and Tax Rate Flexibility in a Cash-Flow-Type Tax, in 12 TAX POLICY AND THE ECONOMY 151-52 (James M. Poterba ed., 1998).
51. Stanley Siegel, The Coming Revolution in Accounting: The Emergence of Fair Value as the Fundamental Principle of GAAP, 42 WAYNE L. REV. 1839, 1850-51 (1996).
52. The use of income-tax accounting plus interest on basis to achieve expensing equivalence might make a consumption measure comparably informative to an income measure, as I am grateful to David Kamin for pointing out to me.
53. See supra note 30.
54. See, e.g., Kevin J. Murphy, Explaining Executive Compensation: Managerial Power Versus the Perceived Cost of Stock Options, 69 U. CHI. L. REV. 847, 860 (2002); Walker, supra note 16, at 936.
55. See generally ROSS L. WATTS & JEROLD L. ZIMMERMAN, POSITIVE ACCOUNTING THEORY (1986); ROSS L. Watts & Jerold L. Zimmerman, Positive Accounting Theory: A Ten Year Perspective, 65 ACCT. REV. 131 (1990) [hereinafter Watts & Zimmerman].
56. See, e.g., Watts & Zimmerman, supra note 55, at 151-52.
57. See Walker, supra note 16, at 953-57.
58. Id. at 953.
59. Id. at 940-42.
60. Id. at 969.
61. See Edward D. Kleinbard et al., Is It Time To Liquidate LIFO?, 113 TAX NOTES 237, 239-40 (2006).
62. See id. at 242.
63. I.R.C. * 472(c) (2006).
64. Kleinbard et al., supra note 61, at 245.
65. Id.
66. Id.
67. BrainyQuote, Harry S. Truman Quotes, http://www.brainyquote.com/quotes/ authors/h/harry-s-truman.html (last visited Sept. 11, 2008).
68. See, e.g., Desai, supra note 8.
69. Further complicating the normative analysis of earnings smoothing, if market observers are rational but expect managers to smooth earnings, then volatility may function as a signal of more serious problems that made effective smoothing impossible. This might even cause success in earnings smoothing to be genuinely informative about a firm's performance, although at the cost of making current-period reports in other respects less accurate and meaningful.
70. See, e.g., Calvin H. Johnson, The Illegitimate "Earned" Requirement in Tax and Non-Tax Accounting, 50 TAX L. REV. 373, 390 (1995) (noting the importance of relying on objectively verifiable historical cost information).
71. See, e.g., Thor Power Tool v. Comm'r, 439 U.S. 522, 542 (1979) ("[F]inancial accounting has as its foundation the principle of conservatism, with its corollary that 'possible errors in measurement [should] be in the direction of understatement, rather than overstatement of net income and net assets. In view of the Treasury's markedly different goals and responsibilities understatement of income is not destined to be its guiding light.").
72. As my former student Adi Libson once pointed out to me, there might be no reason for rules that "lean against the wind" if managerial incentives simply created a standard degree of error. For example, if managers generally used their discretion to reduce taxable income to 80% of what it really should be, simply increasing the tax rate by 25% would restore the "correct" tax rate on their true income. Thus, for example, the effect of applying a 30% rate to $100 of income is arithmetically equivalent to that of applying a 37.5% rate to $80 of reported income. Likewise, in this scenario, investors could suitably discount all reported earnings if these were typically inflated by a constant percentage. However, with heterogeneity in managerially induced income mismeasurement, rules that "lean against the wind" can reduce the noise factor that is degrading the available information.
73. Thor Power, 439 U.S. 522.
74. Id. at 538-40).
75. Id. at 530-31.
76. Id. at 542. To illustrate that Thor Power is best known for distinguishing between tax and accounting on the ground of the latter's conservatism, see, for example, Linda M. Beale, Book-Tax Conformity and the Corporate Tax Shelter Debate: Assessing the Proposed Section 475 Mark-to- Market Safe Harbor, 24 VA. TAX REV. 301, 350 n. 130 (2004); Erik M. Jensen, The Supreme Court and the Timing of Deductions for Accrual-Basis Taxpayers, 22 GA. L. REV. 229, 269 n. 163 (1988); Lee A. Sheppard, Financial Accounting Conformity: Not the Silver Bullet, 101 TAX NOTES 676, 679 (2003).
