Transcript of Entity Tax Reform Conference Available

It has been our privilege to cosponsor this event with Tax Analysts, the premier publisher of tax articles, analysis, and news. Tax Notes magazine and the other Tax Analysts publications have been a very important participant, and in my view, the most important participant, in ensuring that there is a transparent, public, and thoughtful discourse about tax policy in the United States and in the world.

I would like to recognize at this time David Brunori, the deputy publisher of Tax Analysts, who is with us today, and thank you for cosponsoring this event. Thank you, David.

(Applause)

MR. REPETTI: I would also like to thank the Boston College Law School Polis Endowment for Tax Programs for also helping to fund this event.

It is now my pleasure to introduce Joseph Liu, our dean of faculty, and an international expert in intellectual property, who will bring greetings from the law school administration.

Dean Liu?

MR. LIU: Good morning. As Jim mentioned, my name is Joe Liu, and I am the associate dean for faculty here at the law school. And on behalf of the faculty and the administration, it's my great pleasure to welcome all of you here to Boston College Law School, and to let you know how incredibly excited we are that you are all here.

As Jim mentioned, my field is intellectual property, so the subject of this conference, "Reforming Entity Taxation," is well outside my area of expertise, but even I know how incredibly important the subject of this conference is and how much it has been in the news recently. And so as a result, I am particularly delighted that Jim Repetti, Diane Ring, with help from their colleague Brian Galle, have assembled such an incredibly stellar and impressive group of lawyers, academics, journal editors, and others to spend some real time today discussing this very important issue. And so I do want to thank all of you for taking the time to bring your talents and insights to this conference here today, and in particular, I also do want to thank Tax Analysts for helping to cosponsor and support this conference.

Now, I do think that it is particularly appropriate to be having this conference and this discussion here at BC, not only because of the terrific fall New England weather, which we provided here today, but also because historically we've had a very strong tax faculty with not only Jim, Diane, and Brian, but also professors such as Hugh Ault and others here at the law school. And in addition, both our faculty and students have been increasingly involved in tax and other legal issues in a more global context, which seems particularly appropriate given the topic of today's conference. We've also finally had a very strong tradition of public service here at BC with alumni, such as Senators Warren Rudman, Ed Markey, John Kerry, and all the rest, and so the public policy issues presented by this conference I think are particularly appropriate and very much in keeping with the tradition here at BC.

So we are very happy to be hosting this conference, and extremely excited that you are all here. I hope that your discussions today will be thought-provoking, challenging, and also productive. I hope that you enjoy your time here at the law school and will come back soon. And so thanks for coming, and welcome to Boston College.

(Applause)

MR. REPETTI: Thank you, Joe. A little bit about the format before we begin.

Each speaker, we have three speakers on the panel, a commentator, and a moderator. Each speaker will have 20 minutes to discuss or present their paper, and then the last half hour of the one hour and a half session will be open to discussion involving the commentator and you in the audience. Those of you who have attended conferences here in the past know that we like to have a conversation, and we intend to try to conduct a conversation this time as well. So as the speakers are presenting their papers, please think about points that you might want clarification about or might feel that there would be a different perspective, and you will have a half hour opportunity to present your comments to the speakers and we can engage in a discussion.

The first panel will be discussing the reform of corporate taxation, and it's my pleasure to introduce Jeremy Scott, who will be the moderator of this panel. Jeremy is the editor-in-chief of news for Tax Analysts, and we are very fortunate to have him here with us today.

Jeremy?

MR. SCOTT: Thank you very much. Good morning, everyone. As he said, I'm Jeremy Scott, an editor-in-chief at Tax Analysts. Until recently, I was the editor of Tax Notes, so I have had the opportunity to read, publish, and edit a great many material from a lot of our panelists and audience members today, so I appreciate everyone coming out.

Since 1986, the number of C corporations has declined by one-third, while the number of passthrough entities -- S corporations and partnerships -- has tripled, but you might never know this to listen to lawmakers, the press, or the president. Corporate tax reform is the most talked about topic in Washington today, primarily because of, of course, the inversion issue. While the chances for comprehensive tax reform remain very small -- just look at House Ways and Means Chair Dave Camp's comprehensive discussion draft, which came out earlier this year, generating almost no discussion -- there is a ray of hope that Congress might address the corporate tax system in the near future. At minimum, there is a lot more bipartisan consensus on some corporate tax changes, such as a lower rate, certain base erosion rules, than on individual reforms. And corporations themselves might prod Congress into action. The recent furor over U.S. corporations acquiring foreign companies for the purpose of inverting out of the United States, illustrates how much Congress, President Obama, and the press remain focused on the corporate tax base. While legislative action did not materialize, Treasury has released controversial new rules aimed at reducing some of the tax benefits of inversion transactions. Those remain very much in the news today.

So even though the use of C corporations might be declining fast relative to passthroughs, there is still vibrancy in the literature and debate over the U.S. Corporate tax system. Today, we will hear from three panelists who will contribute to that discussion. First, professor Mirit Eyal-Cohen of the University of Alabama will present her paper on "How Entrepreneurial Opportunities Can Affect the Choice of Entity." Second, professor Deborah Schenk of New York University Law School will look at the role of S corporations and whether tax reform should aim to simplify the various approaches to entity taxation under the code. Professor Dan Shaviro, also of New York University, will close the presentations by looking at whether 1986-style tax reform is desirable in today's environment, and then professor Brian Galle of Boston College will begin the discussion as the commentator and lead us in the audience participation segment.

So professor Eyal-Cohen, would you like to begin?

MS. EYAL-COHEN: Sure. Thank you. And thank you to Boston College and Tax Analysts for hosting us here.

I want to key up, start this panel by talking about organizational choices of entrepreneurial entities. And entity reform discussions do not distinguish between small business and entrepreneurial businesses. In fact, they usually ignore the latter. But law plays an important part in the entrepreneurial process. It has the power to burn or lower the transactional costs on entrepreneurship by imposing rules that benefit or obstruct entrepreneurial opportunities. In this paper, I describe the entrepreneurial process, and I point out the various transaction costs that current organizational forms create. And then I argue that policymakers undertaking entity choice reform should appraise current organizational choices with (inaudible) to the way that they affect entrepreneurship.

So I describe the four main stages of the entrepreneurial process. Schumpeter, the sire of the entrepreneurship theater, and other modern economists, describe entrepreneurs as the principal agents of economic change through cycles of creative destruction. Leebron, Kirzner, and Baumol developed this theory by viewing the process as a continuous process of mutual discovery.

So the main element -- and that brings me to the first stage -- the main element of the entrepreneurial process that distinguishes it from other business decision-making is innovation. So in this stage of the search for discoveries, entrepreneurs conduct observations, study inefficiencies, look at failed projects. So obtaining knowledge then is the key aspect of this stage. But entrepreneurs are not scholars. They're not looking for this information for the sake of increasing the body of knowledge; they're looking to explore knowledge of value, knowledge that will produce pure economic profits for its finders.

The second stage, after the discovery stage, is the business planning, where entrepreneurs develop the business model, their strategy, their theory of how they can make money off of their idea. So once a sufficient amount of planning has been conducted, entrepreneurs will choose the organizational form that they see fit for their venture and their goals. At that stage, establishing the firm is a functional necessity. The firm is instrumental in gathering together resources and function as a place for entrepreneurial.

The third stage is implementation. Entrepreneurs are charged with the tax of successfully transforming knowledge into economic value. So in this implementation stage, entrepreneurs combine people, information, ideas, equipment, funds, and so on and so forth. So after the creation of the business entity, the company initiates production and begins to create new demand in the market.

Lastly, when entrepreneurs are going through this process, they can be successful or they can fail. If they're successful, we are going to see a sharp increase in gains in the sales of the firm, and what makes those entrepreneurial gains so unique and different from other profits, business profits, is the scope and the timing of their onset. Entrepreneurial gains are the portion over and above a normal profit, and these gains usually follow innovation and do not arise from preexisting amends in the market.

Now, the moment that entrepreneurs realize success, those super-competitive gains are only temporary. And they're temporary because as soon as competitors follow, these special premiums transform into common business profits. For that reason, not all entrepreneurs succeed, and in fact, entrepreneurial failure is an important part of the entrepreneurial process. Entrepreneurial failures create knowledge spillover. It signals to the market what ideas work and what ideas do not work. And it helps improve that process.

So after describing the four stages of the entrepreneurial process, I isolate the unique characteristics of the entrepreneurial process and try to see how they're being addressed or not in choice reform.

So the first one is knowledge intensive. The entrepreneurial process, the essence of it is discovery. So entrepreneurs invest more in research and discovery for the next breakthrough. That search process can be very costly. And this is where the law can enhance the value of the search process and make extensive search appear worthwhile after all.

The second element is that the entrepreneurial process is short-lived. The constant threat of rivalry and competition, and the possibility of losing one's position by competing entrepreneurs, is the driving force of that process.

The third one is that it is exit driven. Entrepreneurs recognize that competitors are working to dethroning them of that position, so they need to choose the right moment to cash out of their discovery. The price of that discovery, of course, fluctuates through the entrepreneurial process. Market players, such as employees and investors, also anticipate that potential for large entrepreneurial gains, so they contract with the entrepreneur to have a share in those future gains, and transfer of equity shares in the entrepreneurial equity facilitates that exchange.

And lastly, uncertainty. Entrepreneurials have a unique role in the economy attributable to their willingness to bear uncertainties. And as opposed to manageable risk, uncertainty refers to unknown future events with unidentifiable, uninsurable probabilities, and entrepreneurs develop those skills that help them overcome uncertainty. And it's basically a matter of obtaining more and more knowledge.

So after identifying those four characteristics, I look at the legal considerations and the climate within which entrepreneurs chose their entity. And because of their unique role in the economy, I argue that entrepreneurs should be able to choose the optimal organizational form based on their needs, but today, nevertheless, organizational frameworks do not harmonize with the nature and characteristics of the process I just described. They generate economic confusion and efficiency. The different structures provide too many choices and trade-offs that impose informational and transactional costs.

This is basically my thesis going forward and thinking about entity reform. So I lay out those transaction costs and I start with the first question, and that's the tax consideration. Do we have a double or a single layer of tax? With the promulgation of the "check the box" regulation, many entrepreneurs are advised to choose the passthrough form.

But I argued in the past, the double taxation is really relevant to shareholders with the money-out strategy, those that are looking to claw back the money, the corporate earnings, rather than reinvesting them in corporate expansion. Double fixation really becomes more relevant in later stages of the implementation where the firm is profitable. And even then, with the differences between individual and corporate tax rates, it may not be relevant as such, and Deborah will soon discuss this in connection with the C versus S choice.

Losses is the same aspect of passthrough that provides this benefit. Their ability to claim at the entity level the expenses, start-up costs, and losses at the entrepreneur's tax return. It seems like it's a big advantage. Corporations, of course, can carry losses forward and backwards, but if there are no gains to offset those losses, they remain unused. But due to their tax-exempt status, institutional investors that are tax exempt or foreign investors don't really care about passthrough of losses. They're not as valuable. In fact, they're more valuable to them if you keep it in the corporation and you can offset future gains as Gregg will soon illustrate in his paper.

Venture capital professionals, those that construct those transactions, care little about losses because they don't enjoy them personally. And in fact, they would like to present less losses because that might bring into question their performance. But even at the corporate form, we have loss carryover rules that restrict the use of losses when we have substantial changes of ownership. Losses is a big issue when we think about what are the choice (inaudible) here.

Lastly, self-employment taxes, shareholders and employees that choose the C or the S corporation can devise their income from the corporation as a reasonable salary that is going to be subject to employment taxes, but they can also characterize it as corporate distributions subject to the lower dividend tax rate if they're C corporations, or not taxed at all if they're S corporations. And I think actually the sub-S tax shelter is a key reason for why entrepreneurs do choose the S corporation today as Karen and Deborah will soon touch in their articles.

Other issues to consider -- flexibility. LLCs are, of course, more flexible. They have fewer administrative reporting requirements. C and S have non-attributable transaction costs when they have to carry annual meetings, board of directors' meetings, shareholders' meetings. Contributing capital, incurring debt is treated differently. And certainty is another issue that entrepreneurs are thinking about when they are choosing their organizational form, and they know when they have limited liability that their financial accountability is limited in its scope, and that lowers uncertainty and transaction costs. So LLCs and S corporations, of course, seem to be offering the best of both worlds, limited liability, and passthrough taxation, assuming that passthrough taxation is what entrepreneurs are really looking for.

And S corporations though are severely limited in their ownership issuance. S corporation shareholders cannot be nonresident aliens, so foreign investors are rather limited in that regard. They have to create all those structures, again, introducing more transactional costs. Losing the S corporation status can be very costly. So the S corporations seem to create high transactional costs and informational costs on entrepreneurs.

As for the LLC, the LLC offers costless incorporation, limited liability, flexible ownership and control, but with that flexibility also comes uncertainty when determining the rights of LLC members and the operating agreements and going to court, there is always a risk of a gap of not putting certain issues in the operating agreements and then you default to those young and underdeveloped state laws.

On the other hand, the corporate form seems to be beneficial in reducing uncertainty and increasing predictability. It seems to be less complex, and that's why the conventional wisdom is that venture capitalist firms do not favor investing in passthrough entities and rather invest in portfolio firms that are incorporated, C corporations, corporations that are considered just the safest option.

The last consideration, and the most important one for entrepreneurs is, of course, obtaining funding and exiting. So the process, as I said, the entrepreneurial process is short-lived and exit-driven. So many entrepreneurs want to cash out their investment and move on to the next project. Being able to transfer interest in the entity, of course, is an important factor. Partners and members of LLCs are free to assign their economic rights in the partnership. They cannot do that with the rights to participate in the management unless it's specifically mentioned in the operating agreement, and the situation, of course, is more flexible in the corporate form.

In terms of private investments, because of the lack of information on new market entrants, entrepreneurs are completely reliable on outside sources. So they have to balance their desire to obtain this funding and also the need to obtain control over their operations. Angel investors, private investors provide seed capital, and it's usually in the first discovery stage. The venture capitalists take that place usually in the implementation before or right after the implementation stage where it seems like those entrepreneurs are onto something. So entrepreneurs that wish to obtain those funds have to think about the process and choose their organizational fund that will appeal to the type of investors that are looking.

For example, many venture capitalist firms are organized as limited partnerships, and as such, they have rules that prohibit managers from investing in passthroughs because of the tax implications for their limited partners. Tax-exempt organizations, as I said before, and foreign investors, do not want to have those losses, and in fact, they'd rather have the corporate form because they would like to avoid UBIT issues.

And lastly, fund managers tend to micromanage entrepreneurs, so they have to select the organizational form that will provide them with creative control over the operations of the enterprise, but also offer investors the type of equity rights that will allow them to invest freely. And it seems like the C corporation may be more appropriate in that regard. Of course, if they want to go to a public offering to pursue an IPO, they have to be incorporated, so they have to think about the transaction costs and the trade-offs between either incorporating in the beginning or converting at a later stage. And in some sense, incorporation signals that the market be exit strategy that entrepreneurs are seeking. So choosing the corporate form will provide greater liquidity possibilities for exit. Immediately selecting passthrough organizational forms may signal to the market the desire to control and have a longer progression of the process.

Lastly, ESOPs (employee stock option programs) are very important in the entrepreneurial process because they allow entrepreneurs to attract employees, to pay a lower compensation with the combination of some equity rights. They personally motivate workers to invest in the success of the operation. So those programs are more available in the corporate form. Profits, interest agreements and partnerships, and operating agreements are usually more complex, and in fact, they can turn away competent employees from joining the organization if they have to follow them.

So just to conclude, the legal system has a major role in reducing costly hurdles before entrepreneurial vision and discovery. It's important then to engage in discussions on the kind of roles that the legal system can offer to support entrepreneurship when considering entity choice reforms. And just a few of them -- sub-c -- should not be offered only to publicly traded corporations, as I just mentioned. Private funding, ESOPs, predictability are important corporate features to private entrepreneurial entities. Entity choice reforms should focus, I think, on simple versus complex structures, rather than small versus large. It should provide transition rules that will minimize transactional and informational costs to convert from that simple to the complex structures as the entrepreneurial firm matures.

So I thank you, and I'm looking forward to your comments.

(Applause)

MR. SCOTT: Ms. Schenk?

MS. SCHENK: So for decades I've stood to talk and I just can't sit there and talk, so you get me standing up. And besides, I did PowerPoints. This is my attempt to be modern. So here we go.

So, my topic is whether or not there's a role for subchapter S in tax reform. I want to start by talking about why I want to talk about this, and then I'll talk a little bit about what the options are and I'll draw some tentative conclusions at the end.

So why should we spend any time thinking about subchapter S? Well, the first thing -- actually, my first bullet point, I somehow lost half the sentence. What I really wanted to say was that passthrough taxation is a mess, including subchapter S. There's a lot of agreement that we have a very complicated, distorted system.

Second, any tax reform is likely to affect small businesses. As Jeremy mentioned, you don't hear this mentioned very much. If you read about corporate tax reform, you think we're talking only about multinational corporations. But in fact, many small businesses and subchapter S corporations are going to be affected by anything Washington manages to pull off.

And third, if you look at the literature, for decades now people have been predicting the demise of S corporations. So I have to confess that I have a personal incentive here. I wrote a treatise on subchapter S. Is it gone? I won't discuss that. Actually, I'm going to look at it from a more objective point of view and ask whether they're right. Is there really any reason to keep subchapter S, and if we're going to engage in tax reform, maybe now is the time to put this to rest.

So even though people have been projecting its demise for decades, there are so many S corporations out there, and as Jeremy mentioned, they're increasing S corporations. It's not just the big bulge that happened after the 1986 reform. So in 2001, there were over five million corporate tax returns filed, and 54 percent of those were S corporations. By 2012, which is the latest estimated numbers to come out of the IRS, there were over six million returns and 67 percent of those were S corporation returns. Obviously, a big increase.

S corporation receipts out of the total is a much smaller number, but it's not insignificant. There are $28 billion of S corporation receipts out there, or 22 percent. This is not a tiny part of the economy we're talking about.

When you look at passthrough returns, in 2012, 56 percent of those returns were S corporate returns; 1120 S's as opposed to K returns. That number, by the way, has held pretty much steady for the last couple decades. It's varied somewhere in the 50s but there have always been more S than K returns.

The reason that many people predict the demise of S corporations has to do with the rise of LLCs. I mean, you can find lots of statements in the literature that say there is no longer any reason for a subchapter S corporation now that we have LLCs. So after several decades of that, you'd think people would get the message; right? Well, apparently not. There were three million S corporations as compared to about 1.5 LLCs in 2001, and the number is even bigger today. There are 4.5 million as compared to 2 million LLCs. So obviously, there are a lot of small businesses, even some very large businesses, who are electing to use subchapter S, and that number just continues to increase over time.

So one possible counter fact to that is that they are very small -- S corporations represent a pretty small percentage of the total assets held by corporations, so, but there are some very large S corporations out there as well who hold a significant amount of assets.

And then one fact that just seems to disappear entirely in the discussion of entity tax reform is sole proprietorships, and they make up the bulk of all businesses in the United States. If you look over time, roughly 70 to 80 percent of businesses are sole proprietorships, and obviously, those sole proprietorships are a form of passthrough taxation as well. Not very complex, obviously, but they're a form of passthrough taxation. And my view is we should not forget that that is where the bulk of businesses are.

Another question to think about is why any business would choose to be an S corporation. If you review the literature, you will also find many, many statements that say no business in their right mind should choose to be an S corporation. That's not exactly what Mirit said but there was a hint of that there; that there are other reasons not to be an S corporation.

The main reason that is usually given is that there are so many advantages to being a partnership or an LLC. As she mentioned, there are organizational reasons to choose to be a partnership rather than an LLC.

I think I'm hitting myself here. Sorry. Reasons to be a partnership because of structural reasons or reasons having to do with organizational form or what you have to do.

How can I void this? Sorry. And then there are tax advantages to being a partnership, which I'm sure all of you know about -- that property distributions aren't taxed, entity-level debt is included in basis, and special allocations are permitted. And when you ask most people why you would be a partnership rather than a -- or even an LLC rather than a subchapter S corporation, that's the reason you're given.

On the other hand, there are significant numbers of owners who do not care about those advantages at all, or they can't take advantage of the flexibility of subchapter S. There are a very, very large number of S corporations that have only one or two shareholders. These are obviously more or less mom-and-pop operations. They don't care about fancy partnership agreements. They don't care about the ability to allocate special allocations between mom and pop. It's all the same to them.

Another reason is that subchapter K is too complicated. This is obviously open to doubt. There are some people who say that subchapter K is complicated but you don't have to use any of that complexity. And then there are others working in the field who say, yes, but you have to deal with it in setting up the entity and setting up your partnership agreement. And then there's the perceived FICA Medicare advantage that Mirit mentioned. My own view is that this is more talked about than actually used, and if the IRS wanted to, it could stop it at any time by litigating more cases. They tend to win everything they litigate. So that doesn't seem to me to be the main reason why S corporations are being elected.

The other reason -- our prominent reason I think why we should be thinking about S corporations and passthrough entities in general, not just S corporations, is the importance of the relationship between corporate and individual rates. And this has gotten some attention from the small business community. So when corporate rates are higher than individual rates, there's a real incentive to elect subchapter S, and we saw that happen after the 86 act. There was an enormous number of corporations that chose to elect. That's where the big uptick in S corporations originally came.

And until recently, as you know, the corporate rate -- the top corporate rate was the same as the top individual rate, and so an S election still made sense except in two situations. One is where corporate-level tax is essentially zero debt through salary reductions. The shareholders are the same as the owners. There's not a question about whether they're paying reasonable salaries; they just essentially split the profits as salary, and so the corporate-level tax is just not that important.

And the second is where the corporation is profitable. They're not going to be passing through losses, and there are no distributions. They're plowing it back into the business, and so as I'm sure everybody here knows, a passthrough entity is therefore less attractive at that point because the second level tax is going to be levied at some point in the future, either when there actually is a distribution or when the shareholders sell their stock in the corporation or sell their business interests, and the present value of that can approach zero. So at that point they're also not going to be terribly concerned about a double level of tax.

As you know, currently, the top corporate rate is less than the top individual rate, and for some shareholders in S corporations, they're also going to be subject to the Medicare investment tax. So there's quite a disparity there.

Now, what does that mean with respect to tax reform? So, as I'm sure you know, there are a lot of proposals out there to reduce corporate rates, and the quid pro quo would be the elimination of tax preferences, and the one that's mentioned most often is accelerated depreciation. So the argument runs that this may exacerbate choice of entity distortions because what would happen is that the losers in that kind of legislation would be small business passthrough entities who would be taxed at the higher individual rate and they would not get the benefit of corporate rate reductions, but they wouldn't get the benefit of -- they would lose the benefit of the tax -- the benefits that are a trade-off. They wouldn't get -- they would lose accelerated depreciation and they wouldn't get a lower rate.

