Costs of Compliance

Earlier this week, I had the opportunity to spend some time with tax executives from some large corporations, as well as some other tax professionals. They were in town for a symposium sponsored by the Creighton College of Business, which was planned by Profs. Tom Purcell and Mark Taylor. It was a terrific event, and my hat goes off to both of them for putting together a great program.

The symposium covered a new code section -- section 199 -- which is designed to provide tax relief to domestic manufacturing/production activities. Section 199 was enacted last fall as part of the American Jobs Creation Act of 2004. This provision arose in response to a challenge by EU countries to the previous tax regime governing extraterritorial income. The WTO held that our tax structure -- which effectively rewarded export activity by providing an exclusion from U.S. taxes -- constituted a prohibited export subsidy. To keep trade sanctions from hurting U.S. businesses, we effectively were forced to change our tax laws. One lesson here: we cannot behave as though we are legally isolated from the rest of the world. Our trade agreements affect laws in ways we may not anticipate, even matters of taxation. (As I will discuss in a later post, they may even effect state and local laws relating to matters like gambling, as a recent WTO ruling suggests.)

What we got out of section 199, however, was a labyrinth of complexity that now has nothing to do with exports. The Code provisions are very general and nonspecific, and implementing rules from Treasury have thus far consisted of a Notice (Notice 2005-14, 2005-7 I.R.B. 498) which extends over 100 pages. Needless to say, lots of intellectual capital will be expended in getting the tax benefits under this provision, which are substantial. That is good for tax professionals, and the incentives may well help bolster domestic manufacturing and production activities. However, it will come at a cost that is more than the revenue estimates related to this bill.

Another related topic which came up was the matter of compliance costs for Sarbanes-Oxley. One public accounting firm representative noted that his firm utilized every English-speaking auditor available (including those from foreign offices) as well as a significant number of tax professionals (I believe it was 40% of them) just to help their clients comply with the audit provisions of this bill. Hopefully for the clients, this will not be a recurring problem every year. But it certainly required a significant cost this year.

This kind of spending is obviously very good for the accounting firms and the people who provide these services. Accountants are good people who do valuable work in providing a reliable source of finanical information. However, there are trade-offs involved. The cost of complying with these provisions is not available for investment in making better widgets or otherwise becoming more competitive in terms of products. These indirect costs may well eclipse the direct costs of compliance.

Such matters deserve more attention from our policymakers. We get some value from provisions like section 199 and from requiring additional safeguards for investors through laws like Sarbanes-Oxley. But a vigilant public needs to keep asking questions about the real costs of these laws, and whether it is worth what we get out of them.

EAM