its tax shelters worked. And the JCT was stillunable to determine how much tax Enronshould have paid between 1995 and 2001because the IRS needs to spend many morehours auditing those returns.
The efforts of the JCT team were a mirror image of the hugeefforts of the experts at Enron, the accountingfirms, and investment banks that put Enron’stax shelters into place to begin with.The brainpower spent on Enron’s taxes isa just a fraction of the vast brainpower spenton the 2.2 million corporate income taxreturns filed each year.
Most of the 54,846pages of federal tax rules relate to businessincome taxes.
The JCT concluded thatEnron “excelled at making complexity anally.”
Although it was an ally to Enron, taxcomplexity is an enemy to productive busi-ness management and sound investmentdecisions. A typical large corporation spendstens of millions of dollars per year on taxplanning and paperwork. This paper drawson the numerous Enron tax shelter deals tohighlight the serious efficiency and complex-ity problems of the corporate income tax.Enron-style tax sheltering has not been theonly type of corporate tax scandal in the news.Attention has also focused on the growingnumber of U.S. companies moving their placeof incorporation to low-tax jurisdictions, suchas Bermuda. U.S. firms can save taxes on theirforeign operations by creating a foreign parentcompany for their worldwide operations. At thesame time, there are growing incentives for for-eign companies to acquire U.S. companiesbecause the United States has a bad tax climatefor multinational headquarters.
Those developments have prompted knee- jerk denunciations of corporate wrongdoingand a batch of ill-conceived Band-Aids fromCongress. But something more fundamentalthan a sudden decline in ethical standards orpatriotism in corporate boardrooms is goingon. The more fundamental issues include thehigh U.S. corporate tax rate, the uncompeti-tive and complex corporate tax rules, global-ization, and tax reforms by foreign govern-ments. In addition, Wall Street “financialinnovation is growing rapidly and the tax lawhas not kept pace,” as the TreasuryDepartment noted in a major study of taxshelters in 1999.
For example, the total valueof financial derivatives issued is estimated tohave jumped from $3 trillion in 1990 to $127trillion today.
A recently decided case in theU.S. Tax Court involving Bank One’s use of derivatives concluded an eight-year battle anda trial that produced a 3,500-page transcriptand 10,000 exhibits.
Clearly, the complexmodern economy is creating unprecedentedpressure on the antiquated income tax system.In the next section I examine how the cor-porate tax shelter issue has developed in recentyears and contrast legalistic and fundamentaleconomic solutions to the problem. Then I dis-cuss the three fundamental structural prob-lems with the U.S. corporate tax: the high statu-tory tax rate; the inherent complexity of anincome tax that relies on capital gains taxationand capitalization; and the gratuitous inconsis-tency that Congress has injected into theincome tax, such as the different rules for cor-porations and other types of businesses.In the final part of the paper I consider tworeform options. First, I consider full corporatetax repeal. Second, I examine replacement of the corporate income tax with a low-rate busi-ness cash-flow tax. A cash-flow tax would elim-inate many current complexities (e.g., deprecia-tion) and distortions (e.g., debt favored overequity) that haunt the current tax code. Cash-flow taxation has been part of numerousreform plans over the years, including aBrookings Institution tax plan from the 1980sand then–house majority leader Dick Armey’sflat tax of the 1990s.
I conclude that recentscandals and rising tax competition make thisan excellent time to repeal the corporate tax orreplace it with a business cash-flow tax.
Tax Shelters: Legalistic vs.Fundamental EconomicSolutions
Every few years, the income tax generatesanother cycle of tax avoidance scandals. Inthe 1970s and 1980s, the main focus was on
Although it wasan ally to Enron,tax complexity isan enemy to pro-ductive businessmanagement andsound investmentdecisions.