So I'm not entirely sure how this works out, and I think it's an empirical question that should be studied more. I think many passthroughs are not using, for example, accelerated depreciation. You think of a lot of service businesses, S corporations with one or two people or passthroughs. They're not taking full advantage of section 179 or accelerated depreciation, or maybe any of the other things that Congress might choose to trade off a lower rate. So it's not clear that they would be in much of a worse position than they're in now. That doesn't mean that this isn't still an issue because there will be an incentive to move to C rather than S, but the sort of exaggerated cries from people who are concerned that if we lower corporate tax rates and trade them off with benefits, we'll really penalize passthroughs. I'm not entirely sure that's going to turn out to be true. It clearly would be true for some passthroughs, but not all.

So why have subchapter S at all, and do those reasons still support this kind of approach? So the original impetus for subchapter S was to allow you to incorporate without taking into account tax consequences. You'll find that in the legislative history. This approach seems to me -- this rationale seems to me less and less viable over time. For a start, the logic of this is obscured by the advent of LLCs, because the LLC gives you the option of limited liability and corporate structure by partnership tax treatment.

So the historic difference between subchapter K and unlimited liability in subchapter S and limited liability is now broken. That's not really the justification for having these two regimes. Clearly differences remain. An incorporated entity generally does not or cannot use subchapter K unless it uses an LLC, and complicated entities clearly cannot use subchapter S because of all of the limitations on the use of subchapter S.

So what are some possible justifications for subchapter S? The first is just mere rhetoric in my view, but you see it over and over and over again. Small business is different. It's almost been deified in this country. It deserves some kind of special treatment. We're not exactly sure what is a small business and we're not exactly sure what that special treatment is, but we're all certain that small business deserves some special treatment, and you often see that as a justification for subchapter S. I'm sure you can tell by the tone of my voice I don't think that's worth considering.

The second is the flexibility issue that -- the flexibility of subchapter K is just too difficult for small businesses to handle. I've often heard it said that it's also too difficult for small business advisors to handle. It's not just the small business, but many of these moms and pops are using a small town accountant or maybe even an attorney that has no tax expertise and K is just out there.

There's a reason why our students think it's one of the hardest tax courses there is, so you know, if you have just some accounting training, you don't want to deal with subchapter K.

Another reason is that subchapter S has always been something of a congressional bargain. It's a trade-off. You give up flexibility. You give up the ability to have complicated structures and financial arrangements, and you get certainty and precision. As I mentioned, you get the certainty of using a corporate form which has a very well-developed law, and you get a simple -- a relatively simple, straightforward tax system.

Another reason, and this I associate largely with academics, is that flow-through taxation is the right way to tax business income, and therefore, we should move as many people as possible onto flow-through taxation. And if S corp is one way to do that, then that's a reason to retain S corporations.

And the final reason is that an old law is a good law. We have a lot of experience with subchapter S. There are a lot of businesses out there that are using it and know how to use it, and you better have a pretty good reason before you throw that whole system overboard and ask everybody to learn something different.

So the other thing I want to do, which I did in my paper, I mainly want to ask questions here. And the main question I want to ask is, "So what do people think about subchapter S and what role would it play?" And to do that I've looked at a whole lot of proposals dealing with passthrough entity taxation and asking what the role for subchapter S would be.

So let me briefly go through what those various kinds of approaches are. The paper goes into much more detail about these various proposals, but really what I want to do is ask what are people proposing? And how would that play out for subchapter S? And then I briefly sort of ask whether there are pros and cons to this approach.

So one of them is to just liberalize subchapter S. If subchapter S is such a great thing, and we'd like more and more corporations or businesses to use it, let's make it easier for corporations to use it. This also plays into the idea that if passthrough taxation is the ideal form, then we need to liberalize subchapter S in order to make it available to corporations that are now choosing, in effect, to use subchapter C.

So I won't go through each of these changes. I've catalogued what people have changed over time and they fall into basically three categories. One of them is to liberalize the eligibility rules, things like have more shareholders, elect foreign shareholders, et cetera. A second is to liberalize the structure rules. Under subchapter S you can have only one class of stock, for example. And the third is to make subchapter S less of a trap for the unwary because of the possibility that you could terminate.

So these proposals, which all would permit, basically to incorporate some of the structures of subchapter K into subchapter S, I would argue defeat the simplification purposes of subchapter S. I would be very wary of basically turning subchapter S into subchapter K. In my view, I would accept any rules that are easy rules that allocate income to owners, that don't allow them to shift income, and necessarily those rules must be easy to follow.

Another possibility is a unified passthrough system. And you'll see various proposals like this. There was a unified passthrough system in the Camp working draft proposal, and their arguments were that one system -- you'd have one, rather than two. Less distortion, less complexity, et cetera, and under that there would be no need for subchapter S to apply at all. Privately held corporations could use subchapter C; publicly held corporations, however, would be mandated to use subchapter C. The proposal does eliminate some of the advantages of K, but it does have very complicated transition rules because we're in a state where we have millions of S corporations out there that would have to adjust.

So my take on this is that there will not be a unified system for a very long period of time because of transition rules. I said seven million. It's not really seven; it should be four. All these people would be moved onto a new system, but those who were trapped in C could get out of C. I think there would be planning opportunities for those who want to be C because you have an election base here.

And finally, as Jeremy mentioned, I don't see any support for this. I went through all of the comments that were issued, and virtually no one talked about this. And there doesn't seem to be any discussion about the camp discussion draft.

A second possibility as a two-track system where you have C and K and S entirely disappears, there are a fair number of academic proposals out there to do this. Public companies would be taxed under C; private firms would be taxed under K. Another possibility is to divide it up, not based on public-private, but on complex. Firms would be under C and non-complex firms would be under K, and subchapter S would be repealed. And here the support is subchapter K is just a lot better than subchapter S.

My read on most of these proposals is that the reason people think K is better is because it's got these great tax advantages, and that's not a normative argument as to why you would redesign a system to give everybody tax advantages they probably shouldn't have in the first place. So you would have to buy into this on more practical or planning kind of terms.

And the final argument there is that if we really need two regimes, we can't repeal subchapter K. That's a non-starter. But maybe we could repeal subchapter S, so let's try that. Not being based in Washington, I really can't evaluate whether that's a possibility or not.

As I say on the slide, my bottom-line evaluation of this, I just can't do any better than the late, great Marty Ginsburg, who thought that a C and K system only was a proposition that commends itself mainly to those who find the level of complexity in the tax law too low.

And finally, I know I'm running out of time, so I'll just quickly mention this. Another possibility is to have a three-track system -- a C, a K, and I've got S in quotes, because many of these proposals build on subchapter S. A simpler system, a system with a simple structure, whatever. So they'll be publicly held or large businesses and then you divide passthrough entities into two types -- a simple and a non-simple.

In my view, this is just a proxy for subchapter S, and I am not sure why you would throw subchapter S out and adopt an entirely new system that's based on subchapter S. That seems that we're throwing the baby out with the bathwater there.

So the last possibility is corporate integration of some sort and whether you'd retain S with there and in the paper, I go through the possibilities there and there are some corporate integration models where there wouldn't need to be any role for passthrough taxation. And then there are some where I think there would. And of course, subchapter S is corporate integration, so it's a possibility that it probably would not be extended.

So let me end by throwing out my tentative conclusions. Can I say four sentences? Would that be OK?

MR. SCOTT: Absolutely.

MS. SCHENK: I'll say them really fast. I know (inaudible). You can read them. So the first point is that I don't think corporate tax reform can be divorced from individual tax reform, or at least individual rates, and to talk about it in a vacuum, I think, is wrong.

Second, in the absence of corporate integration, which I don't see on the table right now, and there are two levels of tax retain, there's a justification for conduit taxation for business entities. In my view, it's also the right way to tax.

Third, while one uniform system would be desirable if we were designing a system from scratch, (a) I wouldn't throw out what we already have; and (b) I think that the current subchapter K system is simply too complicated for most small businesses. I think it's desirable to have a two-track system, but I don't think having K as the only option is a good idea.

Third, subchapter S might have not been the design choice ex ante. It doesn't look like a tremendous amount of thought went into the structure of subchapter S in 1958, but we do have a current and administrable version of a conversion of a conduit system, and I'd think twice before I get rid of it. And finally, let's not turn subchapter S into subchapter K.

Thank you.

(Applause)

MR. SCOTT: Mr. Shaviro?

MR. SHAVIRO: OK. Well, thanks to the -- thanks for inviting me, and thanks for all coming here today.

So, as you can see, my thesis is called "Not So Fast: Evaluating the Case for 1986-Style Corporate Tax Reform," a follow-up to a piece I wrote saying that doing that for individuals isn't really where we are.

Now, since the early 1980s, tax reform has almost always meant some variant that broadened the base, lower the rates. Before that, it usually meant broaden the base so that the high rates are real, not fake. That was Stanley Surrey's style of tax reform. We have these 90 percent rates, but rich people aren't paying them, so let's make sure that everything is on base.

My earlier honor got called the "'86-Style Tax Reform: A Good Idea Whose Time Has Passed," because it really was sort of a clever idea at the time. I don't think the times have changed, although corporate is probably the area where the arguments in favor of it are still the best.

Now, doing this type of '86-style process, the advantages are often overhyped. People will say, "Well, the tax rate is lower; that means kind of there's less burden on working and saving because you've lowered the rate." Well, of course, the tax burden depends on the rate and the base. So if you want people to say actually '86, even though I think that probably was a good idea on balance, you didn't necessarily get incentives to work being more if you'd end up paying the same amount of tax.

Another point against this framework being as canonical as it is, the idea that we're going to keep the tax revenues constant, that's really an optical, not a substantive critique, because after all, if tax expenditures are really spending through the tax code, and I think with a couple of footnotes and explanations of what you really mean by that, that's sort of true. That means that you're actually in some way cutting spending and cutting taxes, that could be good or bad, but anyway, just this sort of idea that we're keeping tax revenues the same is really focusing on a -- the question of interest to some extent is budgetary balance. Obviously, there's relevance if you lower or raise the long-term budget deficit. But this idea that taxes are the same is not really that meaningful.

Finally, one of the motivations for the '86-style reform is we had some bad rules in the tax law that kind of tax preference if you're inefficient or bad policy. Taken that as given, obviously some of them could be defended, taken that as given, of course we want to get rid of them. And it's kind of nice to get a budgetary improvement from that. But it's not obvious that what you then do is you give away the budgetary improvement and get back to where you were before in budgetary terms by cutting the rates. Cutting the rates may be good, but there are a whole lot of different things that you could do. Suppose that we could, for example, improve public education while cutting spending for public education in half. That sounds like a pretty good idea if that's actually possible, but there would be no immediate conclusion about what should be done with the budgetary improvement. There would be lots of things you could do with it. So likewise, here, there are a whole lot of really bad tax preferences. Of course we should repeal them. And so the tax community is going to say let's use it for some stuff that we think makes our system better, but there are going to be a lot of other claimants, and the fact that these things come out of the tax system doesn't really tell anything about what's the right way to do it. It was kind of a political convenience idea that made the '86 thing such a good idea at the time, things that maybe changed.

OK. So recent years have seen diminished returns for '86 style individual income tax reform. You broaden the base and you cut the rates particularly on the left. I don't think there's really consensus between the two sides that we should do this. We saw it in the 2012 campaign. Of course, Romney had a proposal of this kind, although he was wise not to try to specify how he actually was going to make it all break even, both distributionally and in budgetary terms, and a lot of people on the left said, "We don't like this. We don't want to cut the top rates." So I think whatever you think should be the top rates, it's clear that it doesn't quite have the same degree of support across the spectrum.

But there still appears to be, at least hypothetical bipartisan consensus in favor of doing this with the corporate tax. You've seen both Senate Finance and Ways and Means having people of either party issue plans that might do this sort of thing. You see the administration telling how they'd like to do it. So there still seems to be some sort of -- there's not a universal, of course, but the parties and the party leaders seem to both think it would be great to do this with the corporate tax. And the one reason that they say it would be a great idea to do it for corporations, namely cut the rate and broaden the base so the revenues are kind of the same, there's concern about tax competition and about the disparity between the statutory U.S. corporate rate and that in other countries. It's, of course, quite true as one side of the debate always points out, our corporate tax rate is like way higher than that of peer countries, generally. And then the other side will say, yeah, but our effective rate isn't necessarily higher; it might even be lower.

So anyway, why hasn't it happened yet? Why haven't we gotten corporate tax reform of this kind, be it good or bad if sort of "everyone" wants it, meaning really the leadership of both parties? Well, one reason, of course, we haven't gotten, it's sort of -- while I'm thinking of that scene, I think it's that Inspector Clouseau movie where it turns out everyone killed -- they were trying to figure out -- there were like so many knives in the corpse that it's hard to know.

So the politics are so dysfunctional and the parties are so -- have knives drawn with each other, that kind of that alone might have sufficed to stop it from happening, even though both parties say they want it, but beyond that, I think there's sort of no obviously good way to doing it, and that means that any proposal you put forth by definition, even if it would be an improvement, is going to have serious objections to it.

This is not in the paper, but I just thought of this as a slide. The redundant conundrum, my words of wisdom are, that if all the choices are bad, then none of the choices are good. And I think if you think about that, you realize it's got to be true.

Anyway, so the original sin here, as I call it, is taxing corporate income at the entity level. And what I mean by the "original sin" is I kind of agree that we have to have a thing, but anything you have that has this system is going to be a mess. So you have a realization-based income tax for individuals. Once you have that, taxing corporate income at the entity level verges on being unavoidable. Now, people talk about mark-to-market taxation for publicly trade and so forth. Obviously we could have a conversation, that's feasible, but that doesn't really seem to be on the agenda.

So once you have a realization-based income tax for individuals, unless you do something like a mark-to-market type of a thing, you're going to basically make corporations a giant tax shelter unless you tax the income to them. So you pretty much have to tax corporate income at the entity level, and of course, as everyone says, it's kind of hard to flow it through. I agree that flow-through is, and should be, the idea, but if we take it as given that we just can't do that, and again, even if we can, no one is kind of stepping forward and saying let's do it right now, so you're going to be taxing corporate income at the entity level. Once you have that, and again, taking as given the setup of the problem, it's kind of the best you can do. But once you have that, any system you have will be a bad system. Of course, you can always defend a bad system if all others are worse, but it's still bad. So we should choose whichever alternative is least bad, but it's going to be a bad system. And unfortunately, "everything else would be even worse" is not a very catchy sales pitch.

It's also often hard to determine what exactly is the least bad system. And so I have a metaphor in the paper that's based on watching the TV show Survivor where you have these people wandering blindfolded through a maze, and there are all these different stages they need to get to. And if you move closer to one station where you have to get a flag or something, you get further from the other stations. So entity-level corporate income taxation is such a mess with such bad things happening. Again, that's not to say that we can do better than that, but it has so many problems that when you make one problem less bad, you often make other problems worse. So in theory there is -- at least in theory there's a best course of action, but it's going to have a lot of things wrong with it and it's going to make some problems worse. So not to say that we shouldn't do the best we can, but it's not going to be edifying and it's also going to be unclear what it is.

So what's so bad about having an entity-level corporate income tax even if everything else you could do would be even worse? And really, the key, or problem number one is an entity tax, the attributes of the entity, not the owners, determine current tax liability. For example, if you had a complete flat-rate system where everything was taxed at one rate, this sort of wouldn't matter. But once you have progressive rates, graduated rates, you can't really do that at the entity level. You're going to be failing when people invest through corporations to apply the graduated rates that you apparently wanted to apply otherwise. And, of course, as is I think probably widely agreed, graduated rates at the entity level kind of make no sense. I think I say in the paper you can have like big -- if you have graduated rates for corporations as the U.S. law does, you can have a whole bunch of like mom-and-pop small investors investing in a giant corporation and they're facing the high graduated rates; Bill Gates invests in a little corporation and he gets the low rates of small corporations. It kind of doesn't make any sense.

Another thing that happens when you are taxing corporate income at the entity level is that you're affecting how loss nonrefundability works. Now, I've always believed that if you were actually measuring income accurately, you would be crazy to make losses nonrefundable, but once you have a world of tax shelter fake losses kind of cutting off the tax benefit to zero, may be better than giving a license to loot the treasury by giving giant losses that are refundable anyway.

So when you have loss nonrefundability, you're going to affect it at the corporate by having it run through the corporate level, rather than the individual level. Not all the effects are bad. It's kind of, of course, if people can elect S and so forth, it can be a way of evading tax shelters. It's very easy to do a tax shelter at the corporate level but you can't get an individual return, including through passive loss rules and the like, then there's a virtue to shutting off some of the bad losses. But, of course, some of the things it does, it means corporations have tax reasons for forming multiple branches that are run by the same company so the loss activities can be deducted against the gain activities. So you've got a bunch of problems like that.

So you can get inefficient, tax-driven, multi-business consolidation. But the biggest taxpayer information problem results from any level income taxation pertains to taxpayer residence. You're going to potentially tax residents of your country on a different basis than nonresidents. It's kind of a shame when it happens -- when it's being determined at the entity level.

So here's my imagined alternative history of international taxation. Suppose corporate income could be and was flowed through to the right individuals. And, of course, I'm presupposing here as the partnership rules show is not the case, that you could actually do it right. By the way, there is no right. As soon as economic income and taxable income are different, there sort of is no right. It's theoretically solvable if a company -- if a business, a business with multiple owners has some amount of economic gain, it's kind of theoretically feasible to say whose income it really is. It's a measurement problem. But when the taxable income differs from the economic income you're saying whose income it really is, to the extent of the difference, it really isn't anyone's. So there's kind of no really theoretical strong answer to questions of that kind.

Anyway, but if you could do all that, bracketing all that, international income taxation would look radically different. It would have far less problems. It would also be less fun and interesting. There would really be no serious dispute regarding the desirability of worldwide tax and resident income. We're obviously seeing many countries that are territorial systems for their corporations. It would be kind of absurd if you were having an income tax on individuals and you were managing to flow through all the corporate income. It would be absurd to say there shouldn't be a worldwide tax because you're trying to figure out how well off these individuals are. It doesn't really matter where they earned it. There also would probably be no foreign tax credits except on a reciprocity basis. That would be a longer discussion.

And it would also be far easier to contemplate exempting inbound investment. You actually should exempt inbound investment from foreign individuals in the case where you cannot actually get the incidence of the tax to fall on them. If they can earn rents domestically, that's different. But if they're just going to get the worldwide rate, there's no reason to -- in that setting, there's no reason to tax inbound. You don't really accomplish anything.

But, of course, once you have resident individuals investing through foreign entities, and foreign individuals potentially using your entities, you mess everything up. You make it much harder. For example, you really can't have a zero tax on inbound investment if it could mean that the -- I say in the paper of course an antiabuse rule could address this, but imagine the corner pizzeria incorporating the Cayman Islands, and now that's inbound investment that we exempt, even though that case, I'm sure, could be addressed through antiabuse rules. Once you have cross-border shareholding, you weaken the taste for a worldwide tax on resident companies because domestic individuals can invest in foreign companies. That's really at the heart of the whole thing about why you might or might not want to have a territorial system, and the zero tax on inbound becomes really hard to (inaudible) because you think domestic individuals are going to use it to avoid tax on domestic labor income.

Anyway, now another thing I'd say is if you knew who they were, you actually want to tax your domestic individuals and their shareholders at a different rate than foreign individual shareholders. Your domestic people, you're trying to impose a tax based on how well off they are; foreigners, it's really just a question of what you can get from them. So you kind of want to have different tax rates on these two groups. But obviously, the entity-level tax is not going to be able to do that.

So you've created the horrendous mess of international taxation that many of us had fun writing about and the many practitioners and businesses have had fun playing with that, that whole thing, you're going to face that once you have any level corporate income tax. Again, not to say that you can do better, but still, you're going to be doing quite badly.

Problem number two is sort of a thing that's less of a forced move. It's hard to resist imposing tax at the owner level and distinguishing debt from equity. Not a forced move and not a surprise. Suppose General Electric just had a bunch of U.S. individuals that are shareholders. You've taxed GE. Then someone gets a dividend. Hey, this person hasn't paid tax yet. And also, there's these formalistic rationales about the equity holders, the same person as the company, but the debt holder is a third party. It becomes very natural and very unsurprising to get all the problems with classic corporate income taxation. Once you have a tax at the entity level, it's theoretically possible to cure it, but once you have that it's going to be unsurprising if you don't.

So you can discourage the use of C corps, you can create excess corporate leverage, you can lead to lock-in of corporate earnings depending on whether you actually benefit from postponing dividends, for example, because you'll eliminate the tax of death.

There could also be opposite effects. One of the fun things in the literature, you can actually make equity financing better than debt financing, for example, because you get the lower corporate -- this, of course, requires the corporate rate to be lower. You get the lower corporate level and you're not worried about the second level of tax. Martin Milner wrote about this too soon, about 34 years ago.

Ooh, I guess I better speed up a little bit. I know I speak so slowly in my southern drawl, so I think I'm not going fast enough.

Anyway, so you might like to -- now, it's natural. Once you have this shareholder-level tax, you might want to lower the corporate rate to reflect that, but the problem is there's no well-defined burden of the second level of tax. It could be high for some, low for others, depending on their ability to avoid it. So it's very hard to (inaudible) say how the corporate rate should be adjusted in light of the fact that there might, for some, be a second level of tax.

Then Deborah already referred to this -- there's the problem that you have corporate and noncorporate business at roughly 50/50, and so this is really an important point. Revenue-neutral '86-style corporate tax reform is likely to involve "broadening the base from an income tax standpoint and lowering the rate." Well, guess who only gets half -- only gets the medicine and not the candy? Noncorporate business. So this is obviously a political problem, but it's also possibly a substantive problem. Suppose you think that companies are paying multinational companies because they have opportunities domestic businesses don't have, are paying less tax. Well, let's cut their taxes even more. You could see that as being -- and of course, another thing about broadening the base and lowering the rates, you're trying to create neutrality, more neutrality of some kind, but are you creating less neutrality between these two sectors? And as Deborah indicated, it's going to vary by the business and it's going to be very hard to have uniform answers.

Problem number three, and I realize I'm going a lot faster here, is there are good rationales for possibly lowering tax and capital income to lower income labor income, but if you try to use that as a rationale for a low corporate rate, then on the one hand it's true that you kind of -- well, first of all, there's some capital income that's left out, but in addition, when you have owner-employees who are underpaying themselves and it's the subchapter S trick to avoid these other taxes as part of that, then you're going to get corporations as a tax shelter. And that's, I think, a pretty serious problem.

