A complete evaluation of the tax treatment of businesses, which is a  critical element of our overall federal tax system, cannot be made without  considering how business taxation interacts with and complements the  other elements of the overall system, such as the tax treatment of  individuals and excise taxes on selected goods and services. Business tax revenues of the magnitude discussed make them very  relevant to considerations about how to address the nation’s long-term  fiscal imbalance. We will need to  make tough choices using a multipronged approach: (1) revise budget  processes and financial reporting requirements; (2) restructure entitlement  programs; (3) reexamine the base of discretionary spending and other  spending; and (4) review and revise tax policy, including tax expenditures,  and tax enforcement programs. Business tax policy, business tax  expenditures, and business tax enforcement need to be part of the overall  tax review because of the amount of revenue at stake. Efficiency, Complexity, Compliance, and Equity Concerns Contribute to Calls for Business Tax Reform

The design of the current system of business taxation causes economic  inefficiency and is complex. There are some features of current business taxation that have attracted  criticism by economists and other tax experts because of efficiency costs. The goal of those who push  for this type of competitiveness is to improve the U.S. balance of trade. Business Tax Complexity Also Makes IRS’s Job of Enforcing Tax Rules Very Challenging and Can Reduce Public Confidence in the Fairness of the System

Although the precise amount of business tax avoidance is unknown, IRS’s  latest estimates of tax compliance show a tax gap of at least $141 billion  for tax year 2001 between the business taxes that individual and corporate  taxpayers paid and what they should have paid under the law. The tax reform debate of the last several  years has focused attention on several important choices, including the  extent to which our system should be closer to the extreme of a pure  income tax or the other extreme of a pure consumption tax, the extent to  which sales by U.S. businesses outside of this country should be taxed, the  extent to which taxes should be collected from businesses or individuals,  and the extent to which taxpayers are compensated for losses or costs  they incur during the transition to any new tax system. The proposed system should raise sufficient revenue over time to fund our  expected expenditures. The tax base should be as broad as possible. One, discussed in this statement, is through neutral taxation of  investment alternatives. Higher saving and investment from a more balanced fiscal  policy would contribute to increased productivity and a higher standard of  living for Americans over the long term. Finally, the consideration of transition rules needs to be an integral part of  the design of a new system. This, in turn, leads to widely  divergent views on even the basic direction of reform. However, I have described some basic principles that ought to guide  business tax reform. While economic growth alone will not solve our long-term fiscal problems,  an improvement in our overall economic performance makes dealing with  those problems easier. Brumbaugh, David L. Federal Business Taxation: The Current System,  Its Effects, and Options for Reform.
Why GAO Did This Study

Business income taxes, both corporate and noncorporate, are a significant portion of federal tax revenue. Businesses also play a crucial role in collecting taxes from individuals, through withholding and information reporting. However, the design of the current system of business taxation is widely seen as flawed. It distorts investment decisions, hurting the performance of the economy. Its complexity imposes planning and record keeping costs, facilitates tax shelters, and provides potential cover for those who want to cheat. Not surprisingly, business tax reform is part of the debate about overall tax reform. The debate is occurring at a time when long-range projections show that, without a policy change, the gap between spending and revenues will widen. This testimony reviews the nation's long term fiscal imbalance and what is wrong with the current system of business taxation and provides some principles that ought to guide the debate about business tax reform. This statement is based on previously published GAO work and reviews of relevant literature.

What GAO Found

The size of business tax revenues makes them very relevant to any plan for addressing the nation's long-term fiscal imbalance. Reexamining both federal spending and revenues, including business tax policy and compliance must be part of a multipronged approach to address the imbalance. Some features of current business taxes channel investments into tax-favored activities and away from more productive activities and, thereby, reduce the economic well-being of all Americans. Complexity in business tax laws imposes costs of its own, facilitates tax shelters, and provides potential cover for those who want to cheat. IRS's latest estimates show a business tax gap of at least $141 billion for 2001. This in turn undermines confidence in the fairness of our tax system--citizens' confidence that their friends, neighbors, and business competitors pay their fair share of taxes. Principles that should guide the business tax reform debate include: (1) The proposed system should raise sufficient revenue over time to fund our current and future expected expenditures. (2) The tax base should be as broad as possible, which helps to minimize overall tax rates. (3) The proposed system should improve compliance rates by reducing tax preferences and complexity and increasing transparency. (4) To the extent other goals, such as equity and simplicity, allow, the tax system should aim for neutrality by not favoring some business activities over others. More neutral tax policy has the potential to enhance economic growth, increase productivity and improve the competitiveness of the U.S. economy in terms of standard of living. (5) The consideration of transition rules must be an integral part of any reform proposal.