The U.S. tax code, as any politician will tell you, has some problems. First, it’s long: the code now weighs in at an impressive 60,000 pages, almost twice the length of the Encyclopaedia Britannica. It is also intricate. Completing tax forms consumes 6 billion hours of taxpayer time each year and causes large businesses to incur an estimated $40 billion in compliance costs.
It gets worse every time Congress passes a new tax bill. “Over time we’ve had a lot of changes and modifications to the tax code that have only made it more complicated,” says Peter Grabowski, CFO of Gevity HR, a human resources services firm based in Bradenton, Florida. “I believe it’s time for simplification.”
The Bush Administration has promised to do just that. Citing the burden of “an archaic, incoherent federal tax code,” the President has made tax-code reform a top domestic priority; in January, he appointed a panel to explore paths to a new system. The panel will make its recommendations this summer.
What will this mean for business? While it’s impossible to say for certain, it isn’t too soon to make two predictions. One is that radical change—the adoption of a flat tax, for instance—won’t happen. The other is that incremental change will. And given the size of the federal budget deficit and the President’s plans to make his tax cuts for individuals permanent, such change could be very costly.
No Small Change
The last time Congress and the President managed to reform the tax code was in 1986. Ronald Reagan, with the support of a Democratic Congress, ended a variety of loopholes and credits for businesses in exchange for a lower tax rate for individuals. Most experts agree that it is time for another review. “We tinker with the tax code every year, but it’s healthy to ask what you would do differently if you were drawing on a clean slate,” says Ronald Pearlman, a professor of law at Georgetown University and a former Treasury official during the Reagan Administration.
Some argue that the only solution is to replace the tax code entirely with something simpler. But Bush has promised to keep popular deductions for mortgage interest and charitable deductions, which rules out a pure flat income tax or consumption tax. He also demands that any change be “revenue neutral”—dropping taxes in one area will require raising them elsewhere. That means any change will spark opposition, making big change even harder. “Everyone is in favor of reform and simplification until they realize that some people will pay more and some less,” says Michael Kelleher, a partner with McDermott, Will & Emery in Washington, D.C. And while the tax panel’s writ does not extend to fiscal policy, its recommendations cannot help but take into account their potential budgetary impact.
At first glance, many finance executives might welcome a simpler code, especially since governance reforms have made tax compliance more onerous. “The interaction of the tax code with Sarbanes-Oxley is creating very high compliance burdens for large companies like ours,” says Robert Busch, president of New Jersey-based PSEG Services and CFO of its regulated electric utility. And as companies grow wary of tax planning and concentrate on compliance, they see simplicity as a benefit.