You’d be forgiven for ignoring the latest round of crisis manufacturing underway in Washington, DC; the current set of politicians in power, like oversized kindergarteners with cable news spots, seem able to operate only by continually threatening to close the government down and walk away. The markets and the citizenry have seen so many rounds of this brinksmanship they start to blend together and subsequently lessen in importance, but cynicism has often been proved a precursor to real moments of transformation.
That old song and dance routine of raising the debt ceiling is back on the calendar for later this year, and both of the dominant parties are reinforcing their positions and trading rounds of accusations. The difference this time is the tax code.
After briefing everyone in sight that they would definitely be addressing tax revision in the wake of the 2012 election cycle, leadership from both parties are now obligated to at least explain why they wouldn’t put the US tax system into play after acknowledging it is outdated, over-complex and creating perverse incentives for the businesses on which the country is relying for job-creating investment.
The US energy business, a massive source of tax income for every level of government across the US, is deeply sunk into the complex, often counterintuitive morass of the US tax system. Tax-advantaged investment structures that helped build projects for decades no longer reflect the way capital markets work but no new structure for investment exists, while the oil sector has become embroiled in a tit-for-tat over accounting for capital depreciation tax accounting with the Obama administration in a way that mostly reveals how well-intended tinkering with the tax code no longer drives investment in a way transparent to investors, lenders or operators.
The US started out with a simple tax code that has been added to and now includes so many clauses that each new edition threatens to break the average bookshelf. The broad consensus is that it is broken, but the will to fix it is confounded by the very complexity that makes it unworkable. So why waste a good inside-the-beltway crisis in Washington if the opportunity is there to create a tax code that makes sense for the 21st century economy?
We are in the middle of a transition to a “smart” energy world. While the term prompts eye-rolling among those who legitimately bewail the overuse of “smart” as a marketing term, the reality is that the sector will soon be completely awash in real-time information insofar as it isn’t already. That real-time information underpins granular and transparent detail about cash flow, profits and investment needs: so why not a flexible, “smart” tax code that allows for tailoring to individual requirements rather than the current practice of backfilling operational detail to comply with an outcomes-directed tax policy?
The practice of “principles-based” regulation was widely discussed in the wake of the 2008 financial crisis as it became apparent that one-size-fits-all markets regulation failed to capture the speed at which markets were evolving. Since then, regulators have recently been more inclined to threaten banning practices they don’t like to get back at big banks for being overly clever in objections to reasonable oversight, but the idea hasn’t fully died.
Writing last year for the magazine of the American Enterprise Institute, Arnold King defined principles-based regulation like this: “legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines. Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles.”
A change to “principles-based taxation” is increasingly plausible, with real-time tracking and data compilation steadily reducing the need for a retroactive, obtuse taxation system that sows more uncertainty than it does reassurance. Uncertainty kills investment, and uncertainty about the details of taxation policies around which much of US industry is shaped goes some way to explaining why companies have sat on the sidelines of the non-financial economy for the past decade or more.
Shifting to principles-based taxation would be significant, and probably require an immense amount of case law reworking, but the US energy sector (and US business generally) is in for a change regardless as data cracks open corporate practices in the way it has only begun to in our daily lives. Business as an interest group can either seek to shape the outcome or restrict itself to coping with the results of whatever the political establishment comes up with.
“Nothing lasts unless it is incessantly renewed,” said the unlikely radical and French postwar political leader Charles de Gaulle. Without renewal, the US tax code – and the creative economic power with which it is intertwined – won’t last either.
For much more on the idea of principles-based taxation, Oxford University has a detailed discussion of the concept available for download as a PDF here.