77. Thor Power, 439 U.S. at 543 (internal citation omitted); see also RCA Corp. v. United States, 664 F. 2d 881, 888 (2d Cir. 1981) (noting that tax system's emphasis on ability to pay supports following cash flows more closely than does financial accounting). Some cases, however, appear more sympathetic to presumptive tax-accounting equivalence. See Wal-Mart Stores, Inc. & Subsidiaries v. Comm'r, 153 F. 3d 650, 658 (8th Cir. 1998) (emphasizing and following dictum in Thor Power to the effect that "[c]ompliance with GAAP will ordinarily 'pass muster for tax purposes'" (citing Thor Power, 439 U.S. at 540)).
78. Thor Power, 439 U.S. at 542.
79. See Merle Erickson et al., How Much Will Firms Pay for Earnings that Do Not Exist?: Evidence of Taxes Paid on Allegedly Fraudulent Earnings, 79 ACCT. REV. 387, 389 (2004).
80. Id.
81. See, e.g., Alvin C. Warren, Jr., Financial Contract Innovation and Income Tax Policy, 107 HARV. L. REV. 460, 463 (1993) (noting that the tax system takes account of fixed but not uncertain value changes).
82. See, e.g., Sheppard, supra note 76, at 680-81.
83. See id.
84. See, e.g., I.R.C. ** 1031, 9361(a) (2000). Non-recognition rules for gain generally apply to loss as well, and other non-recognition rules apply exclusively to transactions in which a loss is realized. Id. ** 9361(c), 1031. However, as the rationales for disregarding gains and losses are different, I discuss the latter below.
85. See generally Daniel N. Shaviro, An Efficiency Analysis of Realization and Recognition Rules Under the Federal Income Tax, 48 TAX L. REV. 1 (1992) (considering recognition rules from an efficiency perspective).
86. See Dennis R. Beresford, Congress Looks at Accounting for Business Combinations, 15 ACCT. HORIZONS 73, 74 (2001).
87. Cottage Sav. Ass'n v. Comm'r, 499 U.S. 554, 557 (1991).
88. Id.
89. Id. Why the losses did not otherwise have to be recognized under a principle of accounting conservatism, when their occurrence was so definitely known, is unclear.
90. Cf. id.
91. Id. at 556.
92. Edward D. Kleinbard, Equity Derivative Products: Financial Innovation's Newest Challenge to the Tax System, 69 TEX. L. REV. 1319, 1320 (1991).
93. Id.
94. See Jeff Strnad, Taxing New Financial Products: A Conceptual Framework, 46 STAN. L. REV. 569, 576, 602 (1994).
95. See I.R.C. * 1091 (2000 & Supp. II 2002).
96. See generally Daniel N. Shaviro, Economic Substance, Corporate Tax Shelters, and the Compaq Case, 88 TAX NOTES 221 (2000) (discussing the rationale for and effectiveness of using an economic substance approach to deter corporate tax sheltering).
97. For examples of rules limiting particular deductions to the amount of related income, see I.R.C. * 163(d) (West Supp. 2008) (investment interest limitation); id. * 465 (at-risk rules); id. * 469 (passive loss rules); id. * 1211 (2000) (capital loss limitation).
98. I.R.C. * 1211.
99. So long as the sales are bona fide, an economic substance requirement cannot deter this strategy.
100. See Daniel N. Shaviro, Selective Limitations on Tax Benefits, 56 U. CHI. L. REV. 1189, 1198 (1989).
101. See I.R.C. * 172.
102. See U.S. TREASURY DEP'T, A STUDY OF INTERCOMPANY PRICING 6-12 (1988).
103. If worldwide consolidated groups were taxable as such in the United States, the only advantage to shifting taxable income to foreign affiliates through non-arm's-length transactions would be increasing the amount of worldwide group income that can be offset by foreign tax credits, which generally are only allowed against the U.S. tax liability on foreign source income. Lack of worldwide consolidation, and resulting deferral of foreign subsidiaries' income until treated as realized by the U.S. parents (such as through the receipt of dividends), makes transfer-pricing games tax-beneficial even absent concern about foreign tax credit limits.
