The International Revenue Offsets in the American Jobs and Closing Tax Loopholes Act of 2010 (the Extenders Bill)—the 1980s Revisited?

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By Philip D. Morrison, Esq.
Deloitte Tax LLP, Washington, DC

You know you're getting old when your kids are having decade-themed parties about a decade that you lived through as an adult. When my daughters hosted an "Eighties Party" recently it was not only a lesson in aging, however, but it also sparked some modest nostalgia (for me, not my kids) for the days when tax policy development appeared to be more bipartisan. Since many think a return to bipartisanship generally is a good idea and because a little history may explain the difference between those days and today, I hope the reader will allow me to reminisce a bit and to stray somewhat from the more technical focus of my usual commentary.

In contrasting the 1980s tax legislation with today's (at least with H.R. 4213, the "American Jobs and Closing Tax Loopholes Act of 2010" (the extenders bill)),1  we may discover some reasons why tax policy today seems more partisan than it once did. More practically, I am naive enough to believe, at least a bit, that understanding this contrast may assist taxpayers and policymakers to design proposals in the future that may have a better chance of bridging the partisan gap.

Various news reports make clear that the extenders bill will likely be passed with few, if any, Republican votes. While that may be chiefly the fault of spending provisions the bill contains, an examination of the differences between the tax provisions (many of which are targeted, though temporary, tax cuts for business), particularly the international tax revenue raisers, and tax legislation of the 1980s may help us understand, at least a little, the partisanship that surrounds tax legislation today.

In my view, one of the important differences between tax legislation today and in the 1980s is that at least some conservatives in the 1980s viewed many "loophole" closers in a positive light. Not all supporters of these kinds of changes were condemned as "tax collectors for the welfare state" as one wag once called Bob Dole (the author of the 1982 Act). Closing loopholes was embraced by those who thought reducing the impact taxes had on economic decision-making (neutrality) was a good thing. Indeed, there were influential legislators on both sides of the aisle who believed and espoused this point of view.

There was, of course, a lot of rate reduction enacted in the 1980s along with "loophole" closing, which made the loophole closing considerably more palatable for conservatives.  But liberals, as mentioned, also thought base-broadening was a good policy for reasons in addition to raising revenue. Base-broadening and rate reduction was once a powerful combination. That, obviously, was the great compromise of the 1986 Act, and perhaps the signal domestic policy accomplishment of the second Reagan Administration.

Base-broadening and rate reduction were also the overall result of tax policy changes during the first Reagan Administration, if you combine the 1981 Act with the 1982 and 1984 Acts. There seemed to be a consensus (or grudging acceptance) back in those days, on both sides of the aisle, that tax policy was an imperfect tool for social or economic engineering (if only, perhaps, because of the messiness of the legislative process). Policymakers believed that tax policy should be motivated more by collecting tax in a fair and efficient manner rather than trying to encourage or discourage specific types of economic behavior. Even base-broadening for deficit reduction (think 1989 and 1990) could be embraced on the theory that getting the tax code out of the business of dictating certain economic decisions would let the free market be a little freer. "Loophole"-closing, a part of the base-broadening effort, was embraced because it leveled the playing field, made the collection of revenue fairer and less economically distortive. It was embraced even where the "loophole" being closed was a loophole to some, but a defensible (if perhaps originally unintended) policy choice to others. And it was embraced on both sides of the aisle.

So, let's compare this to the international revenue offsets contained in H.R. 4213, the "American Jobs and Closing Tax Loopholes Act of 2010" (the extenders bill). If loophole closing was bipartisan in the 1980s, for the reasons summarized above, why isn't it now? There are several reasons why it isn't — none, by itself, a complete answer but, in combination, perhaps an adequate response.

First, the current debate is heavily influenced by fundamental and partisan disagreements over the size and role of government. Although these debates were also important in the 1980s, major tax legislation (other than the 1981 Act) was mostly outside that debate, considered either with an agreement, as in 1986, to neither increase nor decrease total taxes or considered under reconciliation instructions that set revenue goals.

Second, of course, there's no rate reduction on the horizon. Indeed, with the looming expiration of the Bush tax cuts, individual rate increases for some taxpayers are highly likely and, given long-term deficit projections significant tax reductions seem unlikely. Although the United States has one of the highest corporate tax rates in the developed world, corporate rate reduction isn't seriously discussed by anyone in a position of power in government.2  Still, that alone cannot explain why enacting provisions that arguably "level the playing field" or at least broaden the base are not more widely supported.

Third, the international revenue offsets in the extenders bill pay for the extenders—a collection of special provisions that provide tax relief for particular types of businesses or particular individual or business activities. While each of the (depending on how you count) 81 extenders has an attractive justification for its enactment (and I certainly don't mean to suggest that any should not be extended), most are relatively narrowly targeted provisions that could be described as the government picking winners and losers—encouraging specific behavior or, more negatively, engaging in economic/social engineering. If closing "loopholes" is, in part, justifiable as a means to level the tax playing field or broaden the base, using the revenue raised to create furrows and hills on that field, to narrow the base, sort of undercuts that justification, no matter how independently worthy any one of the hills or furrows may be.