OK. So what are the arguments for 1986-style corporate tax reform? One is that we're out of step. I actually feel a little nauseated by the kind of boringly cliché nature of hearing that said time after time, but there are two reasons why being out of step might matter. The first is the wisdom of crowds. I say in the paper, the mother watching the high school parade, "Look, everyone is out of step but my Johnny." When the U.S. is out of step with everyone else, there's a good possibility that they kind of know what they're doing and that we're the ones who don't.

But two responses to that. The first is that we do have somewhat different circumstances. We have more market power. The second is the real uniqueness of the U.S. system, which I think might be crazy, too, is not having VATs and having so much reliance on the federal government income tax. Maybe they're right and we're wrong, but just lowering the corporate rate isn't really the right response because that raises questions about how the corporate rate relates to the rest of the income tax. It's really the level of not having a VAT where our mistaken uniqueness would have to be considered.

Now, competitive pressures do matter, but an important thing to keep in mind is that if you're keeping the effective rate in companies about the same as you broaden the base, it's not clear, it's not immediately obvious how much you're affecting tax competition. A company that invests in the U.S. is going to pay the same amount of tax but just at a lower rate and slower cost recovery.

Argument two for the '86-style move for corporations is lower the rates, broaden the base is Tax Reform 101. But again, why is the -- if there are bad tax preferences, sure, let's repeal them, but why is the lower rate necessarily the way to go? There are questions defining whether it makes things more neutral given the noncorporate sector and the fact that not all cost recovery will be the same. There's also the transition issue that if you kind of say we're going to cut the rate and slow down cost recovery, to some extent you have the windfall gain to all business that deducted at the old rates is now going to have deferred income at the lower rate in exchange for higher cost of capital for new businesses. That's not always a great trade-off, especially when you have a down economy and a persistent failure to address the lack of full employment.

Finally, the third point is -- well, actually, there are a bunch more arguments for the corporate tax reform. My tone in this paper is not that it's all wrong, that we shouldn't do it, but simply that it's very unclear. Basically, in a sense, because the corporate tax system is such a mess and there's so many different things, moving and going in different directions, it's very hard to know -- I guess we'd have to have another metaphor -- it's like you're spun around in a child's game of blindman's bluff and you don't even know which way you're facing. It's just very hard to know. So my point is really that the confidence level of people, and this is a good idea, (inaudible) not that they're necessarily wrong, there's an argument for a lower tax rate for capital income and labor income. I'd be happier about lowering the corporate rate if there's the labor capital and centrifuge, as Ed Carnhart calls it, to make it harder to shelter labor income in the corporate sector. Response to the second level of tax. But again, we don't know what that tax is, and many will eliminate it through the stepped-up basis of death.

Addressing debt bias in the corporate sector. I think there is some argument that despite the fact that in theory (inaudible), there is too much leverage. It's tax driven and it has bad effects. Lowering the corporate rate is now kind of the way you'd naturally address that. It would be more like through interest deduction limits or an ace-type thing where (inaudible). Nonetheless, there might be some virtues to lowering the corporate rate in terms of this problem, but the problem is, again, it's just one of a whole bunch of effects.

Finally, the first step towards improving our international tax rules, I kind of feel I should stay away from international today because there's a whole panel on it and I couldn't resist dipping my toe in the water a couple times. But I think that in my view the foreign tax rate and foreign-source income should be lower than the tax rate -- the effective rate, let's start with that, and then after, domestic. Everyone kind of agrees with the belief in foreign tax credits, but lowering the domestic rate doesn't necessarily mean we should have the same rate for foreign as for domestic.

So anyway, finally summing up, the case for '86-style corporate tax reform is widely viewed as very strong. In fact, the net policy improvement is likely to be, at best, quite modest, if everything else stays the same. I, myself, would be more enthusiastic if the package included something to address the problem of addressing sheltering labor income in the company and appropriate international tax reform. Even so, it would be hard to be enormously confident that you're making the system a lot better. And also, if you kind of try to make it more ambitious and do more, you're creating a very different type of process that won't just sail through the way some people were hoping this would.

OK, thanks.

(Applause)

MR. SCOTT: Professor Galle?

MR. GALLE: Thanks. Well, I don't think we have enough arguments on the table, so let me offer a few more. I'll say a few comments about Mirit's paper and Deborah's. I'll have a general discussion (inaudible).

So Mirit's paper, I like it as a good backdrop for a sense of what kind of distortions might be created by our current tax system (inaudible), but I think maybe she might bury the lede a little bit. And maybe this wasn't news to some of you. For example, maybe it wasn't surprising to most of you, but it was surprising to me to hear that actually there is a tax explanation for why startups choose the corporate form. A lot of smart tax lawyers have presented that as a riddle. There have been some nontax academics, Larry (inaudible) probably most prominently, who have nontax explanations for that choice. But her story, which you heard just real briefly, is basically that your institutional investors would have UBIT, that is may be taxable if they were getting passthrough income whereas a dividend income generally is exempt from UBIT. And so those investors are driving the choice with the corporate form. I hadn't heard that argument before; again, maybe you guys have. It's been presented as a big puzzle. So that would be my headline, at least, unless everybody else knows and I'm the one who doesn't.

About Deborah's paper, her general take is that at least (inaudible), maybe broadening tax-type rules would be good, perhaps because it would reduce (inaudible), and maybe just because it's the right way to tax corporate income. It's not clear in the paper which, if any, broadening measures she would favor. And, for example, I'd be interested to hear her thoughts about the Camp proposal to allow non-U.S. residents to be shareholders. The tension with broadening, as I think she knows, is you have to, if you broaden the eligibility for S treatment, you're going to have to increase the complexity of the system or you're going to lose a lot of money. That's basically because it's very easy to shift income between shareholders if you can find shareholders who have significantly different tax rates, for example, if one of them is exempt.

So right now, as she points out, restrictions on eligibility for S corporations to a single class of shareholders and proportional allocation makes those kinds of income shifting tricks more difficult. But if you have an exempt shareholder in your S corporation, it's still probably not that hard. And I would suggest it probably also is still not that hard if you have a much more progressive rate structure than the one we have now. It sort of works now with a fairly flat set of rates, but maybe it wouldn't work if we had more progressive individual rates.

So the implication for that is if you wanted to shift to just one passthrough system, it would have to be a pretty complicated system. You would have to have a 704. You would have to have mixing bowl rules. And once you've had a 704, I mean, once you go 704, you have a headache. At least that's my experience.

The other thing is that I'm not convinced that the passthrough model -- and here it's getting into the more general discussion -- is really the right way to tax corporate income. And the reason for that, you know, Dan's paper suggests it often could be optimal to tax different classes or kind of groupings of revenue services at different rates. And that's because the optimal rate on a particular kind of income is a function both of the elasticity of that income and also the extent to which you want to redistribute that income to other people. And so if you think about the elasticity of salary, it can be very different from the elasticity of business income. It could be -- within business income you have very different elasticity between the old businesses and entrepreneurial ones. You have very different elasticities for domestically versus foreign-owned businesses. You can have very different elasticities for businesses that own a lot of real property. Does anyone want to talk about REITs? We don't have that on our timeframe?

So what that implies is that there's a fundamental design question for our system that no one, I think, has guessed, which is, what's the optimal number of different tax rate structures? And you can imagine that there's probably some number and it's probably more than one but it's less than 100 because there is increasing cost of complexity as you have more systems and people trying to switch between them. And there are also probably diminishing returns of being more than one.

So the point is this. When you're expanding eligibility for S, you are pushing more business income into the individual income tax rate structure, unless you're going to create special rates for passthrough income. And by the way, you are doing the same thing under a market proposal, such as Jim has proposed and (inaudible).

Now, maybe that's a move in the right direction. Maybe you think we have too many rate structures right now, but my intuition is maybe that the opposite is true; that is, it would be better if we had more rate structure. That's also not to say that you necessarily need a double tax to achieve what I'm suggesting. For example, one way to get a different rate for business income would be to have a corporate tax, but if you have a dividends paid deduction, then you don't necessarily need a double tax.

I'm also unsure about the merits of (inaudible) brought in because I think that a double tax is normatively defensible. I don't have time to explain to you why. Come ask me the question. I know, it's a crazy point and I'm not explaining it at all.

So one last point that I'll make about Dan's project. I would propose that it might be useful to think about tax breaks as a long-run game between governments and taxpayers. In particular, I think revenue-neutral reform is just another form of tax holiday. It's locking in the fairly light burden that's resulting right now from a system that's been severely undermined by I want to say fairly abusive behavior in some cases. And so thinking about the dynamic effects of cutting a revenue-neutral deal. It just tells industry that if they can undermine the next system and riddle that next system with holes, and then they can clamor for another revenue-neutral deal, and so on and so forth.

Similarly, Dan, in his paper, it's a very well accepted point, which is that the rates on international business probably should be lower because its responsiveness to tax is more elastic. But I want to ask, what if the elasticity -- the tax elasticity of international business is, itself, a product of government's responses to that elasticity? In other words, if I can succeed in making to shift income across borders, what I get from governments is lower rates. And that increases my incentive to invest in the ability to shift taxable income across borders.

So what I would suggest, maybe one way out of that trap is for governments to think about ways to commit in advance to punishing those kinds of behaviors instead of rewarding them.

I'll stop there because I think you guys will say many more things that are more interesting.

MR. SCOTT: Thank you. Before the audience, does anyone want to respond to Brian's points?

MR. SHAVIRO: I like the point about the tax holiday. It wouldn't apply as much to, say, base broadening and accelerated depreciation, but in the international realm it really is, especially like Deborah talked, for example, (inaudible) burden-neutral reform and so forth. I think the setting where it's on the international tax plan, that's actually a very good point.

MR. SCOTT: Questions from the audience?

Yes?

SPEAKER: Dan, not surprisingly, you were very persuasive.

I just had one point on the undistributed labor income. Your point at the end about one of the things that you would think about taking, about fixing would be the (inaudible) income. And it sounds like it's Fleischer's point about founder's stock and Zuckerberg.

MR. SHAVIRO: Yeah. That's certainly a big piece of it.

SPEAKER: Right. But for me, right, and we talked about this a little bit last night, when Zuckerberg gets paid that way in the form of depreciation, the corporation is giving up a deduction (inaudible) stock options and the like. And so I always thought that the corporate, sort of indirect taxation (inaudible). That's not so bad. And then you said, well, maybe, you know, there's NOLs. But to the extent there is this tax break (inaudible) NOLs (inaudible) partially ameliorating the loss for fundability problem (inaudible) early on.

MR. SHAVIRO: Right.

SPEAKER: So I've never sort of been persuaded by Fleisher's account of this calendar stock, it has a big problem there, and so I wondered what you thought about that.

MR. SHAVIRO: OK. So take Apple and take the late, in some circles, beloved (inaudible). I think it's, with the corporate rate 35 percent and the individual rate at the time 35 percent, it was completely relevant to me that leaving aside other tax issues that instead of paying him a big salary and deducting 35 percent, being inclusive 35 percent, none of that happens. For me, that's part of the problem with the fact that Apple's income all shows up as Google. In a way, it means we're not taxing Steve Job's labor income, and then, of course, when he dies, if they sell the stock (inaudible). Whenever I tell Europeans we have section 1014, they're bewildered. That's completely crazy. They almost think it can't be true.

SPEAKER: That's one good thing you get from reading all these papers (inaudible).

MR. SHAVIRO: Yeah. So that's -- I'm actually quite happy with the surrogate taxation at the same rate. The problem with the rates the same, like today we're leaving aside 39.6, is that the company isn't paying the tax either. But then if you get the corporate rate lower, say the corporate rate is 20, then the surrogate taxation isn't working well enough because you really do want Steve Jobs at 35 or 39.6 or whatever.

MR. SCOTT: Other questions? Yes?

SPEAKER: At the risk of being practical, as I understood it, one of the reasons the special committee couldn't come up with a deal in 2011 when they were charged with trying to come up with a budget fix was on the tax reform side. They really stumbled of the conundrum of buying some votes on the committee with a lower corporate rate but not being able to figure out what to do about the negative effect on passthrough (inaudible). And I think that still is a poor structural problem in all of the tax reform stuff, for which otherwise there appears to be a consensus. So one question is how people think that might be addressed. And the only different direction one of my colleagues, (inaudible), has proposed putting a tax on large private entities. And if I understand his argument correctly, he's actually concerned that we're creating a disincentive for entities to have access to the public capital markets which I think he thinks are a good thing. Now, he does have a joint appointment with the business school, so I can understand that. But I just wonder if people can comment on that.

MS. EYAL-COHEN: I'll say something briefly about your first point, Steve, which I alluded to when I was talking. I think we're just lacking empirical evidence as to what the effect would be if you broaden the base on the passthrough entities. It's a possibility that it would not affect them hardly at all; that they don't use many of the programs that would be used to broaden the base. It may be the opposite; we don't know that. And people assume, the rhetoric assumes that all passthroughs are exactly the same and they'll always be affected in the same way, which I don't think is true. And if you assume that, then you're not interested in what I'm interested, is the underlying evidence which might point one way or another. If we knew, for example, that passthroughs really wouldn't be affected much by broadening the base, it seems to me there would be much more likely to be a political view but we don't know that.

MR. SHAVIRO: I think there are revenue estimates that there are noncorporate entities that own assets that -- capital assets -- LIFO or cash accounting or ACRS -- accelerated depreciation, whatever it is. So we know that there is -- there are a lot of taxpayers, businesses that have capital assets. So I guess the revenue estimates, they kind of have a fix on that.

MS. EYAL-COHEN: And I'm also guessing those are the ones with the ability to lobby on their behalf.

MS. SHAVIRO: They're not looking inside. Actually, the problem you're saying is you look inside, and I think I agree that hasn't been done really.

SPEAKER: Just a quick comment. (Inaudible) has estimated that the elimination of the deductions, there are a whole slew of them, about 25 percent of that cutback falls on passthroughs. But I entirely agree with you that it falls on passthroughs differently depending on their composition. But it's real.

SPEAKER: To follow up on one of Brian's points also, I wonder if you would care to comment about the role of base broadening and efficiency. It's not at all clear to me that as we broaden the base, that we're necessarily going to be achieving economic efficiency, because while we're reducing the tax burden on some activities, we'll be increasing it on others. And the question is whether the deadweight loss from the activities for which the burden is increased are less than or greater than the deadweight loss for the activities for which the burden had been decreased.

The reason I bring this up is there was actually a study, and I can't remember the year for the tax reform proposal, but it looked at a proposal to broaden the base tax reform, and that study actually concluded that because of some of the items that were included in the base broadening proposal, it would be a decrease in efficiency because the deadweight loss would be increasing for those items that were highly elastic and therefore, we're creating a greater tax wage as you increase the tax burden with respect to the items.

So I wonder, it seems to me that it makes it even more complex in terms of the proposals, but I wonder if any of our panelists would care to comment on that.

MR. SHAVIRO: Yeah. I kind of break it down essentially into two pieces. One is that you're making the overall thing more true income tax. You're moving some items faster, correcting a tax accounting to correcting a tax accounting. So there you're moving away from expensing so you're actually kind of making the burdens, you know, the argument, of course, expensing would be a fairly easy system. Concession tax does this. It would be a fairly easy system -- I mean, it's easy to make it neutral; you kind of make everything expensive rather than having to figure out the correct economic life. And you also address the (inaudible) of the services. Obviously a much bigger conversation once we have the tax base we want. But you're moving stuff more towards income tax accounting. That's actually generally creating greater discouragement, although again that's a much bigger discussion.

The second thing is you're trying to make it more neutral within assets. So obviously, consistent, like '86 act (inaudible) approached the idea. We have preferences for some assets, not others. It's not like we're moving to everything being expensed. We're taking a hodgepodge, and we're putting more stuff on neutral income tax accounting. The problem there is you're going to fall way short of neutrality no matter what, so you actually have to assess, based on the actual proposal, what things you're making more neutral, similar to each other, and what things you're making worse. And there are corporate versus noncorporate, and debt versus equity financing is going to have to be part of the analysis as well.

MR. GALLE: So Dan has a way of looking at the '86 act and analyzing it as a trade-off of base broadening for lower rates. Again, trying to be practical, you could analyze it differently.

MR. SHAVIRO: Actually, I would analyze it differently. I think that's how it was thought of "efficiently" or generally. Yeah.

MR. GALLE: Well, and another way of articulating what happened in '86. And I think this is very much underappreciated. And I did live through it.

So the Treasury took out Treasury proposals. What people forget is those proposals did not go to the Hill. Jim Baker and Richard Darman came over from the White House on the exchange, so Baker became Treasury secretary, and then Don Regan went to the White House to become chief of staff. And Baker and Darman went through the whole package. And then they became what were known as the "President's proposals." And then they went to the Hill. There were a different set of proposals, and what had happened in between was transition from a technical staff's view of what would be good tax policy to a highly political sophisticated team's view of what might (a) not be dead on arrival; (b) win on majority.

So one way to think about tax reform, '86-style tax reform, I think is going to be common to any tax reform. It has to win on majority. The practical problem that we face today is we have, unlike in '86, a vastly more disparate set of objectives with respect to tax. The notion that there is consensus on any major part of the reform packages I think is false. It's superficial at the most basic level. And the question you should be asking is do any packages -- part of the package or whole package that you think there's a consensus for, the question is will it get the support of the administration, the Senate, the Senate Democrats and enough Republicans, or Republicans and enough Democrats, depending on who controls? And that's actually much less important for this issue than some people put credence on because the last consensus that does not exist today in my judgment, is between Senate Republicans and House Republicans. I think we're missing -- what's going to happen in this next election apparently is increased conservatism of about 15 to 20 members of the Republican caucus. If that happens, it increases the disparity between the House Republicans and the Senate Republicans, in my judgment, with respect to some core aspects of fundamental tax reform. So I don't review fundamental tax reform as remotely plausible or any major case of reform as remotely plausible for the next couple of years, at least until after some event-changing election. And if that's true, then I think the focus has to be very much on what can we do with our existing instruments to maintain them until we have some potential for consensus. So, that's a long speech. But the question is, is there a potential for consensus within the areas that we're talking about for this panel? That seems to be part of the test. Or for Dan, since you took on the whole system, is there a potential for consensus for the whole system or any subpart of it? Do you think it's important within the existing political framework?

MR. SHAVIRO: I don't think there is. I really agree with you that the big consensus about corporate tax reform is really a superficial consensus based on the fact that they don't actually know what it gets you into.

To some extent, and I was trying to say it in the paper, even if all these problems didn't exist, and I agree with you that they're kind of disabling, there still would be a mess. It would still be difficult to say what should be done.

I was in a meeting -- I think you might have been there, too -- a few years ago, a few years ago when Gardner was starting out, kind of called in "all the experts" including groups like Trade National Business Manufacturers and Labor, and kind of said, "So guys, what should we do?" And he kind of thought there would be this answer, like -- which he would have gotten in 1984 because everyone would have said we should do the income tax reform. Well, maybe not the business interests. And because the corporate tax is such a mess, even if you ask Alan Auerbach versus if you ask Mike Bress, you just get these completely different (inaudible). You just get these completely different views. So I think it's only when we say, "Let's pretend everything you said isn't true, then how much better does it get?" And the answer is it doesn't get as much better as you'd like. So.

MS. SCHENK: I've got only one point. You would think that, for example, liberalizing subchapter S might be a place for consensus; let's move more people there. There have been bills to do that. All these proposals have said every single year in the house they go nowhere. So it doesn't seem like there's a consensus even for that minor kind of step.

MR. GALLE: Is that because people recognize that as something that has support and they want to hold it as a way of moving?

MS. SCHENK: It's possible, possible, possible. It's just a fact to their constituents, I'll put this on the table; I don't expect it to go anywhere. But I don't know what the reason is but there's just no consensus for that either, which seems pretty straightforward.

SPEAKER: Well, Jim stood up, so I think --

MR. REPETTI: No, we have three more minutes.

SPEAKER: I'm a little reluctant to ask a question because, of course, I'm going to go into international. And Dan, you really did tempt me. You put the bait up there, so I'm (inaudible).

Here it comes. So you talked about policy flexibility. You claimed we have some policy flexibility because of market power. We're still a market force in the global economy. So is it not -- I'd like you to just sort of think that through with me, because if that's true, then what is this claim of powerlessness, which is embedded in the name of competition? That is, we can't fix a lot of these things because if we do, we risk losing foreign direct investment, we risk losing American businesses overseas. So, you know, this question, you said there is no right, but you do think there is a right, don't you, on this?

MR. SHAVIRO: I guess what I meant here was the tax rate that the U.S. can levy on U.S. companies' foreign source income, we're seeing it shuttering. That's what's happening with the inversion, is we're seeing the problems with trying to get it. But between the U.S. and the Netherlands, or even the U.S. and the U.K., who can benefit from having -- what's the highest effective tax rate on foreign service income that we could get away with that it's arguable would be in our interest? It's going to be higher for the U.S. than for, I think, the U.K., and certainly for the Netherlands. It may be dropping, and maybe it's just not for that long, but I think right now it's still higher. Which is why some people in this room are talking, where I agree with some, not probably 100 percent, talking about things like making it harder to do inversions, making deferral (inaudible), things like that. It would be just a ridiculous discussion to be having if we were in the Netherlands.

MR. GALLE: It's about time, isn't it? MR. REPETTI: Right, it is. Thank you very much for the presentations. I would like to remind everybody that these papers will be published in Tax Notes over the next several months. So if you're interested in following up, look forward to reading additional detail in the articles.

We're now going to take a 15-minute break, and we'll resume at 11 o'clock. And I would like to thank the panelists for a great job. Thank you very much.

(Applause)

(Whereupon, the PROCEEDINGS were adjourned)

First, professor Karen Burke of the University of Florida's Levin College of Law in Gainesville will present her paper outlining many of the various ideas that have been suggested over the years to reform the taxation of passthrough entities. She'll also discuss how a proposal to expand subchapter S and tax large partnerships as corporations might play out in a world where the top corporate tax rate is much lower than the top individual rate.

Then we'll be hearing from professor Andrea Monroe of Temple University's Beasley School of Law in Philadelphia who will discuss her version of a reform idea that's been around the block before. She'll explain why she thinks flipping a default rule so that gain would generally be recognized when appreciated property is distributed to the owners is a sensible, but in her view, not seismic way to simplify subchapter K.

Then professor Gregg Polsky of the University of North Carolina's School of Law in Chapel Hill will present his paper describing four tax minimization strategies used by private equity firms, two of which he explains are obviously illegal, mainly fee waivers and the pushing of compensation deductions down from the fund, the portfolio company. Given that use of these strategies is pervasive and that they've gone unchallenged by the IRS, he will discuss their implications for entity tax reform.

And, finally, Jim will help us -- will comment on the presentations and then we'll open up the discussion to the audience. Professor Burke?

MS. BURKE: I'm going to stand and follow Deborah's lead here, but I'm actually just using this mic so let me know if I'm either speaking too loudly or too softly.