104. See George Mundstock, The Trouble with FASB, 28 N.C. J. INT'L L. & COM. REG. 813, 835-36 (2003).
105. Id.
106. See Walker, supra note 16, at 993.
107. See id. at 994-95.
108. See, e.g., Stephen A. Zeff, The Rise of "Economic Consequences," J. ACCOUNTANCY, Dec. 1978, at 56.
109. See William W. Bratton, Private Standards, Public Governance: A New Look at the Financial Accounting Standards Board, 48 B.C. L. REV. 5, 32-33 (2007). Ironically, in the tax realm, the capitalization rule for intangible drilling costs that the oil and gas industry successfully demanded, in effect as an accounting preference, is widely regarded as correct from the standpoint of income measurement, albeit not followed due to the industry's political influence.
110. See Gary John Previts & Dale L. Flesher, A Perspective on the New Deal and Financial Reporting: Andrew Barr and the Securities and Exchange Commission, 1938-1972, 23 BUS. & ECON. HIST. 221, 226 (1994).
111. See id. at 227; Zeff, supra note 108, at 57-60.
112. See Zeff, supra note 108, at 57-60.
113. See Beresford, supra note 86, at 74.
114. Id. at 76 (quoting The Pooling Method of Accounting for Corporate Mergers: Hearing Before the S. Banking, Housing, and Urban Affairs Comm., 106th Cong. (2000) (statement of John Doerr, venture capitalist, Kleiner, Perkins, Caufield & Byers)).
115. See generally FIN. ACCOUNTING STANDARDS BD., STATEMENT OF FIN. ACCOUNTING STANDARDS No. 141 (June 2001).
116. See Beresford, supra note 86, at 74-81.
117. See FASB Interpretation No. 48, supra note 11, at 1.
118. Id. at 2-3.
119. This reflects that, on average, the tax benefit would be lost 12% of the time, or in 60% of the cases, themselves 20% of the whole, in which there was an audit challenge.
120. A further aspect of FIN 48 is more neutral as related to overstatement and understatement of expected tax benefits. It provides that the tax benefit that one recognizes cannot exceed the largest amount that one is considered more than 50% likely to realize. For an example where this leads to under-estimation of value, suppose one claims a $100 tax benefit and has a 60% chance of realizing exactly $60 and a 40% chance of realizing zero. One can deduct $60 from reported earnings, see FASB Interpretation No. 48, supra note 11, at 16, even though the expected tax saving is only $36. The method leads to over-estimation, however, if one has a 60% chance of realizing exactly $60 and a 40% chance of realizing the full $100. Here, the permissible deduction once again is $60, but the expected tax saving is $76.
121. If A were initially more profitable, investment would shift from B to A, increasing the marginal return for those who continued to hold B while driving it down for those who held A, until the two returns were equalized.
122. See Walker, supra note 16, at 995.
123. A further complication here is that a true Haig-Simons measure of income would in theory include the present value of all enhancements to expected future profitability. The hypothesized managerial bias reflects that conventional, historical cost-based income tax accounting excludes these aspects of value on the ground that they are hard to observe and verify. Slower cost recovery to account for this oversight could be viewed as improving the income measure, rather than as sacrificing it to advance other purposes in the manner of instrumental accounting.
124. See, e.g., DAVID SOLOMONS, MAKING ACCOUNTING POLICY: THE QUEST FOR CREDIBILITY IN FINANCIAL REPORTING 233-35 (1986); Victor H. Brown, Accounting Standards: Their Economic and Social Consequences, ACCT. HORIZONS, Sept. 1990, at 95-96.
125. FASB's mission statement states the goals of being "objective in its decision making and... ensur[ing], insofar as possible, the neutrality of information resulting from its standards" and of "report[ing] economic activity as faithfully as possible without coloring the image it communicates for the purpose of influencing behavior in any particular direction." See FASB, FACTS ABOUT FASB 2 (2007), http://www.fasb.org/facts/facts-about-fasb.pdf.
126. See Walker, supra note 16, at 958-59. This distinction could reflect heterogeneity either in managerial preferences and corporate culture, or in companies' circumstances. Thus, a company with large tax losses may respond less to special deductions and exclusions, while one with volatile earnings may respond more to opportunities to smooth earnings for financial accounting purposes.
127. See Joel Slemrod & Shlomo Yitzhaki, Tax Avoidance, Evasion, and Administration 64 (Nat'l Bureau of Econ. Research, Working Paper No. 7473, 2000) (arguing that "the variety of behavioral responses to taxation greatly enriches the normative analysis of taxation" because it raises new policy questions and changes the answers to traditional questions defining what is "optimal").
