Good morning.  Today we are continuing our series of hearings on comprehensive tax reform.  This morning’s hearing will focus on the interaction of tax policy and financial accounting rules (such as Generally Accepted Accounting Principles, or “GAAP”), and we will examine how this interaction affects the way in which publicly-traded companies respond to tax policy.  

A subsequent hearing will look at the special challenges faced by small and closely-held businesses that might be less concerned with GAAP but must confront tremendous complexity in dealing with tax accounting and related rules such as choice of entity.  

During today’s hearing we will consider how public companies evaluate tax policy options in light of financial accounting – or “book” considerations.  As such, we will examine whether tax legislation works as intended when Congress does not consider the effects of financial accounting.

When companies report profits in their financial statements, the primary purpose is to convey information about a company’s financial condition to investors and creditors.  

Conversely, the primary purpose of tax accounting is to measure income for levying the Federal income tax.  These two functions are not necessarily consistent, and in some cases, may even be at odds.

For publicly-traded companies focused on Earnings per Share (EPS) in addition to cash flows, changes in tax policy might not produce intended results if the effect of tax policy on EPS is not well understood.  

As a recent Tax Notes article suggests, when presented with an option between targeted tax benefits and a lower corporate rate, many publicly-traded companies might prefer a lower corporate tax rate over those tax benefits because of the “book” treatment.  Similarly, tax provisions that provide cash benefits might not have their desired effect on behavior due to a less favorable “book” treatment.

A variety of factors can affect publicly-traded companies, and their decision-making processes, differently.  For instance, the high U.S. corporate rate is an important factor for companies that use either GAAP or international accounting standards.  If the rate is too high, companies will, all other factors being equal, allocate capital to a location that provides more favorable tax treatment.

Today, the current top Federal corporate income tax rate in the United States is 35 percent, and the average combined Federal-State corporate income tax rate is 39.1 percent, second only to Japan’s 39.5 percent rate.  However, in fewer than 60 days – effective April 1, 2012 – Japan will lower its combined corporate tax rate to 38 percent.  That will leave the United States with the highest corporate tax rate in the entire industrialized world.  This dubious distinction will make it that much more challenging to attract businesses to hire and invest here at home where we need jobs.

However, not all employers have the same tax profile. The impact of federal tax policy on certain key book calculations can diverge significantly from the impact of the same policy on a company’s cash tax liability.  We need to understand better how public companies respond to tax policy when such divergences occur.  

If the goal is, as I believe, to transform the code and create a climate ripe for hiring and investment, then we must solicit input and insight from the very job creators who will do that hiring and investing.  

Properly designing tax reform requires an understanding of the financial accounting rules and how those rules might influence the investment decisions of public companies.  

I am pleased to have some of those businesses here today, along with members of the academic community who have done extensive research on how financial accounting affects corporate behavior, and I look forward to hearing from all of them.