A Reform Tool: Tax Returns
Policy responses to our financial-sector meltdown have largely been viewed as patches that do little to address the underlying issues, and they have to some extent generated, rather than reduced, fear and instability. It is tempting to think the answer lies in a return to balanced regulation, but any new regulatory scheme would take, at best, years to put in place and demonstrate its effectiveness. We simply don't have that kind of time. But significantly increasing business transparency could immediately improve the way private-sector entities calibrate risk and deal with each other. A proper starting point is to make corporate tax returns available to the public, not just to the IRS.
Five years ago, the U.S. tax administration system was poised to spin out of control. A decline in enforcement by the Internal Revenue Service converged with the erosion of professional standards on the part of many tax practitioners, producing the scourge of abusive tax shelters. In 2003, the IRS reversed course. With the aid of the Justice Department and bipartisan support from many in Congress, but without significantly greater resources, the IRS rebuilt its traditional enforcement programs, developed and employed new tools, and went after taxpayers who crossed the line as well as after rotten practitioners. We strove to be firm but fair. Broadly speaking, the results were favorable. Many of the worst abuses were curtailed.
Of course, greater compliance and enforcement programs get you only so far. Any government regulators will be hard-pressed to fulfill their responsibilities, given the pace and complexity of financial transactions, the numerous tear lines between national legal and tax systems, and the resources at the disposal of large corporations. Dramatic growth in the regulatory structure would not only be costly but beyond a certain point would be so intrusive as to harm the financial system. More regulation is needed, but it might create an exaggerated sense of safety and will not deliver if changes are not made in the way corporations assess risk and deal with each other.
Federal tax returns include important information about corporations beyond that available in financial statements. Making corporate returns available for public inspection would provide a powerful tool to analysts who follow companies and industries, and it would help others better evaluate counterparties and risk. It would assist other federal and state regulators, who currently are prohibited from reviewing the details of federal returns. (The IRS itself is precluded from sharing returns with the Securities and Exchange Commission and the Justice Department except in narrow circumstances.) Large corporations file their federal tax returns electronically, so the data can easily be shared. Information returns filed by not-for-profits are already available online.
Currently, Congress bestows benefits through tax provisions (earmarks on steroids) but has limited knowledge of their impact on companies and industries. If corporate returns became public, many additional nongovernmental players could analyze outcomes and quickly report back to lawmakers, speeding and heightening their understanding of legislation's effects.
Advocates of the current system argue that corporations, like individuals, have a right to privacy, that complex information on their returns is likely to be misunderstood, and that making federal returns public would place the United States at a disadvantage in the global marketplace.
But corporations need not automatically enjoy the same rights as individuals. Their owners are shielded from liability, which is implicitly shifted to others, as recent events demonstrate. And the notion that corporate tax returns are too complex to be made public simply isn't credible. A trillion dollars later, Wall Street's "trust us, we understand this and you don't need to" approach doesn't pass the laugh test. Yes, complexity obscures understanding. But greater transparency and the analysis it fosters will help mitigate this problem. And the attitude of foreign investors toward the United States is critical. The governments of other developed nations face the same frustration as we do in regulating businesses about which they understand little. If the United States makes its corporate tax returns public, other nations are likely to follow suit.
Making corporate tax returns public would signal that we are serious about reform and would help rebuild worldwide confidence in American businesses and financial institutions. It would demonstrate that we're not simply trying to buy our way out of a crisis and return to a discredited status quo. At a minimum, Congress should not allow businesses to participate in taxpayer-funded bailouts unless we taxpayers can assess who we're signing up with. After all, Americans routinely provide copies of their federal tax returns to financial institutions before they give us money. Shouldn't entities looking for taxpayers' help do the same?
The writer was commissioner of internal revenue from 2003 to 2007.