An Overview Of U.S. Tax Policies

Friday, February 24, 2012 - 16:16

The Editor interviews Hap Shashy, Partner and Practice Group Leader of King & Spalding’s Tax Practice Group.

Editor: You’ve served as IRS chief counsel, been a private practitioner and taught in two tax LLM programs. How would you rank those different roles?

Shashy: I have loved every aspect of my professional career. I have been privileged to work with terrific people in each context. Serving as IRS chief counsel provided me with great experience. I also enjoy private practice. What I love the most is solving difficult, complex problems with high stakes. Finally, teaching is just a wonderful experience because in helping people learn, you also learn a lot yourself.

Editor: What, in your view, are the tax policy implications of the current fiscal crisis in the United States?

Shashy: The U.S. government spends more than the revenue it takes in. That creates a deficit, and something has to give. Since the federal government doesn’t do a good job of cutting spending, it is likely that part of the solution will be a revenue increase.

Revenue increases can occur in two different ways: either taxes can be raised, or the economy can grow. If GDP grows even without a structural change in the tax system, this would produce more tax revenue.

I would think a tax increase of some sort would be in the offing as part of deficit reduction if the government ever gets serious about reducing the deficit. Most economists say that GDP is unlikely to grow at a level sufficient to reduce the deficit to something sustainable.

Editor: Do you think there is any prospect that significant tax legislation will occur this year?

Shashy: I don’t think there is any real prospect of significant tax legislation occurring before the election. The really interesting observation is there are some things scheduled to take effect on or after December 31 that will force congressional action either in the lame duck portion of 2012 or sometime early in 2013. For example, the Bush tax cuts are scheduled to expire on December 31. It’s ironic that if Congress were to do nothing, the expiration of the Bush tax cuts could lead  to trillions of dollars of additional revenue over 10 years. This would go a long way to reducing the deficit to something more sustainable.

But if the Bush tax cuts expire, then individual tax rates across the board would increase. The tax rate on a long-term capital gain would increase from 15 percent to 20 percent. The maximum tax rate on dividends would go from 15 to 39 percent. The estate tax rates would return to 2001 levels, which are much higher than what they are now.

Obviously, it would be very unpopular with individual taxpayers if the Bush tax cuts were simply allowed to expire, so it’s likely that Congress will do something. However, what it will do is a matter of conjecture.

Editor: When Congress takes up tax legislation in earnest, do you think serious consideration will be given to a consumption tax?

Shashy: The consumption taxes that are most discussed are a value-added tax and a national sales tax. The U.S. is the only large and highly industrialized nation that has no consumption tax at the national level.

The experience in most countries is that once a consumption tax has been enacted, it typically is set at a fairly low rate to begin with, but over time it creeps up, which makes it unattractive to merchants and consumers. Also, it is regressive, creating a disproportionate burden on middle- and low-income earners.

Because consumption taxes are very regressive, they are politically unpopular. So, I do not think there is much realistic possibility of a consumption tax being enacted in the U.S. and zero possibility of a consumption tax completely replacing the income tax system.

Editor: What is the likelihood of more fundamental tax reform?

Shashy: Fundamental tax reform or comprehensive tax reform means, to most people, lowering tax rates on the one hand and increasing the tax base on the other by eliminating deductions and exemptions. For example, that is what happened in 1986.

For fundamental tax reform to happen, some taxpayers would have to give up some cherished deductions and tax benefits in order to pay for lowering of rates. That means some taxpayers or industries would be winners and others would be losers. From a political standpoint, it creates difficult dynamics and makes it hard to get anything done.

In any event, if fundamental tax reform happened, it would be a good thing because with fewer deductions and loopholes, more business and investment decisions could be made based on economic merits rather than on tax considerations. The effort would be laudable in that it would eliminate deductions that unfairly benefit particular taxpayers in order to get lower rates for all taxpayers.

The downside is that while tax reform might result in taxpayers getting lower rates as a result of giving up deductions and other benefits, over time rates likely would be increased as the government tries to find more revenue to fund more spending, and the deductions and benefits might never come back.

