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The Tax Foundation taxfoundation_episode_14 …
Tags: academic affairs, associate dean, capital gains tax, dividend, flagler business school, frequent participant, kenan flagler business school, meade, national bureau of economic research, professor douglas, public economics, research associate, shackelford, stock market, stock prices, tax cuts, tax foundation, time in history, university of north carolina, visiting professor,Pages: 7
Language: english
Created: Thu Nov 9 10:13:17 2006
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The Tax Foundation taxfoundation_episode_14 Page 1 of 7
Scott Hodge, Douglas Shackelford
Scott Hodge: Thank you for tuning in today. I'm Scott Hodge, President of the
Tax Foundation. Joining me for our weekly Tax Policy Podcast is
Professor Douglas Shackelford, who is the Meade H. Willis
Distinguished Professor of Taxation and Director of the University
of North Carolina Tax Center. He is also the Senior Associate
Dean for Academic Affairs at Kenan-Flagler Business School at
UNC. Doug is also a Research Associate in Public Economics at
the National Bureau of Economic Research and was a Tax
Foundation Visiting Professor in 1993 and 1995 and has been a
frequent participant and speaker at the Tax Foundation over the
years. Thank you for joining me today, Doug.
Douglas Shackelford: Delighted to be here.
Scott Hodge: Well, as you know, the stock market has recently topped 12,000
for the first time in history, and I think that's a good opportunity to
look at some of the work that you've been doing over the years in
looking at the effect of tax policy on the stock market, both in
terms of how stocks are priced and how much they're traded. And
in particular, I've found your stud y that you published last summer
very interesting, looking at the effect of the '97 capital gains tax
cuts and how those affected stock prices, etcetera. Could you
briefly summarize that study, and then maybe relate it to the recent
cuts in capital gains and dividend taxes and how that might have
affected today's stock market?
Douglas Shackelford: Well, as far the '97 legislation, our study showed that stock prices
increased on news that the White House and the Republican
leadership in the Congress had reached agreement to cut the capital
gains tax rate. The share price of the average firm increased
around 8 percent that week. The increase was another 1 percent
higher if you were a firm that didn't pay dividends, which would be
consistent with the market recognizing that investors in those firms
were going to tend to receive their gains through capital gains tax
depreciation.
The following week, however, the congressional tax writers
announced that that day would be the effective day for the rate cut.
And we found that the market then fell three percent on this news.
This is what we would refer to commonly as the lock-in effect.
The decline was greater for firms mostly held by individuals and
by firms that had the most depreciation and suggests that these
investors were either selling their shares, or the market anticipated
their selling their shares sometime in the future.
So there's really, we found, two effects -- one, the stock run-up and
then the stock coming back down as there was a sell off. However,
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Scott Hodge, Douglas Shackelford
the net effect was a substantial increase in share prices. In both
cases, we found that the trading volume was very high as investors,
understandably, were rebalancing their portfolios.
We've also done a study of the 2003 cuts in capital gains and
dividend taxes. There, we found that both dividend payments and
share repurchases surged. These findings, we interpreted as
evidence that the firms responded to the lower rates by flushing out
some of their cash and increasing their distributions to
shareholders. We also had an interesting result. We looked at the
margin whether firms were shifting from share repurchases to
dividends since the dividend tax cut exceeded the capital gains tax
cut. And interestingly, we found that the shifts only occurred in
companies where insiders -- that is, officers and managers -- held
disproportionately large shares of the company. So I think a
takeaway from this is that the effect of the 2003 rate cuts depended
on your ownership structure. And I would guess that was probably
an unanticipated consequence of the legislation.
As far as today's stock market, I personally am quite pleased with
the rising prices. Unfortunately, I'm not sure my research can shed
a lot of light on the increase. Changes to the tax system tend to be
impounded in share prices very quickly. So my guess is a little of
the recent appreciation's attributable to changes in the tax law.
Scott Hodge: Well, it will be interesting to see how this stock market run goes on
or whether it tempers back. But it also kind of relates to some
other work that you've done on double taxation. And you testified
before the President's Advisory Panel on Tax Reform last year and
talked about the growth of the non-corporate sector and non-
corporate entities such as S corps and how that's eroding the
corporate tax base. Tell me a little bit more about how double
taxation can affect this and what Washington can do to address this
double taxation issue.
Douglas Shackelford: The corporate income tax has really become a tax on publicly
traded companies. Privately held, closely held firms have
restructured themselves to that their profits are taxed on the
individual tax return of their shareholders. Now, the question is
whether we should tax publicly traded companies differently, and I
think we'd all agree more heavily than privately held firms. I don't
see any justification for doing so. I thought that the president's
original 2003 plan to exempt shareholder taxes on profits that had
been taxed at the corporate level was a step in the right direction.