So it's a great delight to be back at Boston College, having tried here. I'd also like to imagine that in the Tax Notes Pepperdine Symposium in 2012, I had an article which is the "Passthrough is the Missing Link." I think The Guardian changed it to "Missing Element," but I thought clearly if you're talking about corporate tax reform, you'd better be talking about what happens to passthroughs. And then I later saw the Camp proposals and I learned to be cautious about what I wished for.

Now, I need one more disclaimer, which essentially is that I, too, have a book on subchapter S. An updated book, Jack McNulty's little book, and it's just hitting the press now. You may see a flyer for it soon. So don't trust a word of what we say about how wonderful S is. I have more books on partnership tax and there I hope you will trust me a little.

My paper ends without a conclusion. And the conclusion is the part that I've really been struggling with, and so I'm hoping that you'll help me with it. Because if you sort of look around, what is happening is if we reduce the corporate tax -- not even terribly radically, just to 28 percent -- you create an 11.6 percentage point spread between the corporate tax and the individual tax. That's the biggest that we've had since 1986.

What happened in 1986 -- and let's look a little cynically about the 1986 tax reform -- is we lowered individual rights and we shifted the burden to corporations. How did individuals respond to that? Demanded corporations add in passthroughs. What's going to happen if you reduce the corporate rate? You're going to get added passthroughs and go into corporations. What I'm concerned about is in 2022 the total revenues, business tax revenues from passthroughs, is going to equal or exceed the expected corporate tax revenues. So what we are talking about I think is the individual tax system. And I sometimes think about that as how can we hollow it out even further; that's why I have trouble with the conclusion.

So I was fascinated by the Camp proposals. I did not immediately rag on them. My coauthor, George Yin, wrote and said look, we do this stuff in ALI and we decided we needed a two-tract system because sub K is very abusive. Let me just say this partnership side and then I'm going to focus a little bit more on S.

Students when they learn partnership tax learn about 704(b). I just want you to know that in practice, people have decided they can simply ignore it. It's worse than that, it's worse than that. Target allocations, not blessed by 704(b), but everybody does them. So in other words, the problem with K, with subchapter K, is extraordinary complexity and extraordinary noncompliance. And I don't mean noncompliance by small people. I mean noncompliance -- however you define them -- I mean noncompliance by hedge funds, private equity, and then the games they play have been shifting into the rest of partnership tax. Things called stuffing allocations; if you don't know about them, they're very important. Say you have a departing partner. Stuffing all the income to her gives you the equivalent of being able to deduct the purchase price of her interest at no tax cost. She's going to be taxed on gain if she got cash out. She doesn't care. Is that waffle? Of course, it's not. It doesn't have any economic effect, but you will see people say because of some technical rules, it does. And the government has not challenged it. It's the same thing with what Gregg is going to be talking about. I even thought the practice interest were legal, let alone the gains.

So what about S? Well, S -- and I think Deborah wrote a remarkably good paper on this. I mean, it's a wonderful paper. It's kind of where we are, where are we coming back to? So a really wonderful paper and I think actually many of the people that I think we should look back to as a generation of scholars. Martin Ginsburg. We all have favorite quotes that he has from subchapter K. Mine is the saying that subchapter K is a swamp best avoided and if you're really competent, don't even try it. And that's, you know, 25 years ago.

I think -- and professor Jack McNulty was gone when I took over. It was mentioned also in Deborah's paper. These are people who were thinking very seriously about even if we reform our system, isn't S a pretty good model for passthrough and it doesn't have all the subchapter K abuses? And the problem -- and I totally agree with that -- is that what the Camp reform is about? Well, the Camp reform, and Willard Taylor said it best. Willard Taylor actually supported, one of the few academic/practitioners who supported the Camp reform, and his title was "Subchapter S Out the Window?" I don't think subchapter S is out the window. My cynical view is the option 2 proposal, the so-called radical reform, doesn't see a snowball's chance in hell being passed, right? Gain recognition, but in partnerships? George Yin, head of the ALI, I'm a consultant to that. Jack McNulty was a consultant. A lot of people were. We could not get the partnership people to budge. Every time we said we need a little stricter rules, they said things are working fine. We asked about 704(b) and are there any problems with it? Working perfectly. The question is for whom? So how are you going to reform subchapter K when the people who actually know how it works are really not going to be there? And I think that's what happened with carried interest. The bar had this choice. Do we tell them this doesn't work the way they're trying to draft it, or do we just let them make a mess of it? And in some ways it's better to let them make a mess of it because nothing will happen.

So what about subchapter S? Well, here's a testable hypothesis. People elect subchapter S for the employment tax loophole, not just little people. Some of the fund managers if they're going to get fees, they route them through an S corporation to eliminate the employment tax in 1411. So let's test it. When people like Walter Schwidetzky said the only reason you pick S, this really defective blend with very limited flexibility, is because you want to avoid employment taxes. We've got to fix the employment tax mess for passthrough entities. It's not just S, it's LLCs. There's a lot of money on the table. We've got to fix it. Let's fix it. If S disappears, my book goes out of print. I mean I'd be happy to have that trade-off.

But there are, if you think about leaving that aside, there are real reasons to have a good passthrough model and I think S is a better passthrough model than K is. K has proven to be an enormous problem because of its flexibility. And many of the things that we'll talk about today -- and I know Andrea is talking about -- they stem from the 1954 flaw. The ALI had a proposal for subchapter K that was almost identical to what Phil Andrews resurrected in 1991 actually not knowing -- he wasn't that familiar with that historical doctrine. You had things called partial liquidations. You can't make subchapter K rational without a partial liquidation concept. Everywhere else we have them. If I sell 99 percent of my house, shouldn't I have to bifurcate my basis? Well, not in the world you don't and people will say oh, no, that's what Congress intended. Yes, it is what Congress intended. They changed the language when it was in the Senate because people thought it was a little too complex.

So what do we do about what they ask? What I see as a practical matter has too many corporate rates go 28 percent, 25 percent. Now S can be really abusive because now I have all this gain in the corporation. Now I'm making temporary action, caps the gain, single-level tax. Hopefully we repeal it though. I mean just 5 years I wait it out; no second level of tax on that gain, so single level tax is also a gain. And then I revert back to a C corporation. Why? Because with those low rates, I can stuff my labor into it, I can stuff my outside investment into it, and come up with some really good benefits.

So here -- and I'm going to sort of try to skip to the problem that I have in making a conclusion. I didn't want to say that the staff, the House Ways and Means staff, they worked so hard on their proposals, that those proposals didn't make any sense. I think they got -- who provided the proposals? This is tax reform without any currency. I don't know -- that funny stuff about single distributor share meaning economic interest. That's code for give us target allocations, get rid of 704(b).

If you really had gain recognition, yeah, that'd be great, but nobody thought that would happen. The farthest reaction, and I outlined it in the paper, is this is an incredibly complex way of handling mandatory basis adjustments. When you take one asset, you keep bifurcating that asset. I mean that's the most -- I don't want to say silly, but it's utterly complex and there's a much better way to do it even if you didn't agree with partial liquidations. There's a new book out on 704(c) allocations. And what the Bar said to that proposal was there's something about this we like. What we like is no partial liquidation. The gain doesn't get taxed immediately. But let's have the Treasury draft the regulations. You can't do it with staff. That's where they've done. And I mean so I simplify it as -- I'm not saying that the staff understood that that's what was happening with their proposals, but I think that's what happened.

So here's where I wanted help on the conclusion. There's an article that just got posted I think by Bret Wells about a tempest in a teapot. Why are we talking about passthrough reform? We know that everybody is going to go off to the corporate sector, so this is kind of a joke. Why worry about whether it should be S or K? It will be neither of them. I don't think that's true. But the reason I don't think it's true is this: If you reduce the corporate tax rate, I think we will at the same time -- and actually I think this is good -- we will at the same time provide a low equivalent rate for business income through all other entities, including partnerships. Sound good? Well, notice what's happening. Who owns passthroughs? They are predominantly -- most of that income goes to the wealthiest individuals. So in other words, this is what I think of as individual reform, as individual reform for the wealthiest. They get a huge tax cut. We know Republicans -- sorry -- we know it's impossible to do individual tax reform with a low rate because we just don't have the revenue, but you give the revenue benefit to the wealthiest and then we worry about 1014, erasing any kind of gains.

I didn't want to write this. The better conclusion to this movie I'd like to know it, but that's specifically where I think we're going.

So am I OK on time?

MS. ELLIOTT: You have 5 minutes.

MS. BURKE: Oh, I have 5 minutes. Then let me use it to -- can I see maybe if anyone has any reaction to what I said?

QUESTIONER: Well, where is the revenue? How do they break even on revenue?

MS. BURKE: They don't, do they? I mean we have to add something else. We're going to have to add that. So basically it's going to be wage taxes out of that. I mean I hope that's not the outcome. Let me just say for a few moments about partnership tax because here was the problem and then maybe we can talk a little bit about what the dilemma was in the ALI when George Yin and David Shakow spent really a lot of time coming up with two systems, one of which was for subchapter S, which the K people dubbed "sub-K lite." You know, it was a good system. It was a little bit more broad and that's why it can sort of start there and think about how could we broaden it a bit because I think we probably should without adding complexity. And then we tried to tighten up on K and that's when most of us, most of my academic career, you know, we know that these reforms out there, if we just tighten it here, it would work better.

I think what's happened with subchapter K, though, is every time you tighten up K you put in a statutory provision -- think 74(c) -- there are unintended consequences. It becomes enormously complex, but also people are so smart at this level -- I won't name names -- if we can create a tax shelter out of almost anything, then to me -- I remember I was very junior when I started at ALI. I remember in a lunch line saying to one of the New York partners, a very well respected person, and I just said to him -- and then he started saying, you know, we don't need to change K. It's just fine. If you don't like flexibility, don't use it. It's up to you. And I said well, but my problem is nobody's conforming. And I didn't even know all the games that were going on then. And that got sort of a brushoff. I think compliance matters. It matters for reasons that I now know. Look at the basket options. Look at Renaissance Capital. Look at the whole shelters done by the best partnership practitioners and accountants. We know how to make tax disappear. Don't give us those tools.

So I would say the best for passthrough, single-entity-level tax. Best of all and most important of all, preserve an individual income tax. The corporate tax just backs up for an individual income tax.

MS. ELLIOTT: Can I -- we have a couple of minutes. I'm curious. I mean you gave a few examples of some of the noncompliance, but how do you really know how much noncompliance is out there? There are some different opinions about how bad stuffing allocations are for entities and targeted allocations.

MS. BURKE: Actually, I can give you a great example of that. It's in the ALI study. It was actually given by a practitioner -- 99 percent of partnerships do not observe 751(b). That's the hot asset rule, 99 percent. This was a while ago. I'm sure it hasn't increased. I've had many calls from hedge funds about how to use stuffing allocations. The part of the problem, and Gregg could say this, if you actually know how this stuff works, you're better off going over to the dark side. I mean, financing you're better off. So a lot of times when people -- this is the very frustrating thing to me about the carried interest debate. I think Victor Fleischer came up with a nice thesis. He forgot the joint -- this was about joint tax arbitrage, which is the point that Gregg just made about overall if you have a loss. And then when professor Mark Gergen talked to the hearings he said it's really easy. We just fix it with 704(c) with book-ups. But book-ups are quite unreliable. I mean there's a reason why we don't want to give carte blanche to people to do book-ups. And I think the -- Gregg is going to talk to you about this, it's the new Camp proposals on private equity.

Private equity isn't a partnership at all. This is just these huge distributions coming out to the private equity managers because they can fold a deal. They have no capital account. And, finally, in a new Camp proposals, which are incredibly complex, but if you look at them carefully, they finally recognize this. We don't want an investment return on our capital because we don't have any capital. We just borrowed on an interest-free loan and probably we don't even honor our callbacks. So now we need a bill that will give us some results we want without having any zero or negative capital account. That's what that bill does. And it's on the employment tax side. The new Camp bill closed the S loophole? I don't think so. It's going to give a 30 percent deduction to all entities to exclude their income from employment taxes. And the devil is in the detail and I'm just a little concerned that oftentimes it's the people who understand the details who want the result that many of us might not approve of.

MS. ELLIOTT: Well, thank you very much. You've given us a taste for what's to come. Professor Monroe, do you want to go next?

MS. MONROE: Well, I thank you for having me here today. And I hope Karen, before we start, I have a decently small proposal, and I'm going to blame Karen for everything I have to say.

I actually had a hard time thinking about what I wanted to write about and what I wanted to talk about here. It's hard to think about tax reform I suppose generally, and it seems particularly hard to think about partnership tax reform these days. It doesn't seem like there's anything that's really going to happen. So I tried to think of that as liberating, and I tried to think all sorts of different things we could do subchapter K if we were going to start from scratch and start from the beginning.

And then I decided to go in a different direction and see if I could figure out something that was a little bit smaller and that maybe met the politics halfway. And I tried to think of something that might be sensible and might achieve what I think are the most pressing needs we have today, which to me are simplification and working on the administerability of the system. We talked about sub S being a mess. We talked about corporate tax being a mess. I guess also to jump in and say I believe partnership tax is a mess.

But Karen has written a lot of great articles over the years and she's written a bunch of stuff about partnership distributions. There was something she wrote, I don't know maybe a decade ago. There was an article and a couple of points in this article. It had a great reform proposal in it. It talked about various options for reforming partnership distributions. At a couple of points in the paper, she says, you know, if we don't clean up this mess, somebody's going to start saying we should just tax distributions. So we'd really better think about it because this is going to come back and bite us one day. And today I think is my day to see that. I think we should start thinking about taxing more partnership distributions. I don't think it's a revolutionary proposal. But it's something that once you get over I think the initial shock of it, actually might make a lot of sense in a pretty troubled area.

So what I propose I think really goes back to the Camp proposals and back to the 1999 ALI stuff. But I think that we should think about partnerships recognizing gains on distributions and appreciated property, and partners recognizing gains when they receive distributions on property or cash in excess of their outside basis. It's not a big change -- well, it is a big change in some ways, I shouldn't say that -- but it packs a lot of punch if you think about the real needs of the system.

And so what I thought I'd do today is talk a little bit about how I got there. It's been a long road for me, and I hope that might try to illustrate why this does make a little bit of sense. And the story starts I think where a lot of distribution stories start with what I think of as sort of a gateway drive to partnership distributions, which is 751(b). And my story actually starts in a partnership tax class that I was teaching a few years ago. For those of you that have had the pleasure of teaching the class, 751(b) is not usually a happy day for the class. And it comes late in the semester and it's sad times for some -- a very happy day for me, but a sad day for the other 20 folks in the room.

So on this particular day I went into class early and I started writing on the whiteboards. I have four whiteboards in this room and I start writing and writing and before I know it, the whiteboards are full. There are balance sheets and exchange tables and disproportionate distributions and proportionate distributions and it's beautiful and it's an example where 751(b) actually works, which is the rarest of all examples, and it's wonderful. I go in the back of the room to see what I've done and see how this is going and I stop and I look at the whiteboards and they take my breath away. And I think this is what I love about subchapter K. It's hard and it's complicated and sometimes it works and it's elegant and it's fabulous and I love it. And I'm sitting there just marveling at the craft and my students walk in. They sit down and all of a sudden I realize it doesn't just take my breath away. What's up on the whiteboards is also taking their breath away. And I realize that when heads started going into hands and the sighs and, again, this is an example where 751(b) really works. They don't know what's coming next. It's only getting worse for them.

And it dawns on me that I've got a class full of smart folks. They've taken every tax class they can or they wouldn't be in partnership tax. They're all going to be tax lawyers. They are all talented, and they are just mortified at what they're seeing in front of them. And it hits me in that moment in a different way than it had before, that this can't be right. This can't be the system we have because they are not the average people that have to navigate these rules. They are above average people that are going to have to navigate these rules and they can't believe what they're seeing. And it shouldn't be that difficult for partnerships to work through these rules.

So I decided then and there I'm going to write a very fast article and I'm going to write that I think we ought to repeal 751(b). It works once in a while and I think it's sort of awesome for its craft, but it doesn't make sense and there are more problems than good things in it and we should just repeal it. And I figure it will take a week or two to write and it will be easy and it'll be out the door and that will be wonderful. And I'll have learned something in class and this will be great.

And about two years later I'm still writing the article and I no longer think that we should repeal 751(b). I really sort of think we should just get rid of the whole system. I realized that the problems with distribution run far deeper than hot assets and the whole system is dysfunctional and the whole system is a mess. There are practical problems with it. On the one hand, sometimes partnerships are tax free; sometimes partnership distributions are taxable. Sometimes the partner receiving the distribution pays half on the distribution; sometimes the partners that aren't receiving the distribution are taxable. It's really hard to make heads or tails of what the rules are and as a result, a lot of people just ignore them and 751(b) is one example. But they're largely in a breach, and compliance is a problem. That's a big problem.

So you've got practical problems there, but there are also theoretical problems with distributions. We try to achieve so many goals through these rules that we actually don't really achieve any of them. On the one hand, we want to preserve every partner's share of unrealized gains and losses through the distribution rule. And then we want to preserve the character of each share. And then we'd like to preserve basis. Then you want to maximize nonrecognition and we want to do all of this in a simple and an administrable way, and the truth is we can't. And for the most part we sacrifice complexity. We sacrifice administerability, but we sacrifice the rest of the goals as well. There's great use in the area. We've eroded the nonrecognition rule dramatically through the antiabuse rule after antiabuse rule.

I think if you dig down, the problem ends up being the nonrecognition rule. The problem is just 751 as it is drafted and at the base of the system. Whatever the policy justifications are for nonrecognition, I'm not sure that they support a rule as broad as the one we've got and that's what's led to the complexity and that's what's led to the abuse.

And I think the truth of it ends up being that distributions -- in a lot of cases distributions are actually the appropriate time to impose tax. We may not do that for a lot of reasons, but it's the right time. It's a transaction in which taxpayers are terminating investments and property. I mean that's partnership interest. And that makes sense and once we move away from the economic consequences and the real underlying transactions, that's where we get into trouble.

So the conclusion I came to was that we needed a theoretical flip of the system. We ought to start first and foremost by thinking of distributions as taxable events and then think about carving out the situations where nonrecognition might be appropriate. But we need to just sort of flip the thinking and flip the paradigm for distributions. And basically the conclusion I came to was the opposite of where I started -- 751(b) is a bad provision. It has more flaws than good things. It is a bad, messy -- but fun -- provision, but it actually got the theory right on a lot of fronts. It starts by thinking of distributions as taxable exchanges and there is something to that. And so maybe the one problem about 751(b) that we don't talk about as much as we should is that it just didn't go far enough.

MS. BURKE: But Congress changed it. They do. They changed the whole premise. That's why it's a problem.

MS. MONROE: Yeah. So that's what I started with. I started with flipping the premise. I need a partial liquidation rule. Karen was absolutely right about that. I put in a full fragmentation system. I had great fun writing this paper. The trouble for me is that there have been so many proposals over the years to overhaul distributions, and they've all been fabulous and they're all far smarter than I. The only problem that I saw with them was that they make a different trade-off between how much nonrecognition you want to preserve and how much complexity you're willing to sustain.

You can fix the whole system with it by basis adjustments, and we probably would have had a better system if we'd started there in 1954. You can do that. You can fix the system with a more modern approach. You can look at 704(b) or 704(c) and book-ups and you can do that as well, and it preserves more space for nonrecognition. But it's really complicated. It doesn't give you enough of a break on complexity. And so the more you're willing to part with nonrecognition here, I think the more room you get to simplify the system. And this is a system that certainly needs to be simplified.

So that's what I did. The only problem with it was I was never happy with it and I never liked it and it was one of those articles that I wrote that sort of got out the door, but it always bothered me because I never quite felt like I said what I wanted to do and I never felt like I achieved what I really wanted to achieve. And the problem to me was that I hadn't made things as simple as I had hoped I would. Full fragmentation is really complicated. There's a reason that we don't use full, full fragmentation. Partial liquidation rules, which would be one of the best things we can do in this system, are really complicated to figure out. There's a reason that we've debated it and never done it. And those were the things that I built my proposal on.

So it always troubled me that it was too complicated and I also sort of had the sneaking feeling that if Congress was ever really going to think about reforming partnership distributions, this was not going to be -- these would not be the tools. It was more likely than not that they'd go with something that was 704(c) -- based and it probably wasn't that realistic.

And as I thought about it and I fretted about it and I tried to figure out what I did wrong and what I could do better, I ended up coming back to Camp's proposals and to the unified passthrough proposals and what they did with distributions. And it's not flashy and it's not perfect. I do not mean in any way to suggest that those are proposals without problems and without controversy, but there's something about them. I think, again, once you get past the initial sort of shock of passthrough distributions, it makes a lot of sense. If we thought about passthrough distributions, passing more distributions, it better achieves a lot of the goals we care about here. It allows us to better preserve the gains and losses to particular partners. It allows us to better preserve the character. It allows us to actually think about really simplifying subchapter K. You could talk about repealing 751(b). You could talk about repealing the missing goal rules. You could even talk about repealing the disguised sales rules and you'd have less partnership distributions that would require inside basis adjustments, which is a really complicated thing to do. Those are real tangible simplifications that would go a long way towards I think making subchapter K manageable for a lot of partnerships that it simply is not manageable for these days. And it's not just the partnerships; as Deborah said, it's their advisers as well.

So it started to make a lot of sense. And, again, it's a more appropriate time to tax a lot of these transactions. It's consistent with the commercial reality of the distributions. It's consistent with how we think about distributions all along the business end of the spectrum. And the truth is, it's probably pretty consistent with what subchapter K does today except for the fact that it's so complicated that nobody understands what it is that it's actually doing. But I think there are probably a lot more distributions today that are subject to tax than folks actually understand.

But like I said it's not perfect and it has its own problems. One could certainly say it's overbroad and it's going to accelerate gain on certain distributions. Karen has said many times it may result in the taxation of more gain than it should for particular partners if you take up your aggregate for things and that may be right in some cases. I would probably say that the law right now is also overbroad. It just cuts in a different direction.

There are also practical problems. We need to think about what to do with partnership mergers and partnership distributions. As we adopt one set of rules, we probably have to think more about the robust use of antiabuse rules here, think about 701-2 again, things that we don't always love to see and think about in the partnership world. But I think the most important thing about it is we shouldn't let the partner be in another year. This may be a second best answer and it may be a flawed answer, but it also may be the least flawed option on the table.

So I know the Camp proposals weren't that popular, but I think this one might be worth a second look just for subchapter K. Thank you.

MR. POLSKY: So I'm going to talk -- my paper's really sort of an anthropological study of sort of the largest and the most sophisticated partnerships and their advisers out there and seeing if we can draw any conclusions that are relevant for ending tax reform.

So I'm going to use most of my time sort of describing what's going on out there. Some of this is a rehash of stuff I've done, but I think I've put it together in a way in my own mind for the first time to see how they all sort of fit together.