In my assessment, it is more likely that comprehensive tax reform rather than a consumption tax will be taken up, but I do not know exactly how to handicap whether a fundamental tax reform will be enacted or be taken up in earnest by Congress. I certainly hope so.

Editor: Let me ask you about the corporate tax rate. Some feel that the corporate tax rate has to be reduced to the high 20s in order for U.S. companies to remain competitive on a global basis. Do you agree?

Shashy: Intuitively, a lower corporate tax rate would seem conducive to high economic growth. Having said that, I would point out that tax rates are not the sole determinative of economic growth or competitiveness.

You can find periods of time in this country where relatively high growth occurred notwithstanding that tax rates were relatively high.  You also can find the converse of that. So tax rates are one factor, maybe an important factor, but not the sole driver.

Editor: In your view, should U.S. companies be able to repatriate foreign earnings without U.S. tax? Should there be limitations on the use to which the repatriated cash can be put?

Shashy: I would favor U.S. companies being able to repatriate foreign earnings without limitation, that is, without tax and without a requirement that the cash must be spent in any particular way, like in a territorial tax system. I basically say, let companies bring foreign earnings home and then figure out what to do with them.

Editor: What trends do you see in tax planning and compliance from the standpoint of corporate taxpayers?

Shashy: There are a number of them. One trend is that tax planning has become more of an adjunct to the achievement of business objectives. Less tax planning is done simply for the sake of saving taxes. Another trend is that international tax planning continues to grow in importance -- and as part of that, transfer pricing continues to grow in importance. In fact, the importance of transfer pricing will accelerate if the U.S. as part of fundamental comprehensive tax reform moves to a more territorial tax system.

Another trend is that corporate tax directors and tax functions are spending a lot more time and resources focusing on the financial accounting consequences and tax items in the publicly traded company context. That creates an increasing need for documentation and tax analysis with respect to tax positions.

I would also point out that there are some trends that are peculiar to the current state of the economy. For example, there is a lot more planning around debt restructuring and workouts and less around merger–and-acquisition activities.

Editor: Do you see codification of the “economic substance” doctrine having a material affect on the type of tax planning corporate taxpayers are doing?

Shashy: Not really. The codification occurred in 2010, and I do not think it’s had a big effect. Case law was well developed before the codification, and the trend away from highly tax-motivated planning began some years ago. It does add pages to tax opinions, though.  

Editor: Shifting gears a bit, what are some of the trends that you see in the IRS’s approach to tax enforcement in the corporate and business tax contexts?

Shashy: There have been a number of new trends, and some are very positive. First, tax audits are done more promptly. The IRS has completed audits of distant years so that it is now more current in the case of large corporate and business taxpayer audits. Another trend is that there are a number of alternatives to traditional tax enforcement. There are many examples, such as the government’s advanced pricing agreement program, whereby taxpayers can agree in advance with the government on what terms are appropriate to govern transfer pricing and transactions between affiliates. That can be done prior to the transactions being entered into and prior to their being reported. Such alternatives take a lot of contention out of the system.

Another trend in tax enforcement is that stakes surrounding privilege seem to be growing. There are increasing instances where the IRS seeks materials in the course of a tax audit or tax litigation that the taxpayer maintains are privileged. Those instances are going to increase. The government has been very good about following its policy of restraint when it comes to asking for information that may be sensitive (even though it is not necessarily privileged). Nonetheless, I think we are going to see more disputes around privilege and confidentiality in the future.

Editor: Should taxpayers be able to withhold relevant information from the IRS under the cloak of privilege, and does that make sense from a policy standpoint?

Shashy: The doctrine of attorney-client privilege is still very much intact. It’s really only part of the picture because in addition to attorney-client privilege, there is also the protection of an attorney’s work product. So you really have to talk about both of them. Taxpayers rely on both of them in many instances to withhold privileged materials from the IRS. Tax litigation in that sense is no different from other litigation, and the doctrines of confidentiality, attorney-client privilege and protection of work product apply.

Please email the interviewee at hshashy@kslaw.com with questions about this interview.