Fourth, the extended targeted tax cuts are temporary while the tax increases are permanent. Fiscal conservatives have been asked repeatedly to support permanent tax increases to pay for only temporary tax relief.

Finally, from a technical view, the corporate revenue raisers in the 1980s were typically broader and more comprehensive than the international revenue raisers in the extenders bill. The 1986 Act's changes to source rules and to the foreign tax credit, its enactment of the PFIC regime, and its enactment of comprehensive foreign currency rules, for example, while not simplification, could easily be termed comprehensive international tax reform. And that Act's elimination of a difference between capital gains and ordinary income was a vast (though short-lived) simplification.

Even the 1982 Act, which had its share of cats-and-dogs revenue raisers, enacted a comprehensive reform of penalties and information reporting and significant reforms in incentives for capital investment among other items. And the 1984 Act, also not purely reform, enacted moderately comprehensive schemes for financial instruments and services (straddles, tax-exempt entity leasing, and discount on debt instruments), among other things.

The extenders bill's international tax revenue raisers, on the other hand, whether one supports them or not, tend not to fit into anyone's concept of even modestly comprehensive reform or simplification. Instead, they tend to be targeted toward stopping certain planning techniques without addressing any of the vagaries of U.S. international tax law that compel such planning. What's more, they may act only to put pressure elsewhere on the system of U.S. international taxation, i.e., they may prove to be only a "finger in the dike," a dike that most think needs some major repair.  At the same time, some of the provisions may be drafted more broadly than necessary to achieve their desired results and may snare transactions that ought not to be snared.

The anti-splitter provisions (new §909 of the Code) and the FTC denial relating to "covered asset acquisitions" (new §901(m)), for example, fail to be as comprehensive as the Administration's anti-Guardianand FTC "pooling" proposals. Nonetheless, they may be overbroad due to unclear definitions of new terms of art, such as "related income" (in §909(d)(1)) or "covered asset acquisition" (at least the portion of the definition of that term in §901(m)(2)(B)). The amendment to §960 regarding "hopscotching" §956 inclusions is another narrowly targeted provision that is more properly thought of as a limited change to the mechanical §960 rules applicable to a §956 inclusion rather than a "loophole" closer.  Likewise, the §304(b)(5) amendment included in the extenders bill is targeted at a common but narrow planning opportunity that is a natural result of the mechanics of §304 and reflects the latest in a long series of tweaks to §304 to prevent yet another apparently unintended result.

Even if there are plausible policy justifications for each of these changes, the fact that they just add greater complication to an already seriously complex system is a disappointment to many.  And the fact that they are piecemeal changes rather than more systematic reform may also be disappointing. It's as though they represent a missed opportunity to begin to fix the underlying problems with the U.S. system of international taxation — to do reform that might be bipartisan.

The underlying pressure that generated each of the planning techniques targeted by the provisions noted above is the so-called "lockout effect" on foreign earnings of U.S. multinationals. The non-Subpart F foreign earnings that bear foreign taxes at less than a 35% rate are often "locked out"—unable to be repatriated without unacceptable cost—because of the residual U.S. tax that will apply upon repatriation. When compared to the typical foreign system—where the corporate tax rate is materially lower and foreign earnings are exempt—the U.S. system arguably makes U.S. multinationals less competitive. Failing to address the lockout effect may well encourage U.S. multinationals to expand, and to create jobs, offshore, rather than in the United States. The same impact might be expected from provisions, like those noted above, that stop taxpayer self-help in avoiding the lockout effect. This is not to say that self-help such as that prevented by these provisions shouldn't be prevented; just that the underlying cause should also be addressed at the same time. Proposals to take the pressure off at least a significant segment of the pipeline of international taxation as well as to plug the holes, rather than just plugging the holes, would be more likely to have bipartisan appeal. Senior tax writers on both sides of the aisle also know that, as long as the pressure is high, the pipeline is likely to spring new leaks, and existing, unplugged ones will grow larger. Had the extenders bill addressed in some fashion the lockout effect, this commentator would venture a guess that it, or at least its tax provisions, would receive bipartisan support.

This commentary also will appear in the August 2010 issue of the BNA Tax Management International Journal. For more information, in the BNA Tax Management Portfolios, see Isenbergh, 900 T.M., Foundations of U.S. International Taxation,  and in Tax Practice Series, see ¶7110, U.S. International Taxation — General Principles.


1 At the time this commentary is being written, the Senate is considering amendments to the extenders bill.


2 Although ex-Chairman Rangel proposed reducing the corporate rate in 2007.



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