So the four -- I call the four games that are played by private equity firms. Carried interest, which converts ordinary income to capital gains for all the risky pay that private equity managers receive. A manager's fee waiver, which allows them to convert ordinary income to capital gains for even their nonrisky pay. Then they have a misallocation of the expenses, the manager's out-of-pocket expenses, they're all allocated to the management fee. The effect of that is to convert even moreso ordinary income to capital gains for non-risky pay. And then, finally, through some moving around of deductions there's some corporate tax avoidance thrown in there for good measure.

The implications for tax reform: I have a narrow sort of implication for carried interest reform that we can learn from this, and then sort of broader implications.

A disclosure? I have a disclosure. I don't have a book on private equity tax or partnership tax or S corp, but I am co-counsel for whistleblowers that relates to some of the things we're going to be talking about. So maybe I'm wrong, but I can tell you I'm not influenced by my mentioning these claims because I'm absolutely confident that I'm right.

So are there any private equity tax lawyers in the audience? OK, so that's good! So I won't get shot.

So starting off, what is private equity? Just some private equity background for the uninitiated here. Private equity funds are private pools of capital. They go out and buy portfolio companies using a lot of leverage. One key characteristic is that the investors are mostly tax indifferent. You're talking about CalPERS, other pension funds, foundations, foreign taxpayers. They don't pay U.S. taxes. A fund is a partnership for tax purposes, so that's why it's relevant to this discussion. The fund realizes mostly long-term capital gains and dividend income, so they recognize mostly tax-preferred income. The 2-and-20 compensation range that managers get paid to income strings, the 2 percent annual management fee is like their salary; 2 percent of capital commitments, it's their fixed pay. I call this the non-risky pay. They get that. It doesn't really matter what happens with the fund. Then they get 20 percent of the profits; that's the profits interest, the carried interest. That's the incentive pay. That's the risky pay. Sometimes there's a whole rate, sometimes there's not.

I'm going to leave out some of the nuances here and try to get through these slides. My friend, Brent Hailwood, when he saw these slides, said you're going to get through these slides? I'm like no way. So I'm going to try to get through them so I'm going to talk faster than I can. I don't know if that's possible.

Modern transaction fees with offsets from portfolio companies, I'll get into that later on. The GP is required. There should be some capital. The LPs made the GPs put some skin in the game so it's usually at 1 percent, maybe a little bit more at Bain at 10 percent. So when you put it all together -- well, this is the 2 and 20, more detail here. Again, the key here is ordinary income if it's a management fee. If it's just your salary and it's your nonrisky pay, then your carried interest because of the revenue procedure -- I know Karen thinks the revenue procedure is wrong. I'm assuming --

MS. BURKE: It doesn't apply.

MR. POLSKY: It doesn't apply. There's all sorts of reasons why it actually doesn't apply, technical reasons and just philosophical reasons surely. But the allocations come out as capital gain and that's your carried interest. So here's a structure here and there's your carried interest, the additional 20 percent of the profits. If you have 1 percent for your capital interest, management fee -- these are separate entities, but you can think of them as one economic unit. Bain owns all of these and they just set up a different GP for each private equity fund that they sponsor.

So strategy 1 -- I don't want to belabor this because this has been talked about a lot -- but carried interest of current rules the way they work, notwithstanding some technical problems maybe, is that the carried interest 20 percent comes out of this partnership as capital gain. So gain does all this work. Their partners get capital gain. Their managers get capital gain because when they sell the company, it comes out as capital gain. There is -- and importantly this is the joint tax perspective that Karen mentioned, that we talked about -- because we've got to take into account the counterparty -- the counterparty in theory is losing an ordinary deduction, so you might think if one gains, the other one loses, who cares? But because of the tax indifference of the investors, it's a pure taxpayer win here because the investors don't care about converting ordinary deductions to capital losses.

So I just -- to illustrate this, if you assume there's $100 incentive fee to get structured as a $100 fee or $100 carried interest allocation, contingent fees like lawyers get. You can have it be a fee. So what if you had it as a fee, so up here there's a fee that managers' 20 ordinary income, the investor here would have a 100 capital gain because they're recognizing all the capital gains, then they're paying the 20 to fee. That's an ordinary deduction, so you get this result here. Now if we structure it the way we do structure it now on the carried interest, now the manager gets allocated 20. That's that character conversion that everyone talks about.

Here you've got a similar character conversion. Here the investor doesn't have a 100 capital gain and 20 in ordinary deductions. Now there's an 80 to capital gain because 20 just sheared off. You can deconstruct that to 100 capital gain and 20 capital loss and you can compare that. Everything's the same except ordinary deduction to capital loss.

So in theory, the joint tax perspective could do some work here, but in practice the investors don't care about deductions. That becomes important because all of these strategies make sense because the investors are tax indifferent. If the investors were higher-rate individuals, none of these strategies would make any sense. And then even if the investors are U.S. individuals because of section 67 and AMT, they don't get as much of a benefit anyway, so little harm to the investors at all.

Second strategy has gotten a lot of attention recently, management fee waivers. So you say I have non-risky pay. I have salary. I would love to convert my salary to capital gain. How do I sign up? And the managers are saying I get all these capital gains. Can I get more instead of this ordinary income? So they try to convert their management fees to capital gains, and they do this without changing the economics of the deal. No one disputes that they went from 2 and 20 to 0 and 30 that we have all the capital gains, but they're just going from 2 and 20 to a dressed-up 2 and 20 deal where they've taken the 2 as capital gains. It's been going on for 15 years on the current IRS tax plan. Rumors are they're going to have guidance out by the end of the year. I'm hopeful that they will, and I'm hopeful that it will come out the right way.

So how do these work? Management fee waivers or a fee is due. You waive it in advance. You say OK, don't pay me that fee that's due next year. Instead of paying me that fee, however, the next time I have to make a capital commitment, you're going to make the capital commitment on my behalf. And then when you make the capital commitment on my behalf, I'm going to get the distributions from that capital commitment just like I made it in cash. Now, if we stop there -- that's step 4 -- we'd have a problem because it's a clear capital shift and would be immediately taxable. There's no doubt. So they have put a bell and whistle on it, but the bell and whistle that the lawyers put on it as they say, yeah, you'll get distributions with respect as cash as contributions just like if you made it in cash. However, we're going to condition it on you have to have enough available profits or available gains after the fee waiver or else you've got to give it back or you won't get it. And available profits and gains are generally defined as just positive items, so available profits would be your net income in an accounting period. You don't take into account loss periods. So if you made $500,000 in one period and then you lose $500,000 in another period, you still have $500,000 in available gains, not real economic gains. You have zero economic gain. And then available gains even more aggressive in the sense that you just count all your winners and you don't count your losers. And they use that to avoid the taxable capital shift and they try to fit within the revenue procedure. And they think this works.

Here's an example of $1 million fee. Don't pay the $1 million. The fund calls the 100 capital. GP's got to put in $1 million. They say OK, don't put in $1 million. GPs, LPs, you put in $100 million. The company's then sold for $200 million. GP still gets $2 million like he contributed $1 million. And now GP claims he's got $2 million in capital gains. The comparison was $1 million fee had it come earlier. So, yeah, you've got the deferral here and then you've also got the character flip. And how many available profits do we have? Well, we have $100 million in available profits. That's the only exit in the accounting period. You have $100 million of gains and $100 million of income. That's available profits, so that would be supported and maybe get that.

It doesn't work; 707(a)(2)(A) hits this. When this was going on -- this came out in the Mitt Romney -- when Bain waived a $1 billion of fees that came out that offered documents from staffers, and they said this is bad. How do we stop it? They said you already did. You have a statute that's designed to deal with this. What more do you want? You want to make a more specific statute? It can't be more specific because it's got to capture the whole universe of things. I don't know what more you can do. The legislative history says we're concerned about this sort of stuff.

MS. BURKE: But, Gregg, you don't have the regs.

MR. POLSKY: Right, we don't have the regs, no regs. I know, we have no regs. And the 707(a)(2)(A) says look, if you have these artificial partnership arrangements that lack entrepreneurial risk, we're not going to treat them as -- we're going to treat them as compensation, not partnership allocations. Where's the entrepreneurial risk? The risk is basically that I'm never going to have a positive accounting period. That's basically the risk Bain saved $250 million.

That's just one -- and this is the thing that really annoys me because if you look at these agreements, and I've seen a few. Naked Capitalism got his hands on a bunch of them. They don't even define the term "available profits." They say the clawback is if there are insufficient available profits. They don't define what that term means so they can decide whatever they want it to be. They don't even bother to paper this up the right way. There are other firms that are very detailed and they'll have lots of very complicated definitions, but there are a lot of firms -- in fact, and I'm not talking out of school here because these are public. There are two fund agreements that were disclosed that were run by Simpson Thacher that had no definition for available profits. They could make it up. And another KKR fund that was in that document down to Naked Capitalism -- had a clawback that was modifiable at the will of the GP. So they could change it however they wanted it without LP's signing off. I don't know how that works. It doesn't work, so Karen Burke, everybody mentioned Fleischer. I mean these are all -- Ed Kleinbard who was at Cleary, right? It doesn't work. It doesn't work.

OK. Strategy number three, misallocation of expense and time management. So you can say carried interest is legal and I don't think they're doing anything wrong with that. I mean we say it's wrong. I know there's some technical arguments that maybe the IRS can pursue. It's not going to happen. That's going to require lots of change. Strategy two doesn't work. The IRS hasn't gotten around to enforcing the law. Strategy three, perfectly legal. And this came to me kind of late but, you know, these private equity firms they have a lot of expenses. They pay salaries, they pay rent, they pay things, and they allocate legally all of those expenses to their management fee income. So whatever is left after they waive their management fees they can then zero that out effectively using all of their cash comp. In theory you should be allocating. You've got two streams of payment, you should be allocating your expenses reasonably between the two streams of payment, but I don't think we'll talk about (inaudible) anymore -- allow this. And so that's wrong theoretically, but -- and so what it's saying here is that the expenses, and they get to use those expenses off the management fee and the carried interest does not get reduced. So the effect of this if you look at it -- I just showed an example -- if you have a $100 management fee in year one, $100 carried interest in year two, $100 expenses in year one, equally allocable to both, they're equally important to both, the theoretical result, you should have $50 ordinary income and $50 of capital gain. Under current law you get to wipe out all of your management fee income with your expense -- zero; you have $100 capital gain. The effect is to swap ordinary income for capital gain plus deferral which is what the fee -- whatever it does. So all of these convert ordinary income to capital gain.

Finally the last one is -- OK, when we do have fees at the fund level we don't really like those fees because the expense, the deduction is allocated to the tax in different investors. CalPERS doesn't care about deductions so why want CalPERS to get deductions, we don't. But the portfolio companies down below are corporations. Let's put those deductions down at the corporate level. Well, how do we do that? The way they do that is they charge monitoring fees. A private equity firm charges monitoring fees to the portfolio company. And the investors, they don't like that because they say wait, isn't that why we're paying you the management fee? So they say OK, let's offset these fees. We have a management fee offset. So for every dollar you receive up here you reduce the management fee by a dollar here or maybe 80 cents. Mark Maremont is in the crowd; Mark Maremont just wrote a great article in The Wall Street Journal talking about how termination of monitoring fees are -- it's -- appear to be going by the wayside. But the effect here if it's 100 percent fee offset then you're just moving deductions from this level down to this level. And the question is then can you take these deductions at the portfolio company level, are they allowed? Five minutes? OK. So under 162 you've got to have compensatory intent. So I looked at these monitoring agreements and I said do they have compensatory intent? And you look at them and they're crazy. They are 10-year terms, lots of money, total management discretion as to when -- this is explicit, this is not reading between the lines -- management gets to decide when, how, and which services must be performed, no known service obligation, negative description, long-term contracts. Many of them have termination fees where they can cancel at any time, the service provider can cancel at any time and get paid the full present value discounted by the U.S. Treasury rate of the future payments. Where's the compensatory intent there if I can just stop and still get paid? Pro rata distribution when you have multiple private equity funds involved they'll make the -- the fees will be pro rata from the share ownership. So these seem completely inconsistent with compensatory intent. The theoretical answer is the fund is more. The services are being performed at two levels. There are services here being performed and there are services here. There's no doubt that there's both. Selecting investments and the like, there should be some allocation. They don't even purport to allocate it. It goes all to the extent the monitoring fees are just these fixed amounts. So these deductions should be disallowed.

So what are the implications for partnership tax reform? One on carried interest, if we took away the managerial tax break then you'd expect them to do the second best which is push all the deductions down to the portfolio company level. Mike Knoll wrote about this. He said this is going to be the response. What nobody has written about yet as far as I know is that how would they do it. Well, one way to do it is just juice up the monitoring fee arrangement. The IRS doesn't get involved and stop monitoring fee arrangements. The way they work now they'll just do that. You know, they'll basically have the outside supply of carried interest. And everything will move down into the portfolio company level.

Broader implications for any tax reform -- so I'm still working through this but obviously one is again the taxing different partners makes all this stuff work. Just an incredibly bad IRS regulatory enforcement here. And again the role of elite tax bars, something I've been thinking about lately -- this can be like humor. (Laughter) These are the old-style thoughts about what tax lawyers are supposed to be doing and how they're not supposed -- they're vested with the principal responsibility to the public to uphold the law. So this as contrasting that sort of stuff with, you know -- these are the elite firms that have crafted fee waivers. I mean they're all rankings. I mean the top of the top. These are all elite firms. What sets them apart, they do private equity work. All the private equity firms do. Simpson Thacher rates the worst I've seen. Even though again this is the same slide sort of, ACA monitoring fee agreement, this was -- just to give you an idea of pro rata -- the Frist family was a co-investor so they gave pro rata to the Frist family. Within the Frist family they gave pro rata to the family members. Patricia Elcan, she got $10 million. She's identified there in her own period as a homemaker. (Laughter) HCA, so 200,000 employees nationally helped pay the $10 million for consulting services to a homemaker. HCA was Simpson Thacher, Bain, Wesbrooks, Proskauer, Sullivan Cromwell. I don't know -- you know, I don't know how it happens. I don't know how they do it. I don't know how -- it had all that, the termination fee, everything terrible. I don't know how it happens. Is it any better than corporate tax, but.

Last thing is Monte Jackel's Tax Notes on the comment. I just thought this was great. I now think that things have changed that much from tax shelter days, at the outer edges things, yes, (inaudible). The cookie-cutter deals are gone but if you look beneath of the hood other wonders will be found in practice today. But to find those wonders one needs to have effective IRS auditing occur. Knowledge gap and the like, either we may perform in these areas where we didn't in the past. And then I just -- Lee Sheppard quoting Monte Jackel in an article on fee waivers, said Polsky is right, I think he is in the waiver of the fee is treated as a tax (inaudible). So I think Lee was giving the line Monte Jackel might be saying that one of the wonders of the modern tax practice is in fact these fee waivers. And so what does that have to say about any tax reform.

I've sort of run out of time, but hopefully there's some implications there. (Laughter) Thanks.

(Applause)

MS. ELLIOTT: You want to make some comments?

MR. REPETTI: Sure. I'd be happy to. Let me try to tie this together. I think the papers were excellent. And I'm sure there are a lot of questions that want to be asked on here, but let me try to tie it together with some of the things that I think are underlying the papers. First we've all been brought up learning partnership tax or reading about it and I hate to say it but in my book we start with this concept of entity versus aggregate. I think what we're seeing now is that that concept is totally misplaced and useless. We really shouldn't be worried anymore about whether it's something that's being taxed looks more like an entity or looks more like an aggregate. In fact in practice most of the entities that are formed are clearly more entity-like than they have been in the past. They have limited liability, they have centralized management. The notion that aggregate applies anymore is irrelevant. Even law partnerships which were at one time the classic general partnership are now limited liability entities. So we need to totally discard the notion that we start our analysis by asking is this more entity-like or more aggregate-like and then trying to determine which of the features should be dominant for purposes of then trying to wrestle with the tax implications. So what should we then think about? Well, even if you discard the notion of entity versus aggregate you still might decide that you want to have a flow-through tax system for efficiency reasons and for equity reasons. For equity reasons given the flip that we have now in the tax rates with corporate tax rates lower than individual tax rates you can make a stronger argument as many of our panelists have discussed for flow-through taxation in order to preserve vertical equity, to preserve progressivity. You can also make an argument as also has been mentioned quite frequently today that a flow-through entity may be more efficient by helping reduce the wedge that we have now on some of our business profits. That's point number one, eliminate aggregate versus entity.

Point number two, in our system when we're dealing with subchapter K and this clash of classification, we're creating boundaries. And whenever we create boundaries that's when we create complexity. Now on the boundary that we create in addition to this notion of aggregate versus entity is taxable income versus economic income. And this was referred to in the first panel, I think Dan and Deborah refer to it, and it come to floor in the notion of partnership taxation because of this notion of trying to keep track of capital accounts, trying to keep -- have a tax follow book so that there's some semblance of economic reality. The problem is that the castle crumbles, it's a sand castle, because in fact the income that is being allocated has no relation to economic income. We have accelerated depreciation, we have nonrecourse debt. Just as an aside when I first started practicing at Ropes & Gray one of the tax partners had been in the solicitor general's office and I asked him what he thought was the biggest mistake that they ever made and he said without blinking, Crane. Absolutely. You know, we let the horse out of the barn with Crane. And one of the things that I think we need to focus on now, and if we really are going to have some sort of realistic tax reform is maybe we need to revisit among other things that have been discussed today very ably this notion of our treatment of nonresource debt.

The third principle that I think sort of summarizes and ties a lot of the comments together is this question of enforcement and compliance. Flow-through entities have the lowest by far audit rate. It is truly astounding how low the audit rate is for flow-through entities. I often tell my students at the end of partnership tax that they have joined a very elite group of about I think maybe 1,000-2,000 practitioners in the United States who actually understand 704(b), understand 751, and 752. The sad thing is that unless they continue and practice in the area they will forget it the following year because it is so complex. This complexity has created significant enforcement problems. There is a lot of gold out there that could be acquired by auditing more flow-through entities, by auditing more partnerships. And we're leaving a lot of money on the table as a result of the fact that we're not doing that. I suspect that part of the problem, part of the reason that we're not doing that is because we don't have enough trained personnel in the IRS who know which questions to ask and know where to look where the bodies are buried. Traditionally we look at the return on increased audits and traditionally the number has been up as about a $10 tax revenue increase for every additional $1 that we devote to compliance enforcement. At least that's the number that's been bandied about the last couple of decades. I would venture to guess that with flow-through entities it's significantly higher. Most tax accountants who are doing subchapter K returns do not know about 751, they do not know about 704(c), they may be vaguely familiar with 752. There is a lot of gold out there that could be derived from increasing the audit rate.

Now with those three general principles let me move to a few comments on some of the papers which again I thought were just excellent. With respect to target allocations, Karen mentions target allocations in her paper, I wonder whether -- I think the horse is out of the barn on that one. The only people who worry about 704(b) now are advisors who are forming real estate partnerships in which tax-exempt investors are taking a partnership interest. You know, when your pension fund, your university endowment, is investing in a real estate deal they want to make sure and they will ask for an opinion that the partnership agreement has substantial economic effect under 704(b) because of 514(c)(9), which creates a safe harbor for UBTI purposes if your partnership agreement complies with 704(b). We are the only people left on this planet who --

MS. BURKE: Tax shelters.

MR. REPETTI: Right.

MS. BURKE: And tax shelters.

MR. REPETTI: I'm sorry?

MS. BURKE: And tax shelters.

MR. REPETTI: Right, right. We are the only people who worry about this and everybody else is engaged in the just normal target allocation rules.

MS. BURKE: But if we get the proposal that people want on target allocations we'll fix those for the (inaudible). They wouldn't have to worry about it either.

MR. REPETTI: Well, I don't know. And that's going to bring me up to my second point. The point is that do we simply give up with target allocations? Do we simply say, OK, target allocations are OK? What would the world look like if we said that they're OK, what would we worry about? What we worry about then when the partnership is wound down that it turns out that the allocations didn't in fact reflect the economic burdens and benefits that were being borne by the partnership deal. So one of the things that we have to think about is expanding the statute of limitation to be able to go back and open up the prior years. We also worry about though, even if we can do that, we worry about deferral. There will still be an obvious incentive to try to allocate losses in such a way that you're maximizing the after-tax benefit for the partners and then worry about paying the piper down the road. So we might also start to think about having some other interest charge that might be imposed in addition to what we now have for tax deficiencies in order to discourage that. I suspect that -- I'm fine, it's in (inaudible) now and it's a terrible thing to say as somebody who teaches partnership tax, but I think that we really need to revisit the notion again of eliminating special allocations entirely and so that we may be able to reduce the concern about target allocations that way. But I'm going to leave that for the audience to discuss more and it needs a lot more study.

The notion of 751(b) that Andrea talked about I think is a great idea. I think that it's consistent with the notion that we're dealing with entities, that since we're really dealing with entities there's no reason to make a distinction have 311 apply to subchapter C and subchapter S and not apply to these other organizations that look just like the entities that we're dealing with. So I think that's a great idea and I think it's an example of how we need to discard this notion of aggregate theory applying to partnership taxation and start to think more about the underlying notions of efficiency and equity that we're trying to achieve.

And lastly with respect to professor Polsky's article, Gregg's article, I think that it was very interesting to have this presented in one place. I think you were being too modest. You were saying well, this is something I've written before. True, but bringing it all together I think is absolutely brilliant and it's going to help policy analysts really understand what's going on. And I think that, you know, one of the questions that I have, and then I'll open it up now for general questions, is this notion of entrepreneurial risk. Going back to my principles, one of the principles that I discussed about taxable income versus economic income, what is entrepreneurial risk now? In a world with accelerated depreciation, non-recourse debt, maybe we need to go back and revisit 707(a)(2)(a) as well and think about some other system that could be used to try to distinguish the various types of payments that we're making, or maybe we need to eliminate the distinctive tax treatment entirely. Maybe the notion should be that we simply have one tax regime, which is again why I'm getting thrown back into liking subchapter S so much, have one tax regime that's going to be applied to all tax distributions.

So with those comments, and again the fact I thought these papers were wonderful, let me turn it back to the moderator for questions.

MS. ELLIOTT: Does anyone have questions? Yes.

SPEAKER: Yeah. I have to say, and I haven't been as active in the Department of Tax, I'm kind of shocked by the degree of fraud that you guys are describing. And my first question is should be people be going to jail? As we all know (inaudible) people went to jail. By "people" I don't want name individual firms, but should prominent tax lawyers be going to jail which has happened before, so I know that's a -- I'll ask that first because that's --

MS. BURKE: Yeah. I think on most of these issues with a sufficient degree of uncertainty. When people went to jail (inaudible) was not their truly horrendous opinions.

SPEAKER: Oh, right, it was the (inaudible).

MS. BURKE: But backdating, et cetera.

SPEAKER: Yeah.