128. On the case for a one-book approach, see, for example, Desai, supra note 8, at 189; Celia Whitaker, Bridging the Book-Tax Accounting Gap, 115 YALE L.J. 680 (2005).
129. See I.R.C. * 56 (West Supp. 2008).
130. I.R.C. * 56(f) (West Supp. 2008) (repealed 1990).
131. See supra text accompanying note 15.
132. See, e.g., Mitchell A. Kane, Strategy and Cooperation in National Responses to International Tax Arbitrage, 53 EMORY L.J. 89, 140 (2004); Daniel N. Shaviro, More Revenues, Less Distortion?: Responding to Cross-Border Tax Arbitrage, 1 N.Y.U. J.L. & BUS. 113, 119 (2004).
133. I can testify from personal knowledge about tax consulting that this result is a frequent tax-planning objective.
134. See, e.g., John McClelland & Lillian Mills, Weighing Benefits and Risks of Taxing Book Income, 114 TAX NOTES 779, 786 (2007).
135. Id.
136. For example, President Jimmy Carter, in his successful 1976 campaign, repeatedly called the U.S. federal income tax system a "disgrace to the human race." Michael Fitts & Robert Inman, Controlling Congress: Presidential Influence in Domestic Fiscal Policy, 80 GEO. L.J. 1737, 1777 (1992). Instances of prominent tax scholars calling the tax system a "mess" include Richard L. Doernberg, A Workable Flat Rate Consumption Tax, 70 IOWA L. REV. 425, 426 (1985); Edward J. McCaffery, Cognitive Theory and Tax, 41 UCLA L. REV. 1861, 1866-67 (1994); and David A. Weisbach, Should Legal Rules Be Used to Redistribute Income?, 70 U. CHI. L. REV. 439, 452 (2003).
137. SHAVIRO, supra note 26, at 86-87.
138. See Daniel Shaviro, Beyond Public Choice and Public Interest: A Study of the Legislative Process as Illustrated by Tax Legislation in the 1980s, 139 U. PA. L. REV. 1, 114 (1990) ("Congress often grants the Treasury extensive control to prescribe regulations giving flesh to a vague and conceptual provision." (citing J. WITTE, THE POLITICS OF DEVELOPMENT OF THE FEDERAL INCOME TAX 382-83 (1985))).
139. See id. at 55-57.
140. See, e.g., Richard L. Doernberg & Fred S. McChesney, Doing Good or Doing Well?: Congress and the Tax Reform Act of 1986, 62 N.Y.U. L. REV. 891 (1987); Edward J. McCaffery & Linda R. Cohen, Shakedown at Gucci Gulch: The New Logic of Collective Action, 84 N.C. L. REV. 1159 (2006).
141. Shaviro, supra note 138, at 86.
142. DAVID R. MAYHEW, CONGRESS: THE ELECTORAL CONNECTION 61 (1974).
143. Id. at 52-53.
144. See Shaviro, supra note 138, at 90-92.
145. See generally Jennifer Arlen & Deborah M. Weiss, A Political Theory of Corporate Taxation, 105 YALE L.J. 325 (1995) (suggesting that, while corporate integration-eliminating the double taxation of corporate income-would be good for shareholders, it is bad for managers, who benefit from the lock-in of corporate earnings that results from taxing dividend distributions, and that managers' political clout is an important reason for the non-adoption of corporate integration).
146. See Zeff, supra note 108, at 57-60.
147. Beresford, supra note 86, at 73 (quoting an unnamed member of Congress).
148. Mohamed Elmuttassim Hussein & J. Edward Ketz, Accounting Standards-Setting in the U.S.: An Analysis of Power and Social Exchange, 10 J. ACCT. & PUB. POL'Y 59, 69 (1991).
149. Bratton, supra note 109, at 33-34.
150. Beresford, supra note 86, at 75 (quoting The Pooling Method of Accounting for Corporate Mergers: Hearing Before the S. Banking, Housing, & Urban Affairs Comm., 106th Cong. (2000) (statement of Sen. Phil Gramm)).
151. Id. at 77 (quoting The Pooling Method of Accounting for Corporate Mergers: Hearing Before the S. Banking, Housing, & Urban Affairs Comm., 106th Cong. (2000) (statement of Rep. Michael Oxley)).