Instead, we got lower dividend and capital gains tax rates, which
mitigated double taxation, but less effectively than the original
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plan would've done, and it still retains the public/private distinction
for which I don't think we can justify.
Scott Hodge: Well, you had originally thought that their proposal was a bit
overly complicated.
Douglas Shackelford: Yes, I did.
Scott Hodge: How might we, I guess, integrate the tax systems in a simpler
system than this sort of Rube Goldberg method that they chose?
Douglas Shackelford: Well, I think we have to look at all of the different imputation
systems that are available. The purpose here is to say, "We're
gonna tax income either at the corporate level or at the individual
level." Now, I completely concur that the president's original
proposal, as I said, was a step in the right direction. I don't think it
went all the way there because it did create these pools of income
which were going to have to go through these tests of whether they
had already been taxed. I would like to see something along the
lines of eliminating double taxation, and I think there's a lot of
options out there, but I think we've got to get from -- we've got to
start with the understanding that public and privately traded firms
should not be taxed differently.
Scott Hodge: Well, you know, there's nothing like record profits to bring up a lot
of hysteria on Capitol Hill, and we're seeing that recently with the
oil companies' record profits, and talk on Capitol Hill about trying
to conform book with tax income. And one of the proposals that I
took notice of was the attempt or desire to stop the companies from
using the LIFO, or "last in, first out " accounting, for their
inventories. And I guess the assumption was that it was helping
them minimize their tax burden. But generally, what's your take
on this whole notion of trying to conform book and tax accounting.
I've read that you're considerably against this idea.
Douglas Shackelford: I think that, perhaps, is an understatement. I strongly oppose
book/tax conformity. I'm a CPA, and I've stated before that I think
you lose your license if you believe book/tax conformity is a good
thing and for good reasons. It's a very bad idea because it damage s
both our capital markets and our tax system. It reflects, I believe, a
naivety about the purpose of financial accounting. Book and tax
reporting exist for different reasons. And there's no reason to think
that the most useful measure of a firm's profitability for
shareholders would also be the most useful measure of profitability
for the taxing authorities.
Accounting exists because management needs to provide
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information to outside investors. And without this information,
shareholders would be very apprehensive about turning their
money over to managers that they don't know. I think it's
important to remember that we enjoy the largest and the most
efficient capital markets in the world. Domestic and foreign
investors pour trillions of dollars of capital into U.S. companies
that are led by managers that they do not know. And they invest
because they trust the financial information that the managers
communicate about the companies.
If we went to book/tax conformity, we've got one of two options.
We can either tax book income as defined by GAAP standard-
setters who are outside Congress. Or firms can be forbidden to
report accounting earnings to their shareholders. They'd be
required to report taxable income as defined by Congress. Now,
the first option isn't viable because Congress isn't going to turn
over its authority to tax, and it shouldn't. The second option that is
Congress setting the accounting standards would terribly damage
our capital markets.
And finally, I think even if we were to establish book/tax
conformity, it would not achieve the purported purpose of taxing
the information that companies communicate to their shareholders
because if companies could not communicate the information to
their shareholders in a manner that they thought was accurate and
of the highest quality, they would find other means to
communicate information to outside investors. And so we could
chase this book/tax conformity, but it's neither sustainable, nor is it
desirable from a financial markets perspective nor from that tax
system, and I would hope that we'll hear very little more about
book/tax conformity as a viable option for tax policy.
Scott Hodge: Didn't I read in your testimony that the original corporate code was
conformed around the GAAP?
Douglas Shackelford: That's right. It -- financial accounting--was the foundation on
which the tax system was built, and that made plenty of sense. But
what happened very quickly was that Congress felt for different
reasons that we should have a different measure of income, and a
very easy one we can think of is the accelerated depreciation. So
Congress doesn't really ask the questions that financial accounting
asks, which is, "What's the obsolescence of the equipment?"
Congress says, "We'd like to give accelerated appreciation because
we believe that would be good for the economy," which it may
very well be.
So as soon as you have something like accelerated depreciation as
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being good for tax policy, we now have a departure from book/tax
conformity. And after nearly a century of corporate tax, we now
have a lot of departures from tax and book, and I don't think that
that's necessarily bad, and I think there's a good reason for
continuing to have those differences. Again, we need to remember
that there is a very, very good reason that we have accounting
information, and it's not based on tax law. And there's a very, very
good reason we have tax law, and it sho uld not necessarily be tied
to the rules that are appropriate for communicating information to
outside investors.