MS. BURKE: So that's the problem. It isn't fraud but it does indicate that something has happened in a fashion.

MR. POLSKY: And I would just sort of just agree. I mean the monitoring fees -- I guess part of is the benefit of crowds or the Wall Street or whatever writing, but it's like, you know, you look and you're like in a zebra pack and you're being chased by the lion, you just don't want to be the slowest zebra. And they're all looking around like oh, those zebras are pretty damn slow so I should be OK. But, you know, you have -- four firms signed off on that agreement.

MR. REPETTI: Yeah. I don't think the wisdom of (inaudible) should save them because if they're claiming for it, but obviously Karen's point is more difficult.

MS. BURKE: And I think what is -- I mean, you know, my sense of this is that who actually writes the regulations, who actually understands what's going on subchapter K? There is a revolving door and I'm not criticizing the people who are in the revolving door, but when you revolve out a big accounting firm and you revolve into righting regulations you have a mindset that already exists. And nobody else understands your stuff which is why I think, you know, people get away with it.

Can I just say one thing on target allocations because what's happening is really I think absolutely fundamental. It came originally from private equity. That's where the regs all got started. But what target allocations do, there's nothing in your agreement that says how income gets allocated. It's all about how do the distribution tiers go. So who allocates the income? It gets allocated by the accountants you go to. And, you know, so you all shift your lines to the accounting firms and the accounting firms are now getting a little nervous about this. They're the ones that want to make target allocations legal because they're really uncomfortable, but once it's down in the accounting firms to do the initial allocation, I mean -- I'm not -- I don't want to seem totally cynical, but I can't track what they did, the government can't track what they did, and human nature I think indicates just do the best allocations for your partner. And it is that there are capital shifts going on all the time every day and, you know, the hope is it's like private equity. Hope is in the end it will be rectified, everything will turn out rosy, but there's no guarantee and statute of limitation is probably expired. And on the enforcement side it's 0.08 percent of partnerships were audited in 2012 compared to 27 percent of corporations.

SPEAKER: Because if you audit more of them they'd complain to their congressmen. (Laughter)

MS. BURKE: And the other thing is when do you audit them there's a kind of minimal adjustment. That's what the TAO is coming out with. Why? Because there's nothing there? There's no gold there? No, it's because of all these multiple tiers of entities and apparently the IRS can't match the tiers. And three years and the audit is over. I mean I know how to run out three years. And they know how to do it much better.

SPEAKER: I just have one other question which is totally different which is say we get rid of special allocations, of course in some cases as well all know the a hypothetical special allocation actually does match the economic reality, so if you get rid of special allocations does that mean you simply play the game the other way around where you put two people in a partnership, they need to keep their own return because they know special allocations you get to have fun, kind of the opposition direction to the same end?

MS. BURKE: To me or to Gregg? SPEAKER: Either. Yeah.

MS. BURKE: Yeah, look, the comment on special allocations, many special allocations are efficient, but many are really for economic purposes. I would let them make their economic deal be as complex as they like, but that's why you want a single entity level tax hopefully at the highest individual rate. Because you can't -- the government shouldn't be in there trying to figure out which of these allocations was for business purposes and -- when the tax payer has got all the information. And then you add in multiple tiers and you can't even figure where the source was, let alone its purpose.

SPEAKER: Well, I just don't know how you would outlaw special allocations when it has flow-through models though. I just don't see -- I've never understood how that works.

MS. ELLIOTT: So that question goes to everybody. I hear there's a problem of enforcement. The IRS doesn't audit and when they do audit we don't know how many cases do get to the Court. I want to ask all three of you what role do you think the Court can plan in solving some of that problem? Back in the 1920s we had those shoulders using the sequel portion and then we had a lot of judicial doctrines that this absence of a forum, transactions of business purposes. Finally we had 7701 be enacted with the economic substance. Do you think we're there? Do you think it's not even being brought to the system, to the judicial system to work through this? Is there any help of solving those issues through the Court system?

MR. POLSKY: So the optimistic view of some of the stuff that I talked about is that it's just a matter of time that, you know, the corporate tax -- when I gave this paper to Larry Zelenak to look at it he said, oh, this is really pessimistic, but who's not to say that five years from now we'll be looking back at this and we'll be like where we are now with corporate taxes. It's like, oh, you know, they lost, you know, tax payers lost and some people went to jail, there was a lot of penalties and maybe it's just the wheels turn slowly. I'm not an optimistic person by nature (laughter) so that doesn't make sense to me, but I'd love it to happen on many levels.

MS. BURKE: You know, I actually got involved in writing a lot about first corporate tax shelters and then private tax shelters and I thought the government was kind of undermanned and I thought if I made these arguments they'd resonate, but it was a -- it's a fun thing to do. But the biggest case is the General Electric case. This is the capital (inaudible) case. 704(b). No court wanted to touch it. I mean McKee wrote the regs and he wrote the shelter and McKee and Nelson were arguing for the taxpayer. But Court sort of reached back to Culbertson from the 1930s and, you know, it didn't have any substance. So the government won on two appeals in the Second Circuit. They had I think at least three trips in the district court, the district court fellow was like mesmerized by how interesting this was. And they ended up with actually -- and they never had to show their tax opinion, which I think would have detailed the no business purpose. They never had to show that. They lost but they ended up with virtually no -- they should have gotten a penalty but they didn't end up with one. I mean theoretically they got one, but it fell down the bottom. So the last district court opinion said but no substantial -- it's a substantial overstatement penalty. For some reason they didn't substantially overstate.

I mean the courts have done a great job but this is not the way to run the system. And I just -- to me what bothers me always about the partnership tax -- although I love it and love the game -- is the lack of transparency. If the public doesn't know and Congress doesn't know what's happening how can you say this is a fair system? And I think that the whole lack of enforcement -- why wouldn't you write that opinion, right? 0.08, which isn't a lot. I mean I know you can't consider that but --

MR. POLSKY: Nobody writes opinions on fee waivers by the way. It's all that you do it, you render no opinions.

MS. BURKE: Yeah. And that's facts and circumstances.

MR. REPETTI: I think we've got to step back a little bit. I'd like to take on the enforcement question and then be sure Eric gets a chance because he knows a lot about partnerships in Germany. We might get a real perspective here. But the law firm involved -- you know, full discloser, I'm a retired partner of Ropes & Gray. I still occasionally consult and it's on my website. I see a whole series of problems here involving enforcement that are structural and very, very important. And the role of elite firms is I think has evolved and I thinks it's worth thinking about that first. The law firms that are writing the provisions you're talking about, the real question is -- there's only one real question now as a practical matter and that is is there a return position? And if there's uncertainty over the way we construct our equitable there's going to be a return position if you have more than one in three chance. Then the question is but wait a minute, what about substantial authority, what about more likely than not? Then you get into what the real pressure points are in substance, you know, where you are. Because let's say you're not at more likely than not -- the key point is does that matter? And here is break point that I don't think we focused on enough. How can companies care about more likely than not because of financial statement reserves? Private companies in the private context which is as we've been talking about a much larger part of the context, this goes back to the leader of (inaudible) point. That is much less important. It is important if you think your company is going to go public such that you want a couple of years of financials that are pretty clean and other than that who cares. You don't need more likely than not. A manager may care, but so I think we -- to unpack the enforcement problem there is -- I don't think there's fraud going on, I think there is a real problem, but I don't think it's fraud. I think it's the way we've constructed our incentives for giving legal advice. And it's true that there's really virtually no oversight looking at that.

The other point I would observe is the change in culture in large law firms. It is now -- I was really struck -- when I -- I sent my name to a number of large law firm partners -- I sent my article on conversion regulations, and more than a few reviewed it, gave me excellent comments, and said please don't mention my name. That wouldn't have happened 10 years -- maybe 20 years ago. I don't know how far back I have to go, but I know the world has changed. Look at the number of times -- one of my heroes is Martin Ginsburg because he not only killed the revenue every time he practiced for a private client, he then went and was seminal in the Installment Sales Act of 1980, seminal in the Subchapter S Reform Act. He then went and contributed his time after to the public bar. I think I've counted here two large firm active partners in the audience and my hat is off to both of them that I can identify; there may be more. There is no incentive now in the large law firm to do any of that. And indeed there is potential for real disincentive. So I don't know how to answer that, but I do know one thing. The monitoring of the tax system is not by the IRS, it's by the professionals. We've known that for a long time. It is now happening almost exclusively in the public company arena where accountants are being monitored by second chair accountants because of Sarbanes-Oxley and having to go to the audit committee in order to have -- to the same firm to give you both your audit advice and your tax advice. So we should start thinking about how we're going to move that needle in a similar way for private equity, for all these other things. And, Gregg, my hat goes off to you for what you've been doing on all those issues.

MR. POLSKY: That wasn't the question. (Laughter)

SPEAKER: Thank you. I just wanted to make it I really liked the comments as outsider who is not really familiar with all of the complexities of the U.S. system and Department of Taxation. I'm from Germany and we have (inaudible) not quite but almost as important as in the U.S. And Department of Taxation has of course also in Germany there's complexities. After what I understand for U.S. after this morning's session when compared my impression is that the German systems work just fine. And I think (laughter) one reason for this, and I was thinking about what is the reason, and one reason might be that we got rid of the (inaudible) theory long ago. So we just calculate the profit and the partnership adjusts as if it were a corporation. And then this computes the elevated share according to the (inaudible). And there's no playing around whether it shows as income or it will show as losses. That's it. And there are also a lot of conditional rules. And of course there are some problems but there are also complexities, much abuse, and in general we have provision if there is a change regarding ownership and everybody is happy with it (inaudible). It might be the proposal; it might be possible to do some comparative research.

MS. BURKE: That's an excellent comment. Because I think probably we could learn a lot by doing that comparative research. There are people who recommended here the (inaudible) model. You know we shouldn't be reluctant to go to that and it should be (inaudible) everything that's happening, growth in these large partnerships. Well, you know, hundreds and thousands of partners which are little subchapter K. It's pushing them in that direction. And if we could show in another country how it has worked, I think that would improve a lot the chances of getting it approved. But I think there's something you said in your -- that you said your housing sector is almost as big as ours. I've always understood that we have the biggest tax and that Europeans had a much smaller -- about 50 percent of our business income.

SPEAKER: It's not the exact but I think in Germany it's maybe 20 percent.

MS. BURKE: OK. Good. Significant, yeah.

SPEAKER: It's even higher. We will --

SPEAKER: Yeah, I think --

MS. BURKE: It should be a great comparison.

MR. REPETTI: In a study that's going to come out in a couple of weeks from the Tax Policy Center we were looking at that being in a couple of different countries, Germany being one. And I thank Eric for some comments he gave us on that. And they are strikingly high. But the really interesting part of that, I guess the reason why which is really as Eric has explained it to me, historical, and in part because of not taking approach with respect to limited partners, that they couldn't be involved in managed, that was step A. And then step B is historic during the Nazi period, if I'm understanding correctly, and this is all derivative from Eric, a real disfavoring of corporations is not giving individual responsibility resulting in some very high tax rates during that period forcing large private and medium -- small-medium private businesses to move into the passthrough and not really coming back even after Germany wholly integrated on a split rate basis in the '70s. It is a fascinating history. But everything I just said comes from Eric.

MS. ELLIOTT: Well, thank you all very much.

SPEAKER: I'd like to thank the panel very much.

(Applause)

(Whereupon, the PROCEEDINGS were adjourned)

Well, why is it an F? Well, all we have to do is go back and read what the League of Nations told us. It's an F because economics actually can't answer the question. And when it can't, we start looking for second-best resolutions. We will not take fairness seriously on the international stage. Fairness is deemed either too hard to measure or irrelevant. Therefore we end in power, and when we turn to power, we sacrifice both efficiency and equity and let's, we might as well admit it, administrative ability as well with no clear way out. So why did we do that? Well, Dan Shaviro, you said we're still trying to figure out whose income it really is, when it comes to the corporation. And Karen, you said, with extraordinary -- when you add extraordinary complexity to extraordinary noncompliance, you get a regime that doesn't exist. Exactly. League of Nations tried to solve the problem of belonging with a concept you all know well, economic allegiance. They deliberately walked away from the container of the citizen and the state. This is what they said. "In the modern age" -- remember, it's 1921 -- "in the modern age of the international migration of persons as well as capital, political allegiance no longer forms an adequate test of individual fiscal obligation. It is fast breaking down in practice, and it is clearly insufficient in theory." Just to underscore what they're saying, political allegiance -- claiming that a nation has ownership, a right, that someone belongs to a nation as a basis of political allegiance, doesn't work. It didn't work 90 years ago. We had to find another way. And the League of Nations said, since political allegiance is meaningless, then it must be, let's look at tax. What is it? It's an economic phenomenon. Let's use economic interaction as the way to decide what belongs to who -- whose income belongs to who. And it came up as you well know now, with four containers, situs, enforceability, residence and source. We've settled on residence and source and subsumed situs and enforceability within those two concepts. Source of course -- a parade of horribles, economics cannot disaggregate income. Anyone who's read The Myth of Ownership is well aware that we all forget what it costs to build the state that created the possibility for market interactions, and so anyone who's read The Myth of Ownership applauds the philosophers who showed us that we're just simply forgetting that we didn't build that, that we are pitted together, creating conditions for our own success. Well, if you can't see it within the nation state, I'm sure you can agree that on a global scale, when you take that myth of ownership out into the world, this is a mess. You need global rules, currency exchange rules, property protection, contract protection, rules that protect people on the high seas, rules that protect people under the high seas. When source failed the League of Nations, economic allegiance as a concept failed, what did they do? Turned right back to political allegiance, also known as residence -- wrong, but done. Just how wrong is this? Well today, President Obama is calling on lawmakers -- prevent America's corporations from expatriating. Residence is and will be the basis of BEPS. The OECD says the right to tax is based on connection to a jurisdiction. That's not controversial, right? Then, the OECD follows, we do this on entity-by-entity basis. That's not gravity. It's not science. It's a political choice to do it this way. Reasserting the residence rule, as if it answered the jurisdiction problem, is exactly what got us to where we are today -- the corporation as a citizen, as a member of a social contract, belonging to a nation? Well, a corporation is not subject to immigration policies. A corporation has no family obligations. A corporation has no human needs. You can pick and choose your nationality for yourself, expatriate, repatriate, expatriate again, repatriate again, do it 52 times a year, have children, marry them together, kill them off, assume their personalities and all of their assets, with impunity in any country in the world, at any time you want. What social contract are we talking about?

The multinational corporation obviously is going to strategically align with a nation that makes them a good deal when the basis for making the good deal is political allegiance. So the conclusion is, when we return to nationality and start talking about political allegiance, we're going to get absolutely nowhere. Principles having failed, powerful nations will suit themselves, despite a clear failure of the strategy for 90 years. Look at what the power is yielding right now -- FATCA versus BEPS. Let's look at the world we're building. FATCA enlists the entire world in third-party reporting for U.S. tax purposes alone. Inside the U.S. it looks like good anti-evasion regime, in place, pulling together, gather people in a common goal. Outside the U.S., other governments will be charged with undertaking the administration of the U.S. tax system in the hopes that someday this will be multi-lateral. Proponents of FATCA tell us, it's going to lead to multinational. We're going to get FATCA 2.0. We're all going to share information together. Look back. You can hear the League of Nations saying exactly the same thing in 1921. We're just coming together with this compromise. This is what we can do right now, but together, we're going to work together, converge and we're going to come to a multi-lateral treaty where everybody works together. That is not what we got 90 years later. What will we have in the interim? We will be having a global situation where poor countries with low administrative resources will devote those resources to the United States because that was a priority for us. Closing the tax base, closing out tax evasion, making it seem that we're stopping those rich people from getting out of our tax system was the priority, and the U.S. leveraged its economic power to make sure that happened. Some might say that's pretty fearless. Like, that's pretty fierce. We want this. You're giving it to us. If we can't get it from you nicely, we will take it in the form of economic sanctions, and watch the whole world line up and follow what's going along. BEPS -- Robert Stack, oh sorry -- still FACTA. Robert Stack, who's the U.S. deputy assistant secretary for international tax affairs, says FACTA is an example of U.S. leadership. He says, "FACTA shows that we are rapidly becoming the global standard in the effort to curtail offshore tax evasion." That's exactly what the League of Nations said. But when it comes to BEPS, we have a little bit of a different story, don't we? Robert Stack says we should go slowly. We should wait for unified consensus. We do not want to act before everyone else does. We need a principle approach, principled approach that's not, quote, "governed" by self-interest, Stack's concern as reported by Tax Analysts. But India, China and others want to, quote "recalibrate the global paradigm" that has been in place since the 1920s. That paradigm might be awful and it might be the worst. But is it better than all the worst alternatives that are even worse than the worst one we have? It's definitely not better for other countries right now, and my prediction is, it's pretty bad for the U.S. in the long run too, even though it's serving short-term interests.

So why do I think that? Well, we get a little hint from last December's Baucus plan for international tax return, reform. Baucus's plan suggests the U.S. should not go slow; the U.S. should not be cautious the U.S. should see that we have a problem and we have the means at our disposal, i.e., FATCA as a precedent for imposing our will on what we want using our leverage in the economic -- in the global economy to get what we want. What do we do? Global minimum tax if you're a U.S. company. There is leverage and then there is risk. Willing to put the U.S. current financial market at risk to make sure FATCA could go into place, by levying a super withholding tax -- done. Risk the U.S. might in the global economy, by leveraging American multinationals and taking a bet that they're going to keep going and keep making money and being successful even if they have to pay tax? Not done.

Conclusion from that -- unilateralism, acting alone, means that powerful rich countries like the United States, the United Kingdom, the politicians in place right now make choices that seem to push them ahead now. Poorer countries will be constrained and won't be able to react, will be swept along in the tide and will act accordingly as they always have. That's not -- that's pretty bleak. So my second question was, can we do better?

Well, unilateralism and bilateralism was tried and it failed for 90 years. What happened? Well, what happened is that we have been trying to look at the construction but we forgot to ask who the architects are. So I told you, a few yesterday, that I would show you a cartoon. The construction begins with the architects. It says, "Escher get your derriere up here." If the design starts out kind of being not too workable, then are we so surprised that in the end when it's built, it's totally unworkable? Multilateralism is unwieldy, but experts led us to this. Our experts got us to this. So we're worried that if you let the process unfold in a really multilateral process where all these basket cases can come in, all these fringy countries that we don't really know what they're doing can come in and they can have a say, and all these people can have a say, that we won't get to a better place. But we know that when we were in charge, we made a bad thing. It's not working for us and it's not working for anyone else. So the conclusion has to be that we've got to reject the process we've been using for 90 years, start over. Stop acting like adolescents. Grow up, work together, cooperate, teamwork. But most importantly, and this is controversial, I appreciate it -- we actually do have to include everyone who's going to be impacted by the structure that we build. And unfortunately, we, as Lee pointed out so vividly at lunch, we have created a global population of global society in which everyone is affected by everything everyone else does, and so, multilateralism means, everyone has to have a say. Because they're -- everyone's life chances are going to be determined by the decisions that we make now, going forward.

So one could say, and I think Dan, this is where you would say, you could actually do worse than that. That's the risk. If you change course rapidly or extremely, you could do worse than now. So that's a risk. And one might say, better the devil we know. But what I would say is, the devil we know got us to where we are today. Is anybody happy? Are we celebrating? I can't remember the last time I -- well, we have lots of laughs at conferences because we love to talk about this stuff. It's great for my business, because I've always got something to write about, to complain about, right? It's wonderful for academics. We get a lot of things to think about. But it actually is hurting people, right. It actually is hurting people. And when you know that what you're doing is hurting people, then don't you stop? Not just stop what you're doing but say, why am I doing the thing I'm doing? How am I making the decision? Not just what's the decision I made, but why did I make that decision and not some other decision? We need to do that on a global international scale.

So I'll suggest this. And Dan, that's why I pushed you again this morning. I keep coming -- I know you tried to talk about domestic but you really did talk about international. I said, the U.S. is uniquely suited, right? We have policy flexibility that no other nation has. Lee cemented that by talking about the dollar. The U.S. can move where no other country can. So not moving is a choice. Going slow on BEPS is a choice for status quo. If we all think it's a bad choice, then we could try to convince ourselves that protecting the base would actually give us greater policy flexibility going forward.

So you can argue this from a normative perspective. We're hurting people with our decision-making and with our decision-making process. We're excluding people who are affected by the decisions we make. We are making bad decisions and not considering the cost. We are externalizing the costs of our decisions on others. You could appeal from normativity. Politicians don't want to hear that. Lawmakers don't want to talk about that. So how about this, from a position of self-interest? Someday there might be a global power shift, someday. We don't want that to happen. That doesn't help us if it does happen, but will we someday wish we had built a governance structure when we had the chance? Don't we sometimes wish we could go back to 1989; was it, when we stopped taxing withholding at source on portfolio interest? 1989? 1984. Don't we sometimes wish we could go back, close the door, and start over? No -- Lee says no. Sorry?

SPEAKER: (inaudible)

MS. CHRISTIANS: Right. You need a mic, if you're going to talk. (laughter) Don't we sometimes wish we had not created the problem that we now have to somehow fix with diplomatic, political choice, difficult choices? Don't we sometimes wish we had built a governance structure to begin with that would then last when we hit the hard patches? Now it's harder to move, but it's not impossible to move. So this is the plea. We can't get the architects up here from 1920, but we have the architects now. Let's think about what we're doing not just with the principles we're trying to articulate, not just with the impossibility of the economics we hope to answer the questions, but the way we decide who gets to be in the room when we ask and answer the questions. That's all I have for you. Thank you. (applause)

MR. PERONI: I'm not trying to emulate the first George Bush by looking at my watch. I just realized I did that. But I'm trying to make sure I try to stay on time. So let me start with some things that sort of flow from this morning and as well as Lee's talk. And I think there's sort of givens on the parameters and I'm going to be kind of unilateral mostly, but I'll get a little bit to multilateral with a formula apportionment.

So first of all we were talking, whenever we want to make a reform and Dan asked the question this morning about a reform about where are we going to get the revenue, you know, make up the revenue if we lower it say on passthroughs. Karen's talk about maybe we'll lower the rate on passthroughs, the (inaudible) of the lower corporate rate. And Dan mentioned, well, there is the VAT and there's other countries, but he pooh-poohed it and I think rightly so. Because I think there's the one thing in the United States where there's consensus between the two parties, from Tea Party to Occupy Wall Street, and that is that there will not be a VAT in the United States. Now maybe we can come up with a different name for it and hide it and we're pretty good at that. Call it, but we've lost -- we can't use FIRPTA or FATCA, we'll have to come up with a new acronym and maybe we can hide it in a different way. But it's not going to happen. It's not going to happen in the United States, for different reasons in the two parties, but it's not going to happen. And part of it is, there's an accounting firm study that came up at the University of Chicago Institute a few years ago and I've been unable to find it, that did a study of governments that instituted VATs around the world or significantly increased, and there's not a government that ever survived after that. And if there's one thing our political leaders are good at, is avoiding political suicide, even most of the Tea Party people. So it's not going to happen. So that revenue source is gone, for whatever we're going to do. So anything that shifts that say, from what we're talking about this afternoon, however small amount of revenues in international, if it shifts it from international to individuals, it's going to have to shift it in some way that is in the income tax. And we know all the problems with trying to do that. OK, so that's the gift.