152. Thus, Senator Joseph Lieberman, who led the charge to prevent FASB from requiring that stock options be deducted, subsequently was accused of "laying the basis for the accounting scandals of the stock bubble era." Beat the Press, Posting of Dean Baker to Economic Reporting, http://www.prospect.org/csnc/blogs/beat-the-press-archieve?montt=08&year= 2006base-name=the-joe-lieberman-nobody-knows (Aug. 9, 2006,21:49 EST).
153. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002) (codified in scattered sections of 15 U.S.C. and 18 U.S.C.).
154. See Securities Exchange Act of 1934, Pub. L. No. 73-290, ** 4, 12-13, 19, 48 Stat. 881, 885, 892-95, 898-99 (1934); SOLOMONS, supra note 124, at 25.
155. See Joel Seligman, The SEC and Accounting, A Historical Perspective, in THE SEC AND ACCOUNTING: THE FIRST 50 YEARS, 1984 PROCEEDINGS OF THE ARTHUR YOUNG PROFESSORS' ROUNDTABLE 16 (Robert H. Mundheim & Noyes E. Leech eds., 1986).
156. Administrative Policy on Financial Statements, 11 Fed. Reg. 10,913, 10,913 (Sept. 27, 1946) (codified at 17 C.F.R. pt. 211).
157. See Bratton, supra note 109, at 12-14; Hussein & Ketz, supra note 148, at 76.
158. See Bratton, supra note 109, at 13-15. Until 2002, FASB depended on voluntary contributions from private organizations to fund its operations, but in 2002 Congress provided mandatory funding through fees levied on reporting companies. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, * 108, 116 Stat. 745, 769-70 (2002) (codified at 15 U.S.C. * 7219).
159. Bratton, supra note 109, at 16-18.
160. Mundstock, supra note 104, at 817.
161. I infer this from the statement in id. at 833, that FASB's 1995 retreat in the face of congressional opposition to its proposal to make stock options deductible shows that, "[I]ike a textbook bureaucracy, FASB valued its existence more than its mission." Mundstock does not explain how FASB could have preserved its mission had its independence been taken away, as Senator Lieberman made clear would be the consequence of its not retreating. See Michael H. Granof & Stephen A. Zeff, Unaccountable in Washington, N.Y. TIMES, Jan. 23, 2002, at A19.
162. See Bratton, supra note 109, at 28-30.
163. See Mundstock, supra note 104, at 822-23.
164. See Bratton, supra note 109, at 35.
165. Id. at 26.
166. See generally Edward B. Deakin, Rational Economic Behavior and Lobbying on Accounting Issues: Evidence from the Oil and Gas Industry, 64 ACCT. REV. 137 (1989).
167. See generally Lawrence D. Brown & Ehsan H. Feroz, Does the FASB Listen to Corporations?, 19 J. BUS. FIN. & ACCT. 715 (1992).
168. Mundstock, supra note 104, at 817.
169. See, e.g., Harvey L. Pitt, Filling in the GAAP, FORBES.COM, May 1, 2006, http://www.forbes.com/2006/05/01/ harvey-pitt-gaap-fasb-cx-hp-0501fasb-print.html (calling GAAP "hopelessly complex and convoluted"); Alex J. Pollock, From Making Judgments to Following Rules: The Evolution of U.S. Accounting, FIN. SERVICES OUTLOOK (Am. Enter. Inst. for Pub. Policy Research, Washington, D.C.), July 2005, at 4 (contending that FASB's existence inevitably results in growth of number and complexity of rules, and therefore "[accountants'] lives become less demanding, with an economic inducement to cede intellectual and professional responsibility").
170. See Mundstock, supra note 104, at 830-32 (criticizing, on this ground, rules requiring research and development expenditures to be expensed rather than amortized and permitting certain contingent liabilities to be ignored).
171. For an at-least-partial defense of FASB's pro-rule orientation, see Bratton, supra note 109, at 43-47.
172. Tax lawyers, like accountants, have been criticized for over-valuing the importance of legal certainty, perhaps reflecting their risk aversion with respect to offering legal advice. See, e.g., David A. Weisbach, Ten Truths About Tax Shelters, 55 TAX L. REV. 215, 248 (2002). However, when institutions of the tax bar involve themselves with legal reform, they generally take a much broader perspective than that of members of Congress serving campaign contributors' interests. The Tax Section of the New York State Bar Association, for example, is in my personal experience well known in Washington for offering proposals that, even if reflecting some tincture of professional or client interest, reasonably relate to its stated mission to act
173. Even in this scenario, however, it is not clear that one would want complete conformity between taxable and accounting income, given such issues as whether foreign-source income should be exempted for tax purposes as a way of coordinating different countries' taxation of multinationals.