Scott Hodge: Well, I wanted to get back to the issue of -- you mentioned income
as the basis of the tax system and Congress's attempt to define
income. And you had a very, very interesting question in your
testimony before the tax reform panel. You asked, "Is an income
tax feasible in the future?" And as the new economy is obviously
making the income tax -- or challenging the income tax with
electronic commerce and the rise of other types of products, what
type of tax system should we have in electronic age? And is
basically the corporate income tax sort of a victim of our modern
economy?
Douglas Shackelford: I think it is. I think to fully understand the question really relates
back to your previous question. We need to understand that the tax
system was built on top of the financial accounting system, and the
financial accounting system was designed decades ago -- it came
about over time -- with a bricks and mortar economy. And one of
the reasons we chose to tax income was companies were already
measuring income, again, in a bricks and mortar type world.
Nowadays, the accounting system is struggling to define and
measure income for book purposes, and so we shouldn't be
surprised that the tax system is also struggling to define and
measure income for tax purposes. The reason is that the key
factors for production today are not bricks and mortar. They are
extremely mobile. They are principally things such as brains or
intangibles or information or technology. The thorny accounting
problems today involve realized and unrealized intangibles. Many
of the core assets that a company has, for example, its brand name
or the high quality of its labor force, are not on its balance sheet.
In the old days, you couldn't easily dismantle a plant, so the
balance sheet reflected some stability in the balance sheet. Today,
with intangibles, you can use profits, as we know, around the globe
very easily.
So the difficulties that we've got would measure in income at the
financial accounting level are also creating a week foundation on
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which to measure income at the tax level.
Now, that's the easy part -- talking about the past and where we're
at. Where do we go? Let's just assume we did not want to tax
income because we concluded that the foundation was irreparably
damaged. Then, I think we have to look for the logical alternatives
to that, and obviously, before long, you're going to end up with a
consumption-based system. It will void some of the difficulties
with measuring intangibles. Of course, it brings a different set of
issues, and those things ought to be balanced off.
But I think long term, unless financial accounting theorists can
develop some superior measures for measuring book income, the
tax system that's overlaid based on income is going to increasingly
run into problems. And at some point, we're going to have to face
those problems. When I spoke with the tax reform panel, I
compared it to a person who's aging. I do not think that we are at
the nursing home stage. I don't think we're on life support, but I
think we are aging as a tax system that can be built on a financial
accounting system that measures income. And at some point, we
are going to be elderly and fragile and have to look other places.
Scott Hodge: Well, I have to conclude with kind of a funny tale, a speech you
gave at the Tax Foundation's annual conference a few years ago,
and you were talking about some of the research you had done.
And I still remember the look on a lot of corporate tax executives
when you mentioned how you were able to actually review
corporate tax returns for your research, and I understand that the
IRS is now limiting some of that access. And what effect is that
having on the ability of scholars to do good work on corporate
taxation? And what's been the fallout, I guess, of that revelation?
Douglas Shackelford: Well, I remember that day as well, and I was glad to escape alive.
I -- you were right. There has been a significant restriction in the
ability of researchers to look at actual tax returns, and I think that
that is a very bad development. Society benefits from knowing the
answers to questions like those you've been raising. I know the
Tax Foundation believes that because it's funded many important
studies of questions of critical nature in our tax system.
Unfortunately, many of the most important questions can't be
answered with publicly available data.
The few researchers -- and I should stress there's very, very few
who have gone through all the clearance and have actually had
access to actual tax returns -- have been bound by the same
confidentiality requirements that IRS employees are. There has
been no disclosure of confidential information. Before you can
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release any information based on IRS data, you have to get
clearance from the service, and that is a very tight screening
process.
Scott Hodge: Well, so companies should not be so worried because of those
safeguards.
Douglas Shackelford: I agree completely. And what I believe is that research has helped
us better understand the tax system. If we don't have access to
that, then what we're gonna do is ask our researchers to use poor
information -- for example, financial statements -- to guesstimate
what's going on, and A) we're going to have those researchers
reach conclusions that are erroneous because they don't have good
information, and B) it's going to lead to where tax policy's not as
good. So I think it's in everyone's interest, including those
corporations that perhaps were somewhat horrified to know that
researche rs could gain access -- I think it's in everyone's interest
that we have that access.
Scott Hodge: Well, Doug, thank you very much for joining me today. It's been a
very, very interesting discussion, and I look forward to reading
your research in the future.
Douglas Shackelford: Thanks, Scott.
The Tax Policy podcast is produced by the Tax Foundation, a non-partisan, non-profit
tax research group that has monitored fiscal policy at the federal, state and local levels
since 1937. Please help support our programs by making a tax deductible contribution
at www.taxfoundation.org.
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