Number two -- no matter what we do, the students we send out are going to spend their careers trying to get around it. I don't care how perfect it is, multilateral, unilateral, as I say, I teach students during the day these things and then I atone for my sins by coming up with articles that try to tax the things, or change the things that I help them create. But that's my job. And that's not going to change. No matter what we go to in international or any other area, but particularly inter -- I'm now focused on international.

I often get, when I go around the world, I get people saying how can the U.S. not have a territorial system when the rest of the world has it, and part of it is this power to do what we want to a certain extent. That's part of it. But I think part of it is in this country, we don't have a consensus among industry about what that means. So Walmart could care less about territorial. They care about LIFO. They don't care about territorial. Oil and gas companies, well they care about territorial only in the sense that corporate solidarity -- if it's something that you crazy professors want it, don't like or if it's a -- then we have to be for it. But they don't really care about it. That's not where their tax issues are. On the other hand there are industries where, you know, that they really care about it a lot because they can't use the current system. Whereas probably Google, Apple, GE, whatever system they're -- I mean, they, you could not lower taxes enough. I don't know how you could. I mean, they supposedly have negative effective tax rates on foreign income. So I don't know how you lower it. I guess you could make it a double negative, you know, whatever their rate is, at least allegedly. It's hard, kind of hard, to get it worked through the financial statements.

So that's why it's going to be impossible to get consensus even within industry in this country -- multinationals, let alone different countries and from different. Four -- it's always a race to the bottom. If we create a territorial system of the type multinational (inaudible), we won't have any anti-base erosion, all of that. They'll still say, well wait a minute. There's a country over here that allows negative, even more negative effective tax rate. I mean that's the game. And the game always is, we can't compete in the global marketplace. I tell students, whenever there's a regulation that's going to come at you, or a tax thing, your standard argument if you have no other, if you haven't had time to prepare, just say, you can't do that. We won't be able to compete in the global marketplace. Without any empirical support, that's fine, you don't have to have any support, just can't laugh when you say it. You've got to say it seriously.

Yes, OK, so that said, let's talk about some -- I also -- operating principles. This was in the paper. So first of all, I'm not a fan of separate corporate tax reform, international corporate tax reform. So there was some talk this morning, there may be a slight chance that if we have a new Congress, they could get together and we'd have just that separate. I think that's a mistake. I really do think that's a mistake. They might do -- you might be able to do some, a few antiabuse things that deal with inversions, but that's a Band-Aid, not a problem. This should be done as part of an integrated reforms strategy. And I mean corporate and individual, because what you do with individual and passthroughs and what is the capital gain preference and all of that -- that's all interrelated to this. So I think to do it separately is a mistake and it's probably not going to happen anyway and that, from my point of view, I'm really not optimistic so I made Greg seem like an optimist. I actually think you just walk through it -- two years to a new president, no sensible president would want to do this in the first term. Reagan didn't allow Treasury I to be released until after he was re-elected in November 1984. We're talking six years, and that's when a president is re-elected. If they don't, this could be a rolling forward, but we'd be able to talk -- have this same symposium with the same exact papers ten years from now. And there's nothing wrong with that.

The big thing that I and my co-authors worry about is the effect of international tax reform on either creating more incentives or enhancing those existing tax incentives, to ship business and investment activities or income abroad, so our preference for -- as I'm going to talk about in a moment, real world worldwide versus territorial versus formulary is with that focus in mind. It isn't that I think there's some natural law of CE -- all those initials, CEN or whatever. I just think terr -- it's what Lee said. We're going into this not unknown and it could end up a lot worse with territorial than what we have now. What we have now is a mess. But territorial could be a lot worse. And I'm concerned about that and particularly in the incentives it creates.

Competitiveness plans and -- from what I've already said and you've been saying this for years -- have been largely unsubstantiated, they're overstated to the extent they're substantiated. They take a little bit and make it into a big thing and the focus is all on multinationals. This is what Lee was talking about. No one asks, well why should individuals in any of these countries care about that? How does it affect my employment? How does it affect my family's well-being? How does it affect individuals in the country? Will territorial be better for the majority of Americans, or for that matter, any other country? Has it been better for a majority of the U.K., Australia, or Canada for that matter? So I think the whole focus of competitiveness is on the wrong thing and I do think fairness considerations, Allison alluded to this, they are hard to measure because you're -- it's incomes from corporations largely. But that's -- we got to think more about fairness. And it's both even traditional fairness within the country and then fairness with allocation with other countries as Allison talked about.

Finally, complexity -- so this morning I thought that was a fair focus of the -- that's not appropriate focus for this. Whatever we come up with will be incredibly complicated, no matter what. The transactions themselves, they -- you don't have to create -- and you do have lots of tiers, but you don't have to even create all those tiers. The transactions are complicated inherently, so the tax rules are going to be complicated. People elect into complexity. That's a lot of it. But they create these structures. Oh, people get up at these conferences and places and say, well I have 500 subs and you know, that's going to -- you know, your system that you're coming through is going to really hurt those (inaudible) and I say why do you have 500 subs, and sub-subs? Why do you have them? Well of course -- oh, well -- you know, never mind.

And finally they're big players. They have massive tax staffs. They can handle this complexity. And if they weren't doing this, they're not going to be doing cancer research. They're going to be creating financial products that could do more harm to the society, to the world's society. So I think it's good that they're working on international planning and partnership this morning because they're not designing financial products. And that's much more harmful to society. So that's an argument in favor of complexity. We need more tax lawyers.

Finally, territorial is not the solution to inversions, certainly not world peace, and I really, really do want world peace, like Sandra Bullock in Miss Congeniality, but it's not the solution to really pretty much anything. I mean whether we go to a real worldwide or we go to a keep their -- a really not real worldwide or sort of a de facto, terribly designed elective territorial, or whether we go to a territorial -- earnings stripping is one of the key things we have to deal with. These inversions transactions partly work because they strip out -- forget shifting foreign income, you know, that the tax on foreign income, not paying tax on that because you avoid the CFC rules -- what about the U.S. tax? You strip the U.S. tax base through interest deduction. And then we have 163J. What's that about? It's got all these rules that they're hard to explain and they don't make any sense, and it only applies to interest. It's feeble. It hardly has any effect, but meanwhile there's earnings stripping with royalties and other things. So you know, this little plug, it's in the paper, but for our latest article it will be in North Carolina Law Review about earnings stripping, getting serious about earnings stripping. Whatever system we go to it's going to be important. It's even more important with territorial. And Marty, it relates. It's something Marty will talk about as well.

So, first choice -- so we go through -- we hate the current system. So we join everybody -- there's nobody. This is a -- well, there's nobody. Lots of lawyers like the current system because it's good. It's complicated and yet it doesn't really achieve anything so you can still save your clients money and bill them off for it. Certain corporations are, I wasn't going to name names, but I already named one. They couldn't possibly do better on our new sys -- well, they would find a way probably. But how can they do better? So they, they're taking a risk if there's change. And so part of what's going on, there hasn't been a push because Camp did have some anti-base erosion. I don't think they were strong enough, but that's not what multinationals have in mind with territorial. They don't want any anti-base erosion. They want territorial that reduces their tax liability and loses revenue and shifts it to the wage earners whose wages are being cut as Lee points out.

So our first choice, if we had to choose, we hate the current system, is real worldwide. And or certainly more severely restrict deferral and in the paper we go through a bunch of different alternatives and they even have to be developed and if I did that right now, the one thing it would affect is that early movement towards the cabs and people hitting their desk from boredom. But in any event, I won't do that. But basically, there's various ways you could to it. The more comprehensive you do it, the better you deal with the problem. If you had a -- some form of most of any defer -- from most foreign corporations owned by even small amounts of U.S. people, that would end the lockout effect and inversion. Because if there's -- as long as there's U.S. shareholders holding any shares in that foreign corporation, they're still going to have to have a tax or you could make the toll charge higher in 367. There's a lot of ways you could deal with this.

The other thing you'd have to do though, if you just end deferral but you keep the weak foreign tax credit, the 2004 Jobs Act which did create jobs for tax lawyers and accountants but no one else -- that 2000 -- if you stick with those foreign tax credit limits, any deferral isn't going to do very much good. So you have to also work on the foreign tax credit limit, either per country or more baskets, more thoughtful baskets than maybe we had in 1986. I mean I think it was a good attempt in 1986 but we have to rethink those baskets if we're going to bring them back. But that's the real worldwide system. It's not going to be enacted. I know that, of course not.

OK, it's not. So but it's good. I'll be able to -- as I say; I'll be able to talk about this ten years from now. So second best -- there's two second bests real alternatives. I mean, there's -- and various other things. But there's two second bests. One -- so the two exemption -- they're both territorial, if probably thought of. So we have an article coming out in Journal Michigan, international law journal where we're talking about why we don't -- what's wrong with formulary but why we'd at least be open to serious alternatives to our current system, that's Steve's, Cliff and I.

So territorial, traditional territorial dividend exemption is the way it's going to be done. So forget individual. Of course they don't care about individuals. It's not who's involved here. They're not the ones calling the shots in Congress or any administration, Democrat or Republican. It's U.S. multinationals. And they don't care about individuals. Screw individuals. So dividend exemption, what we're really talking about, and we've come up with an exemption system that no multinational would like, which is what we did in The Florida Tax Review. In the article I summarize it again, but some of the key things. You wouldn't let income be eligible for it that's either not subject to tax, a significant foreign tax or at least comes from a treaty country where they reciprocally waive that subject tax requirement. Secondly, no passive income -- well all the territorials have that but it's all how you define passive income. I wouldn't have all those exceptions we have for example, 954C. Of course, you take them out, that will just create more contributions for them being restored later down the road.

Strong anti-base-erosion rules, even stronger than Camp, maybe different and stronger than Camp, but at least it was a step in the right direction to have them although I don't think his ultimate proposal would have ever had them in them, given his base and his priority. And then earnings stripping rule. You got to deal with 163J, might be kept as you know, the backstop. You got to really deal with not just interest but royalties and service fee payments and other payments and both inbound and outbound, so Marty's right. You got to do it both directions. And the allocation rules are important. If they want 5 percent haircuts in lieu of direct allocation apportionment rules, I know that that's too small a haircut. I know empirically because companies don't -- the one thing they do, they don't pay for rules that don't make sense for them. So five percent is too low. I would prefer allocation apportionment rules. They can handle it. They have staffs who can handle it. But in lieu of that, then I would make the haircut more and it might vary by industry, like along the classic acid lines of depreciation. And we've done it before; we could do it with this. And I know they would hate it so that's why it's the right thing to do.

And then, the other alternative which does put the pressure and it shows how hard it is to get multilateral and we really do -- I do think it's very difficult, is global formulary apportionment. And that would be instead -- what it gets us away from is, both transfer pricing at least are current worldwide. A real worldwide wouldn't put as much pressure on transfer pricing, but our defective worldwide combined and territorial both require reliance on transfer pricing rules. They're intellectually wrong in terms of if they don't recognize efficiency by trying to treat related parties as if they were unrelated. They're hard to enforce. They impose administrative costs on the government, compliance costs on the taxpayer. The government wins some of the cases but loses a lot because they're out manned in litigation. And any system that creates more pressure on, which traditional territory would, is a mistake. So the advantage of global formulary apportionment, you don't rely on that. You use factors. One approach would be acids payroll and sales based on the states. The problem with that is it actually encourages you to move real employment to foreign countries which they're laughing; I mean -- the only thing worse than stateless income is an incentive to move real assets and, for tax reasons, to a foreign country. And so the best way would be sales, just on the basis of sales and then the rest of the income in a more complicated way. But you get away from worrying about a lot of the intangibles rules, you get away from transfer pricing. But there is a problem and you can still sell through intermediaries, and it's hard to come up with non-complicated rules to deal with that.

The other problem with, and this is where I'm probably a little different from my two co-authors in this, and I will say, I really do think, for global formulary apportionment to work correctly and not be too much double taxation or too much double nontaxation, you probably need multilateral consensus. But I will tell you, most of the proponents of it just assume that's total -- I mean, this is the area where you would think there'd be the greatest agreement that you need multilateral, and the first thing they say is, it's not important. We can get around that. Of course we can't do it anyway. We know we can't do multilateral. So we're just going to do it ourselves. And then the rest of the world will follow. So even in this multilateral vehicle, we have unilateral in almost all the proposals in the U.S. And we by the way, I will say, I join this conclusion, in the end I think we could do it unilaterally partly because we have the power.

So at the end of the day, I'm not very optimistic about tax reform in the international area. And I think the best we can hope for is some kind of quick, right now is, quick fix like the administration did as a starting point with their guidance, and that on inversions, and then try to do some piecemeal. But it won't solve the problem and I just don't see how we can get the consensus, in the United States, let alone with the rest of the world to do anything serious about this. Thank you. (applause)

MR. SULLIVAN: I've been fortunate enough to work with some great institutions. One of them was the Joint Committee on Taxation many years ago and one thing that was really fun about that job was, I got to work with a lot of great lawyers. The staff of 20 or 25 excellent attorneys and they entertained us; they allowed four and five of us economists to hang out with them. And what our job was to -- our job was to combine economic analysis to areas of tax law that economists usually don't even talk about, if they don't even know about. And so it was really great for me. These lawyers would come in and teach us pension law and things just about international law. And we just were like blank pieces of paper in trying to figure out if an economic analysis could lend to the situations. And we'd sit there and we'd work on it and a lot of times we came up with stuff and people just thought it was the craziest thing they ever heard of. And then sometimes we came up with stuff which was useful, at least they told us it was useful. That's kind of what I'm trying to do today. I'm trying to look at lawyer stuff and apply some economic analysis to it. And I don't know if it's going to work but Jim and Diane said this was a very friendly audience, so I thought I'd give it a try. The title of my paper is "Inversions and the Economics of Economic Substance."

So the question I'm going to ask is why is economic substance so important in tax law? And more specifically, why are deals that have economic substance considered so good and deals that don't have economic substance considered so bad? And you're probably already going, what is this guy talking about, because it's so ingrained I think in all of our thinking that deals without economic substance have to be bad, and why would anybody like me even start to -- it's not that I'm defending them.

But let me just begin with three observations or three things that you know, I've observed that sort of got me thinking about this. The first thing is, you look at all the different low-tax jurisdictions, don't call them tax havens, they get very upset, around the world. And you have places like Cayman and Bermuda and Luxembourg where really there's no real activity. There's not factories or anything there. And they're considered very bad. While places like Ireland and Singapore and Switzerland where there is real activity, well that's OK. We don't look down upon them as much. But as an economist I look at that and I go, wait a minute. Bermuda -- they're not taking any jobs away from us, but Ireland potentially is. So I really kind of think Ireland is more -- looking at them more favorably than Bermuda. And then you have Peter Moy here, a politician and you're trying to illustrate tax problems. You don't have a lot of visuals. The one visual that we have left a few years ago was the Ugland House that came in Ireland where I think this is the office building where a lot of law firms were located and therefore it was the address of 40,000 brass plate companies. And so they really show this and they go, look at this, isn't it terrible, there are 40,000 corporations inside this building. And then we go, well, would it be better if it was 40,000 real factories in Bermuda? Would that -- you know, that would have economic substance -- would that be a better thing? You know, you just -- most, even an economist is confused by this.

But what really got me confused was, many years ago I also worked in the private sector and was working on transfer pricing cases, and one of our cases was an onsite audit with the IRS, so we were the corporate guys and the IRS guys and we flew first class and they were lucky they got on the plane. And, but any rate, the whole exercise was trying to show why this Irish factory was a very productive value producing entity and because the more we could show that this was the source where the income was being created, the less the transfer pricing problem we had. And indeed over time, our client actually did start shipping real resources to Ireland. And the IRS became less hostile to that. So we really had the IRS encouraging real jobs, to move out of the United States into Ireland. And everybody seemed very pleased with this. And I just couldn't understand why our government was doing things like that. So I think it's legitimate to ask, at least to initially probe the question from an economic point of view, why do we like economic substance?

OK, so we like it, one reason why we like economic substance is it gets rid of tax shelters. So if tax shelters are really bad, economic substance is really good. So we have to ask the question, why don't we like tax shelters? I mean, we sort of assume they're bad, but try to enumerate really why they are bad. And I'll just give you three reasons, and I think it will be surprising, but you don't really hear them enunciated so I will do that now. The first reason is that they create market inefficiency. And what do we mean by that? In this case, for it I mean, if you have 100 firms in an economy and only 10 of them are getting lower effective tax rates with tax shelters, well then you have 10 firms that are tax advantages, 90 firms which are not and those firms can be less efficient, and the other firms which are maybe more efficient, are pushed out of the market and so we have less economic output. And so that's -- we don't want that. We don't have a level playing field.

The second reason we don't like shelters is that they're very cost (inaudible), a lot of transactions cost, a lot of lawyers are expensive, and you need a lot of them often to get these deals going. And the third reason why we don't like shelters and (inaudible) re-emphasized this, in their 1999 report on shelters, is that they're unfair and they hurt taxpayer morale. So, Apple's not paying tax, I'm not going to pay my tax, right? So if we use the economic substance stops, and stopped shelters, that it's sufficiently strong, all these problems go away, so that's good, so economic substance now can be a good thing because if we get rid of those costs and we have a level playing field, we have less legal (inaudible), we have more taxpayer morale.

But what if we require economic substance and we don't get rid of the havens? So let's just look at it from the firm's point of view. The firm, when you impose economic substance, well let's -- let me just define what economic substance is. I'm quoting from the joint committee report from a -- (inaudible) "economic substance is the result of a meaningful change in the taxpayer's economic position." David Harrison, 1999, almost the same quote. "The transaction only has economic substance if it alters the taxpayer's economic position in a meaningful way." So they're doing something different. It's not just the tax department creating economic magic. Now if they're doing something different, they're doing it less efficiently, because if you leave them to do freely, they'll do it in the most efficient manner. Now you're forcing them to change, and I know this is economic mumbo-jumbo, but this is the heart of the issue. You're forcing them to change, so they must be doing something less efficient, and the way that manifests itself is in lower before-tax profits. So when you impose economic substance, you lower the before-tax profits because they're being less efficient. And so they have to compare that reduction in before-tax profit with the benefit of the reduced taxes. So real costs, which we can reduce productivity, versus tax benefits and in way those two (inaudible). So we are left with the following situation. When we impose economic substance requirements, the good news is, we get a lot of firms out of the tax shelter in business. But the bad news is for the firms that still engage in the shelters, they're doing -- those deals are even worse, because now we have those three things they talked about, but we also have the firm acting less efficiently. And so it's a trade-off. And so the policy trade-off, when we look through and pose economic substance is, if we can get enough of the firms to stop doing the shelters, that's a big benefit. But if we don't get them to stop doing it, we're going to have, actually cause more harm than good. Now this is an agnostic framework, and you can figure out whether you like it or don't like it but in this, I think at the internal cost method framework.

Now let's just quickly talk about inversions. The first assertion I would make is that I think inversions are tax shelters, or if that bothers you, they're like tax shelters because they have the same economic characteristics. They create market inefficiency, because some firms get the benefits and others do not, so those firms are advantaged, and the rest are left behind. There's high transaction costs to inversions which you have to hire a lot of people to do the deals, and it hurts taxpayer morale because if Burger King isn't paying taxes, then I'm not going to pay mine.

The next assertion I would make is that the section 7874 which was enacted in 2004 and now the Democrats and the administration are talking about expanding it. Well I look upon that as an increase in economic substance, and economic substance didn't want to -- it's not really reducing the benefits of inversion; it's just making them harder to do. And this will bring on the ears of every international lawyer in the room. Let's just say 7874, before 7874, you could do naked inversions. You could do pure inversions. It would just be a paper shuffling, self-inversion, just a paper shuffling transaction, OK. And then after 7874, you have to find a merger partner. That's the first simplification to that. For my purposes, that counts. You have to do something real. You have to engage in a merger with another firm. And you might engage in that merger even though there -- it cannot be economically justified. And when it's not economically justified, it is better if the firm -- it would be better just looking at that one transaction if the firm just self-inverted. Acquired economic substance doesn't make it a better deal. It makes it a worse deal, because now you're acquiring these new things which are not economically efficient. So you come down to the same rule that I was mentioning more generally, which was that, for shelters, which is, if we could really shut down inversions with a tough economic substance rule, that's a good thing, because it would get rid of the economic inefficiency, the market inefficiency, the transaction costs, and the taxpayer morale. But if we can't, wherein over time, taxpayers figure out ways around it, we may be doing more harm than good, and this is, after all this economic analysis, this gets you right back to where the data is today. Because the administration and the Levin brothers want to increase 7874, which I believe is a good thing because it would shut down these transactions and get rid of the economic costs that go along with it. But on the other hand, and this is what the conservatives have argued, is that it may be causing more harm than good, especially over the long run, if firms find, and now that they have to do even bigger deals, and do more dispersion reactivity, it could make things worse.

And there's a time element to this, because in the short run, you can't shut down the deals, but in the long run, eventually, problems, then we'll figure out ways around it. So in conclusion, what I think I've done in this paper is give you a little bit of a framework, a little bit of policy rules for the way you should do things that require more economic substance like 7874 but I won't go through the rest of it, but the -- what it really tells you is, the better approach is to look for neutrality. Just look to take the juice out of these deals so if you don't do them you get no incentive to do them anyway and engage in any amount of inefficiency and one way of doing that is you know, it's not a be-all-end-all, just, but, you know, moving to a territorial system does reduce giving incentive to inversion. It doesn't (inaudible). And the other thing you need to do is you need to tighten up earnings stripping in order to prevent that. So the better way to go in the long term is to figure out -- I don't know if this is for Dan Shaviro, but in your residence neutral system -- is that your expression?

MR. SHAVIRO: I think so, yeah.

MR. SULLIVAN: But you need a residence-neutral system. And, because right now, U.S. tax rules favor U.S. headquartered -- I mean foreign headquartered companies (inaudible). (applause)

MS. RING: So what I thought I would do, I'm not going to take too much time because my sense from last night's perspectives and throughout today that actual (inaudible) and I would love to hear them so I'm just going to say a little bit, first, in sort of general on the papers, and then just a few points about each one individually.

On one level it might seem like they're sort of hitting really kind of different pieces of sort of the international (inaudible) but as I read them, and maybe it's just because of how I see it. Allison accused me and I think it might have confused me last night -- what was the phrase?

MS. CHRISTIANS: Peacemaker.

