Democratic Tax Plan Would Corrupt Financial Statements

pa href=https://www.cato.org/people/chris-edwards hreflang=undChris Edwards/a/p pPresident Biden and congressional leaders are searching for ways to raise $2 trillion to fund proposed spending increases. They have been floating many harmful tax ideas, receiving blowback on them, and then proposing new ideas that are just as bad. They seem to think that they can find anbsp;magical revenue source that sucks $2 trillion out of the private sector without causing major damage./p pThe recent Biden a href=https://www.whitehouse.gov/briefing-room/statements-releases/2021/10/28/president-biden-announces-the-build-back-better-framework/framework/a included anbsp;new minimum business tax of 15 percent on financial statement (or book) income. The tax would apply to companies with income of more than $1 billion, and would supposedly raise $325 billion over 10nbsp;years. Anbsp;group of Democratic senators are a href=https://www.cnbc.com/2021/10/26/corporate-minimum-tax-proposal-unveiled-by-key-senate-democrats.htmlchampioning/a the plan./p pThis is anbsp;really bad idea. For one thing, it would add needless complexity to the tax code—supporters have a href=https://www.cnbc.com/2021/10/26/corporate-minimum-tax-proposal-unveiled-by-key-senate-democrats.htmlalready said/a that the new minimum tax would retain various narrow tax breaks, such as those for research, energy, and housing. The new tax would also discourage the beneficial use of a href=https://taxfoundation.org/minimum-tax-book-income-stock-based-compensation/stock‐​based compensation/a and undermine investment by limiting deductions for capital purchases./p pPerhaps the worst effect of the proposed minimum tax would be to corrupt corporate financial reporting. Currently, financial statements are constructed according to Generally Accepted Accounting Principles (GAAP), which are set by the independent Financial Accounting Standards Board (FASB). The GAAP rules aim to generate useful information on company performance and aid in the efficient allocation of capital across the economy./p pBut anbsp;minimum tax tied to book income would create harmful distortions. For one thing, corporations would likely adjust or manipulate their book income to reduce the hit from the new tax. That would undermine the usefulness of financial statements for markets and investors. At the same time, politicians would likely start pressuring FASB to change GAAP rules for their tax‐​policy ends, which would further reduce the utility of financial statements for capital allocation./p pA a href=https://news.bloombergtax.com/daily-tax-report/bidens-book-profits-tax-risks-distorting-corporate-financialsemBloomberg/em piece/a identified other possible negative side‐​effects of such anbsp;minimum tax, including companies increasing their lobbying over accounting standards, FASB becoming biased in decisionmaking as it considered tax consequences, and markets increasingly relying on unofficial financial statements as politics distorted GAAP./p pAccountants are worried about the prospect of politicians distorting financial statements. When Senator Elizabeth Warren proposed anbsp;corporate tax on book income in 2019, accounting professors Michelle Hanlon and Jeff Hoopes a href=https://thehill.com/opinion/finance/439693-warrens-corporate-tax-solution-is-fundamentally-flawed?rl=1noted/a: “The influence of Congress on FASB would almost certainly increase if financial accounting income was taxed. As anbsp;result, the usefulness of financial accounting to investors and creditors would be damaged.” Similarly, accounting professor Scott Dyreng a href=https://www.wsj.com/articles/dont-let-warren-politicize-accounting-11557089967wrote/a at the time: “If taxes become tied to GAAP earnings, financial accounting standards will inevitably be distorted. Politicians would pressure the Financial Accounting Standards Board to adjust GAAP in anbsp;way that increases government revenue, or punishes or rewards certain corporate expenditures.”/p pThe American Institute of Certified Public Accountants (AICPA) a href=https://s3.amazonaws.com/files.formstack.com/uploads/2805976/56175896/879802280/56175896_aicpa_comments_on_corp_min_tax_on_book_income_10_28_21_submit_cees.pdfnoted/a that when Congress tied the tax code to book income in 1986, the “approach was quickly repealed because many firms and businesses adjusted their financial accounting choices to reduce their income rather than having anbsp;primary focus of providing the most transparent and useful financial results to the capital markets.”/p pWith regard to the current Democratic proposal, the AICPA a href=https://s3.amazonaws.com/files.formstack.com/uploads/2805976/56175896/879802280/56175896_aicpa_comments_on_corp_min_tax_on_book_income_10_28_21_submit_cees.pdfsays/a: “Public policy taxation goals should not have anbsp;role in influencing accounting standards or the resulting financial reporting. Independence and objectivity of accounting standards are the backbone of our capital markets system.”/p pThe Biden administration and Congress have been warned./p