174. Thus, Germany, like the United States, has long had sizable tax expenditures, conveying targeted benefits to particular groups. See, e.g., Giacomo Corneo, The Rise and Likely Fall of the German Income Tax, 1958-2005, 51 CESIFO ECON. STUD. 159, 168-70 (2005), available at http://cesifo.oxfordjournals.org/cgi/reprint/51/l/159.pdf.
175. As mentioned supra note 11, possible expansions to current disclosure rules might include requiring companies to make public their federal income tax returns, their Schedule M-3 computations, and their financial accounting reserves for income tax adjustments under FIN-48.
176. A recent survey concluded that as many as eighty-five countries around the world currently require the use of IFRS. DELOITTE TOUCHE TOHMATSU, USE OF IFRSS BY JURISDICTION (2008), http://www.iasplus.com/country/useias.htm. Among leading economic powers, the European Union has adopted IFRS subject to a minor modification, Canada has announced its plan to adopt IFRS in full in 2011, and Australia and New Zealand follow national standards that they describe as IFRS-equivalent. Id.
177. See Donna Block, FASB Backs U.S. Accounting Change, THE DAILY DEAL, Oct. 26, 2007, available at 2007 WLNR 21088472.
178. This might suggest allowing foreign tax credits to offset the U.S. tax on the foreign-source income of foreign subsidiaries that became taxable through the adjustment. Foreign tax credits might already be needed under the proposal as it stands, with respect to the income of U.S. Companies' foreign branches.
179. See Rev. Proc. 2004-45, 2004-2 C.B. 140.
180. See Daniel Shaviro, Disclosure and Civil Penalty Rules in the U.S. Legal Response to Corporate Tax Shelters, in TAX AND CORPORATE GOVERNANCE 229, 230 (Wolfgang Schön ed. 2008).
181. See I.R.S. Schedule M-3 (Form 1120), Net Income (LOSS) Reconciliation for Corporations With Total Assets of $10 Million or More (2006), available at http://www.irs.gov/pub/irs-pdf/f1120sm3.pdf.
182. Id.
183. Id.
184. Id. For technical reasons, certain losses, such as those on the sale of an asset, are handled in Part II rather than Part III.
185. Id.
186. See Weiner, supra note 3, at 855-56.
187. For a thoughtful analysis of this and other administrative issues raised by the book-income preference that applied from 1987 through 1989 under the AMT, see N.Y. STATE BAR ASS'N, TAX SECTION, REPORT #568: COMMENTS ON THE PROPOSED REGULATIONS CONCERNING THE CORPORATE ALTERNATIVE MINIMUM TAX BOOK INCOME ADJUSTMENT (1987).
188. See I.R.C. * 7704 (treating publicly traded companies as corporations for U.S. federal income tax purposes, even if they are formally organized as partnerships).
189. See supra text accompanying note 76.
190. An alternative, less clearly desirable effect would be for companies that overstate reported earnings to start paying an affirmative tax penalty for doing so.
191. The studies typically find some response, at least for particular types of firms, but do not address whether reported earnings were becoming more value-relevant or less. See, e.g., Charles E. Boynton et al., Earnings Management and the Corporate Alternative Minimum Tax, 30 J. ACCT. RES. 131, 132 (Supp.) (1992) ("[F]irms subject to the AMT in 1987 that were unable to reduce their AMT exposure through the use of net operating losses (NOLs) and foreign tax credits (FTCs) managed their 1987 earnings by taking unusual income-decreasing discretionary accruals."); Won W. Choi et al., Potential Errors in Detecting Earnings Management: Investigating the AMT of 1986, 18 CONTEMP. ACCT. RES. 571 (2001) (arguing that, in light of specification errors in prior studies, the extent of managerial responses to the book-income preference remains an unresolved issue); Jeffrey D. Gramlich, The Effect of the Alternative Minimum Tax Book Income Adjustment on Accrual Decisions, 12 J. AM. TAX. ASS'N 36 (1991) (finding that companies responded in 1987 through income-decreasing accrual behavior).