MS. RING: Peacemaker. Oh gosh. And it was not said with a loving tone I imagined that they would. So when I (inaudible) I saw five things that to me were themes on the (inaudible), not that they pointed always in the same direction but were common threads. And so first was a sense of urgency, despite what this morning might have suggested about failure and crisis, I think we've actually (inaudible), at least in my view. And then I would (inaudible) is where I spend my time focused, but it does really seem that all three of the papers and then the presentations really take this as a very serious issue and moment in time.

The next one that although there seem to be sort of two connected but distinct agreements for international tax -- one is sort of the global discussion of negotiations and one is for domestic decision-making, policy-making and rule-making that goes on. There really is some ways, you know, quite big, and I see a lot of the same issues happening here, and so I thought it was really fascinating that when they went through they actually kept referencing each other even though one was very (inaudible) and the other two were much more on the domestic side.

So the third point and you can kind of one of these commonalities across it, how are you doing? I mean, it's sort of so obvious to see but on the other hand, and I'm going to say more about it when I get to (inaudible) but the role of power and influences in (inaudible). It's obvious. I don't need to say anything. But then if you contemplated a little bit more explicitly, you know, whose power, whose influence, that becomes relevant when you're thinking about well, where exactly is the greatest problem and what change do I make to sort of (inaudible) so you think of the state as powerful, so that's kind of a conversation about the UADS being distinctly powerful. It leads to different ways and in different contexts. Or certain kinds of (inaudible) so I think you've all identified multinationals as a good resource. And then are they the ones who are actually the problem? Forget the United States -- the United States is not powerful; it's just a vessel through which power can be effectively funneled. I don't know. And it may depend on the question, but like I said, at least thinking a little bit more about how and where we see power can be useful.

The point that's competition, I'll come back to this, but it's sort of been off the table for a while and we talk about all sorts of other things but not quite competition but always competition. And I thought both directly and indirectly, all three permutations bring us back to sort of thinking about that question. I have no answer to it whatsoever, but I do feel like it never left and in some ways I'd like to talk about it a bit more.

But fifth is fairness. Talk about something that I really (inaudible). So I don't even know how you can get in and yours was the most global but others brought it in. How do you frame fairness? One guy tried domestically, moved outside, so if you think about whether it's phrased as cosmopolitanism or intermediate equity, however you try to describe it, other than a really gross level of discussion, I don't know where to anchor that to sort of start to cope, either with people, or at nations, at organizations -- I think that's hard.

OK, so one lays houses and then one (inaudible). So all right, power, so don't (inaudible) so central to what you're focused on. I'm curious to think more about it and again, not that it has to be on the spot but sort of where you think the power is greatest and how that then influences what version of multilateral group discussion, what the process would look like. And so I'm thinking, well if you think it's with the United States and if you bring in all the other countries and each get one vote and somehow we agree we're going to do it, but I'll come back to that. Or if it's a multinational, well now do you bring more people to the table, they just have to sort of visit more countries -- that's heartbreaking, and influence laws in countries. So I wasn't even sure with depending with what power is, how we overcome that.

Then I don't know, I've asked them to what we've thought there was anything beyond power that is, is there anything else to draw upon? Because I'm thinking, depending on how we think about our, how we (inaudible) analysis, let's say the efforts in the early 1920s and where we are today, in (inaudible) there are no actual principles. If there are no actual principles, then what will it be other than power, versions of power, tiering of power -- something like that.

And you know, so help maybe the solution that you're looking for is just power plays. So it's you know, it's -- the U.S. is not happy about BEPS right now, we're not playing very nicely, but the threat of India and China doing things we like even less will bring us to -- is that, is that where we're headed when we think about multilateralism -- which I don't think it's quite what you mean, but I wasn't sure where I was going to see it going.

Bob, so yours brought us back into domestic law. But I was sort of drawn to this is what I saw as your discussion with competitive issues. It's sort of a common thread. So you focus primarily on the empirical substance or definitions of whose, for whose benefit are we assessing competitiveness and really there isn't anything there in terms of the data behind it. And so that kind of got me thinking again about Allison's. Is this a nationalistic inquiry? Is that appropriate? I mean, is that even wrong to sort of frame it that way? I'm not suggesting it is, you know, there's always been that long standing (inaudible) half different than other things. It can't be (inaudible). And so I'm not sure whether just even addressing how do you think about the multinationals versus the citizenry and who's getting benefit -- is that enough? Do you have to start confronting this from a still very nationalistic approach? But even how, regardless of how we exactly decide to define it, I also see it, that idea of competition kind of run through pure higher analysis. And so first it comes up with the immediate level at the choice of going or embracing worldwide and (inaudible), not in your personal choice, but rather sort of this idea of how do we see the positives playing out and what's going to be sort of the driving force. It may be our predictions on competition and what we believe. We don't have enough information but we're going to bet, and so how do we bet? But that's competition for pushing us in one direction. But if that belief or perception of fact was strong enough, to push us towards exemption, doesn't it push us more past all your strict rules for exemption, right, to a really big exemption system? Because if we're that concerned about competitiveness, why did we stop at the (inaudible) exemption system and not drive through all yours and end up with a gloriously neat exemption system, and then, not done yet, we're going to lower our rates? So I'm, again, so competition, and I'm not sure where that points you.

Marty -- so inversions, a hot topic. I'm so happy we can't have this panel without inversions. I actually found it really interesting. I had not thought of them really through that lens and to me that was really quite helpful. And again, I actually sort of saw the sort of tiering Effects. And your big purpose about the focus on economic substance. That was to me very interesting too, with the way you analyzed what we're doing. But then we broke it into the short term and the long term. All right, in the short term, if our economic substance was not refined but long term, it's going to break down even it's worse in the short term, it will break down because we're so clever. And then that pushes us through to what you described, sort of residence-neutral perspective but that comes back to Allison because we're just -- we know residences don't mean anything but then source apparently doesn't either, so where are we headed? Territoriality is essentially (inaudible) and none of those had any grounding. And so, even if we go to the territorial, then we're back to the competition again.

So I'm waiting for yes, 10 years from now when we've all solved this part of the problem, but I'd love to hear your comments and questions.

SPEAKER: Hi. One thing I think wasn't brought up and I don't want to get a discussion just pure territorial versus worldwide. But one aspect I don't think is discussed enough, and I think the correct -- I agree with all the panelists, but competitiveness issue is kind of a red herring. I do think there's an issue that needs to be studied more in academic form, and that is the issue of other countries' foreign PAC expenditures at the corporate level. So if you have, let's say, Canada gives a corporate tax expenditure that if you're a Canadian company, then you provide you know, free job training to disadvantaged first nations members. If you're under our system in theory, it does exist today, on a worldwide system, if you're a Canadian subsidiary of an American multinational, in Canada, because Canada's giving that tax credit but the U.S. doesn't, in its system, essentially the U.S. tax laws are overriding a decision made in Canada in terms of how their tax policy should be. Now you can argue from that standpoint that there should be no tax expenditures or tax credits. I don't think though it's a play because the United States has the same thing. You could reverse the situation. In United States corporate taxes, there are all sorts of tax credits and all sorts of nice cherry things and we might talk in academic form about getting rid of all that but that isn't going to happen. And I think that the issue with worldwide is, in my mind, the overriding of other countries' tax basis, where they made decisions in terms of how this is, as Lee pointed out at lunch, taxes are necessarily all about revenue. It's about how we organize our society and distribute things around. I think that in most industrialized countries now, unlike let's say in the 1920s, we now use tax expenditures at the corporate level and at the individual level to incentivize certain behaviors we want as a society. And I think the issue with a worldwide system is that you're essentially overriding and you're saying the time McDonald's, even if Canada's giving you a tax credit for certain corporate behaviors, they want your Canadian subsidiary view. The people's democratically elected politicians in Canada have decided. From the United States sampling at the level of (inaudible), we don't give a shit. We're just trying to say whatever money you saved on your Canadian tax return, you're going to have to pay it to the United States. We don't recognize that credit. I think that's an issue that needs to be studied more. I think that's how she -- in my mind, a much more important issue than of all competitiveness (inaudible) fix.

SPEAKER: Although there is a reverse argument to that. If the U.S. is forced to then give up its right to residual tax, given (inaudible) its decision by its democratically elected legislature as that legislature is right now, pardon my (inaudible) but they're surrendering their power, their sovereign power to the other country. I mean the sovereign party argument goes both ways, and so ultimately if you really want to solve that, it's multilateral agreement. I mean there's no principle that's going to get you the sovereign and that's part of your point. You have to have multilateral agreements. So I agree that's something that you -- well, obviously would be a key part of this.

MS. CHRISTIANS: But you know it's interesting because (inaudible) if you ask that question, is there anything other than power, well, yeah, there's probably principles but did we -- have we sat down? We always seem to be working partly on the philosophy of taxation. OK, (inaudible) on redistribution, do? Yeah? OK. So that, our -- we have a philosopher, again, the (inaudible), sociologist, lawyers and economists, all working together. I don't -- do we?

SPEAKER: Yeah. It's called (inaudible).

MS. CHRISTIANS: Oh, it's interesting that you call it the OECD G-20 because I actually have called it that myself and been told that's not accurate.

SPEAKER: The G-20 is (inaudible).

MS. CHRISTIANS: OK, so if there's principles being found, we have to actually -- that's hard work. That's a lot of hard work. What's easier is just let's just get -- we're all (inaudible). That's easier.

SPEAKER: Let's do it.

MS. CHRISTIANS: Just do it.

SPEAKER: Ross Perot.

MS. CHRISTIANS: Or if don't, just say no.

SPEAKER: All right, just a couple of things. The first is, people always want to, wish they would work, but one thing I think that is, I bring up about, that I haven't seen a lot of other people write about, and I'm hoping they will, but I think it's important the thing that international is the relationship between deferral and foreign tax credits. Actually (inaudible) and that deferral is obviously a really bad rule, leaving aside the question about the overall tax burden on such things, and everyone on both sides of it knows it's a bad rule. The foreign tax credits make it less bad because you can bring it on the other end of the credits, but foreign tax credits I'd call a really bad rule. You gave one argument for it, which is actually your argument based on the fact that the foreign tax credit is our mechanism and it wouldn't apply that way if you didn't have foreign tax credits which are 100 percent reimbursement of foreign taxes paid. I consider foreign tax credit a bad rule because it means that paying to someone else is just as good as paying to yourself and you don't get the money, but withdrawal makes foreign tax credits less bad in the sense that if you're never going to bring money home, so I think it's important to kind of think about the relationship between those two rules and how they -- helping on one makes the other one worse. I would personally like to get rid of both. Actually what I'd like in the territorial systems is they do get rid of both, the (inaudible) necessarily right. But I would think you'd kind of (inaudible) that foreign tax should just be deductible for the (inaudible) and then you have to ask yourself why do people dislike tax havens and I think you (inaudible) and think that Marty was really saying this -- this gets down to the economic substance question. You could really ship stuff to Germany and real things are shifting but if you're not actually earning money (inaudible) so that's kind of a noneconomic substance way of getting, you know, the tax base, so it's kind of better than shifting real resources out but it's also cheaper so you can kind of try to stop it.

And the second thing, the last thing I wanted to say was, actually I -- the question you guys, Marty, is a great question, actually. Somebody -- I have a thesis -- I'm sorry, I feel kind of walk around like Simon, so then basically, compact economic substance and tax shelters, I was actually a tax analyst in 2000 and I did exactly this thing, that it's kind of completely pointless to have companies do more noneconomic things but it's a trade-off so it's very simply it's a trade-off between how much taxes are raised and how much more they do bad stuff and how much they give up. It's kind of called the -- someone called it the backflip rule. They said that it would be just as -- make as much sense to have the -- tell the CFOs they have to do backflips in the international headquarters. And if it doesn't affect the ratio, not too many more CFOs staying up late doing backflips but that they actually give up, and then they do beneficial things. But I think is basically the right framework to use.

MS. CHRISTIANS: So Dan, why do you say that you can't make any -- or that the (inaudible) analysis does not go -- is a lot -- cannot be accredited with creating any of that income? I mean that's --

MR. SHAVIRO: Well it's -- as an economic factor there's not that much happening. They understand economic resources there.

MS. CHRISTIANS: That's the point, that the -- that's what the League of Nations was telling us, that when you go try to figure out origins of a stream of income, you can't disaggregate from the rule of law. You can't assign to one country or another.

MR. SHAVIRO: Well it's true that -- I'll put income in the Caymans and I won't put it in Haiti, because Caymans is a system I can trust.

MS. CHRISTIANS: Right.

MR. SHAVIRO: But actual economic production, where the people are doing things, actual economic production is not taking place there.

MS. CHRISTIANS: The thing is that in New York, according to Lee Shapner, it's over 10/2014. Right? New York is built on not producing anything of economic substance.

MR. SHAVIRO: Well there are people in New York who are doing things, who are earning money for themselves or --

MS. CHRISTIANS: Yeah, but those aren't the people we're talking about though. I mean, we're talking about the financial industry and what you're saying is you're making an economic claim, that there's no economics for that. And (inaudible).

MR. SHAVIRO: Well something, you couldn't need productive resources including people in that place to actually have things happening there, and in the Caymans it's more limited (inaudible).

MS. CHRISTIANS: There's a nice big gleaming building. It says KPMG on it.

MR. SHAVIRO: Yeah, but it's just another (inaudible) building.

MS. CHRISTIANS: Right. With people in it, who go to work every day and run a financial system, just like they do at (inaudible).

MR. SHAVIRO: (inaudible) They're earning a salary there, I agree with that.

MS. CHRISTIANS: Yeah, they're --

MR. SHAVIRO: (inaudible).

MS. CHRISTIANS: Yeah.

SPEAKER: Thank you. Marty, I thought your paper was very interesting and I know you may not recognize this but just to mention it to other people, you're really dealing with the theory of the second best, in that you're playing out that by dealing with the symptom rather than the underlying cause, sometimes the attempt to deal with the symptom is making things worse rather than better and that's sort of the way I've always thought of the theory of the second best. With respect to the territorial tax, I have often wondered but I haven't seen much discussion about this, so I appreciate the panelists' views. We worry about, what brought me to this, we worry about moving production offshore with a territorial tax and I was wondering, what has been the experience with other countries that have a similar sort of economic structure, infrastructure, you know. If you looked at modern industrial countries, is there any evidence there that might give us some comfort that there wouldn't be, in the words of Ross Perot, a loud sucking sound, as everything leaves the U.S. including our job, to the territorial tax?

SPEAKER: (inaudible).

MS. CHRISTIANS: He said it was a giant sucking sound?

SPEAKER: I don't know that we enough VAT -- I mean most of the countries, well whatever countries like -- I mean, the future one is going to you know, surpass us, to China? I mean, U.K.'s not like us anymore. Canada is not really like us, (inaudible) the power. Japan, they buy a lot, they would have been close but they had all the different problems and Australia's kind of (inaudible). So I don't think -- even if we had (inaudible) but I think there hasn't been much in the way of studies. I know people are studying it but I cannot think of some and I taught this to economic students who are actually going to study that, OK, so we'll have that on there.

SPEAKER: What about the German experience? Is there (inaudible) --

SPEAKER: (inaudible) less complicated.

SPEAKER: And I think Germany's done kind of a rotation of that (inaudible) and Germany has (inaudible).

SPEAKER: One comment I've made too is one of the issues (inaudible) I think we sometimes as Americans are looking out to the rest of the world, is, for a lot of companies in the rest of the world, we in many ways, we can be an asset, is they have a territorial system and then we have very weak earnings stripping (inaudible). So if you're a German company, you know, signing up an auto plant in the U.S., and you created a U.S. subsidiary and then you just load it up with that, you lower your U.S. tax still and then you're operating under territorial systems back in Germany, so you really aren't getting, unless you're running into your (inaudible) you aren't getting taxed again in Germany either. So in many ways, we're a tax haven for multinationals in the rest of the world, who don't want to come and pour a direct investment into the U.S.

SPEAKER: The United States, (inaudible) profits not so much jobs. We don't -- the U.S. multinationals, you don't see that much movement and you don't -- and when there is movement it's not into organized countries. However, just because it still might be a (inaudible) situation if you know, it's not really jumping out at you. Nobody that (inaudible) Ireland jumps out at you and that's because they have very large negative effect on cash flows and it is very profitable to have jobs there. But everywhere else it's not really, (inaudible) in the territorial system knows negative effect on cash rates on the largest (inaudible).

SPEAKER: And by the way, our position, which we've developed now over the years, is that we would actually prefer territorial (inaudible) anti-base erosion over the current system. I mean, we're not the kind of -- so if you're comparing it with the current system, I absolutely would move to territorial but the problem is, the push now, I mean, people walked away from the Bush 2005 tax reform and they walked away from Camp because of (inaudible). The way they tax royalties, the multinationals didn't want it. If you don't do that, you need a (inaudible). You don't get any benefit (inaudible). And honestly, it's just worse for what it will do to the taxes and prevents jobs.

SPEAKER: (inaudible) I don't think they're really distributing (inaudible) somebody tell me how many years of (inaudible) we had in 20 years and then all of those companies that were in. You know, cars are like a visible thing, you know. On the bodies on the ground, economic socialists think that's like a huge part of this BEPS project because the Europeans really think, you know, because they're looking at finance (inaudible) and real pieces of paper into the middle of Europe in their little headquarters, with no bodies in them and they think, well if they can put bodies in them, gosh darn it, we'll -- the biggest multinationals will put bodies in them. And so other multinationals will.

SPEAKER: Isn't it also true if you take finance (inaudible).

SPEAKER: There is a bunch of those little countries are asking for bodies because, not just because of that, because they also want you to hire their people, because that's part of the deal. But I don't think, when the dust clears, that anybody in Europe is going to be any happier, like, because you know, multinational advisors will tell you, you have -- if I got to find bodies, I will find bodies. Then I'm going to say two Steven Tseng things here, just in case he doesn't say them so he can follow up on them. One is, and this goes to the source comments. If you're a bad source rules, it does not matter whether you have a territorial system or a worldwide system. And then the other one, is why don't we subsidize investment in Iowa? I mean, we currently have the (inaudible) and I also think our incorporation rule isn't -- Canada is one of those subsidies. We subsidize going broke. Go to Iowa, you know. We won't tax you if you go there, how about that?

SPEAKER: OK, that was David Rosenbloom, the title of one of his articles, "Why Not Iowa?"

SPEAKER: Yeah, "Why Not Iowa?"

SPEAKER: Des Moines.

SPEAKER: The one in Des Moines, that's right.

SPEAKER: I completely agree with Allison that multilateralism is the future of any solutions in these problems. I guess I'm just a little more optimistic than she is as to how that's going to work, at the point as a kind of an example in a global formulary transparency exchange of information now there's 120 countries all sitting around the table and coming up with rules and monitoring process. Of course that's a small piece and I think you underestimate a little bit the multilateralism of the G-20 BEPS project. It's not just the OECD. It's not just the cigar-smoking tax bureaucrats in Paris. It's much more representative. And even on that, I mean the OECD is just (inaudible). Australia, Mexico, countries that have sort of (inaudible) and then in addition, the OECD had done a lot of regional outreach with a number of developing countries. The U.N. and the OECD are cooperating to get developing countries' perspectives. The U.N. is putting on the table some additional BEPS issues, technical services, subsidies, indirect (inaudible). A) I think the answer is multilateralism, B) I think it's nascent. I'm the optimist here. I think it's nascent but it's developing.

SPEAKER: Yes.

SPEAKER: Secondly, on principles, I do think there are some principles and I think there are kind of two very fundamental ones and one is, at a very general level, double taxation is a bad thing. It's (inaudible). But equally, double nontaxation is a bad thing, because it discourages investment (inaudible). Now we focus -- I totally agree we focus much too much under the influence of the (inaudible). BEPS has opened up the issue of getting at double nontaxation. And that's really how BEPS started. Income that doesn't -- every -- it seems to me, everybody could agree on principles (inaudible) unless it's explicitly agreed interest paid to a charity, there shouldn't be any (inaudible) that isn't taxed anyplace. And that's what BEPS is. That's what the core of BEPS is about. And income that because of the failure of systems to fit together, doesn't impact anyplace. And so the BEPS exercise is -- the core of that is to get at it. Of course, once you've identified income that doesn't get taxed anyplace, the question is, well, who's going to tax it? Should it be the residence country or the service country, and there's (inaudible).

MS. CHRISTIANS: What if it's neither one of those?

SPEAKER: Pardon?

MS. CHRISTIANS: What if it should be neither one of those? Then what should we do?

SPEAKER: Well I don't know. But I, there I think it's just (inaudible) and that is I think, source rules that are conventions.

MS. CHRISTIANS: Mm-hmm.

SPEAKER: I don't -- I think, it's equivalent of getting international agreement on conventions and there I certainly agree there's a certain amount of power involved. Should it be the CFT rules that get the intermediary income between the residence country gets it, or should it be the deductions, (inaudible) which means the country of source (inaudible). Those are being worked on. And I think they can be worked on in the best light. And yet I'm relatively optimistic. When you get into the broader parts, residence versus source with big letters, that's much harder and multilateral really isn't there yet. Just one footnote on formulary apportionment, because (inaudible). Anybody who thinks formulary apportionment is (inaudible), I urge them to read the IMF spillovers report that just came out recently. And they do some case studies on how developing countries would come out under a global formulary apportionment system. And surprisingly, if the country has dollar a day wages, and has a small mark up and doesn't have any assets, they don't get much money. And under existing transfer pricing rules, they do get some money because they get low-risk, low-return monetary returns and the intangibles project that was developed in more and more notion of marketing intangibles, getting an (inaudible) related return in the source (inaudible) so don't give up. Don't give up on the (inaudible) but I think that there is a future here. I think there is a future here.

MS. CHRISTIANS: It's not me that was so bleak. He was (inaudible). I told you what to do. He said there's nothing we can do. That's different. But how about this, so, just a question to follow up on that. We're out of time. People are trying to go to the airport.

SPEAKER: (inaudible)

MS. CHRISTIANS: But the -- I sort of end my paper saying, if we are at a place where we just accept that power is going to be, then OK, that's fine. That's what we're working with, right? Then we just have to remember that with great power is supposed to come great responsibility. We just have to keep reminding ourselves of that, and asking ourselves, are we eluding our responsibility and that's just a different question to ask about how to move forward.

SPEAKER: (inaudible).

MS. CHRISTIANS: Yeah. Yeah.

SPEAKER: Well, sadly, that concludes our symposium. We clearly have our work cut out for us in the future, leading to future symposiums. The papers presented today will be published in the next few months in Tax Notes and we encourage you to look for them. Again, our thanks to Tax Analysts for co-sponsoring this event and to Tax Analysts editors who served as the moderators, and to the panel members for their invaluable contributions. Have a safe journey home, and a nice weekend. Thank you.

(Whereupon, the PROCEEDINGS were adjourned)