A typical consumer spends exactly zero hours a day thinking about corporate tax compliance. Jeff Hoopes, a Tax Maven who devotes approximately 100% of his time to thinking about tax as the research director of the UNC Tax Center, explains why that disconnect matters. In this Episode, he explains the power and the limits of sophisticated enforcement tools such FIN 48 and the Schedule UTP and the humble credit card. He explores whether firms that donated to a particular political party respond differently to tax breaks such as those delivered by the 2017 tax law changes. Hoopes also shows why data from corporate tax returns challenge the conventional wisdom that private companies engage in more aggressive tax planning. His Pencil Question comes from an article by Edward J. Mccaffery in the Wisconsin Law Review.
Jeff Hoopes is an associate professor and the Harold Q. Langenderfer Scholar of Accounting at the University of North Carolina Kenan-Flagler Business School. Hoopes focuses on understanding how taxpayers respond to tax laws and changes in tax enforcement and uses his expertise to explain why. His work emphasizes the intersection of tax law, accounting, public economics, and finance.
In a world where we seem to know more and understand less every day, Professor Hoopes goes to the proverbial videotape to find answers. He works with the Internal Revenue Service to analyze actual tax return data to see how much of what we think we know squares with reality—and what he finds may surprise you. Hoopes and Dean talk about how to achieve the high tax compliance rates that everyone wants but nobody seems able to deliver.
This episode also features a recording by one of our students, Nicholas from New York, NY, reading a quote from Charles Dickens about the window tax, a tax that was intended as a tax on the ownership of luxury homes but prompted the landlords of tenement buildings to board up windows and build new ones without windows.
Speaker 1: All of us should be willing to pay whatever taxes are necessary to enable efficient government to improve or expand any essential services.
Speaker 2: You have a beautiful tax return, the nicest one I've ever seen.
Speaker 3: Okay folks, but you remember your manners, no stampeding, walk slow like you do when you come to pay your taxes.
Steven Dean: Hi, I'm Steven Dean. This is the Tax Maven. Here we are going to, in each episode, talk to our Tax Maven, who will be a person proving Archimedes' point, that a single person with a lever long enough and a place to put it can change the world. The lever in this case is tax and the place to put it is here at NYU Law.
Steven Dean: Tax experts disagree about many things, but pretty much everyone agrees on at least one idea, taxpayers like naughty children, only behave when someone is watching. But today's Tax Maven, Jeff Hoopes from UNC, in his article, "Is Tax Planning Best Done in Private?" shows that that may not be true, tell me about that paper.
Jeff Hoopes: Yeah. So I think there is a common perception kind of in, especially among financial accounts, but even perhaps more broadly that private firms because they face a different set of incentives than do public firms, are able to do a lot more tax planning. So for example, private firms are not subject to the type of capital market pressure that are public firms. They're much more worried about cash flows as opposed to earnings per share or financial accounting earnings, and that enables them to do a lot of things with taxes that public firms would not be able to do. So, when I teach my class, to my students at UNC, historically I've literally said private firms have a lot more latitude to do things as far as tax funding than do public firms.
Jeff Hoopes: So the conventional kind of received wisdom is if you took a public firm, took a private firm, they're about the same, you'd probably expect the private firm to be paying less in taxes. We've got access to proprietary data from the Internal Revenue Service, so we have two IRS employees who are coauthors on the paper that kind of help us get that data. With that data, we compared kind of the universe of publicly traded corporations with a match sample of privately held corporations. So we essentially took public firms, so what's a private firm that's very much like this public firm, that's about the same size, that's in the same industry, and among that group using various different measures of tax planning, we found that public firms are actually doing more tax planning. So they have for example, lower effective tax rates and more likely to have subsidiaries and tax havens.
Jeff Hoopes: They are more likely to have uncertain tax positions. So it kind of a broad spectrum of tax planning measures. We found that the public firms are doing more tax planning than private firms. So the paper still has a long ways to go, but so far we're kind of turning these conventional wisdom on its head suggesting that even though public firms face these kind of pressures to not plan, from what we're observing in the data at least, they're doing more planning than private firms.
Steven Dean: So I think the conventional wisdom essentially is that, when nobody's watching, corporations will be more aggressive in terms of tax planning. Is that fair?
Jeff Hoopes: That's part of it. Yeah.
Steven Dean: What you're finding is that's ... maybe the opposite is true?
Jeff Hoopes: So we can't really figure out why. I mean, we don't know why it is that public firms are doing more and it might be the case that it's because people are watching, right? Public companies do have capital market pressures. We have historically thought of that as meaning that they would be more focused on financial accounting than on tax. But for some types of tax planning strategies, it will improve earnings per share. So it might be that because they're being watched, they're doing better. It might be that here's some unobserved phenomena that we just don't understand yet. But yeah, that was the conventional wisdom unwashed, you just do whatever you want.
Steven Dean: Just it's a little more complicated than we thought. That's super interesting that you found that. So just one more specific question on how you did the work you did. I'll ask it this way. What is the schedule UTP? And how do they help you and your coauthors find your answers?
Jeff Hoopes: Yeah, so in, 2007/2008 the financial accounting standards board created what was called FIN 48 which is basically an accounting standard that says, and this is the very simplified version of it that says, if you expect to get audited in the future and expect to end up paying more in taxes, you have to kind of accrue a tax position for that today. You have to say, "Well we're going to have to pay taxes because the IRS is going to make us pay more taxes in the future. That's going to decrease our earnings today. So we'll create this tax reserve." That's what we call it.
Jeff Hoopes: So the financial accounting standards board, the FASBI created that rule, a few later years later, the IRS kind of piggybacked on top of it and basically said if the FASBI is requiring you to create a tax reserve, then we're going to require you to disclose that tax reserve to the IRS. So if the kind of tax reserve was about a position that's in the United States that the IRS has jurisdiction over, then you're required to fill out schedule UTP and tell the IRS that you have this uncertain tax position.
Jeff Hoopes: So we have various measures of tax planning, one of which is that you have these uncertain tax positions, these positions that if audited the IRS might require to pay a little bit more in tax. Using that as a measure of tax planning kind of helps us round out the story. We have many different measures all of them kind of have flaws, but the kind of belief is that if they have different flaws, then you can still be able to find an answer.
Steven Dean: Professor Hoopes can explain all of this because he is an Assistant Professor of Accounting at the UNC Kenan-Flagler Business School. Like me, he spends a lot of time thinking about tax, but he also understands how important it is to acknowledge that not everybody does.
Jeff Hoopes: It was a hugely kind of controversial thing when it first came out, right? Because you're telling the IRS exactly where they should be requiring you to pay more taxes. So the belief was that the IRS would just take schedule UTP and say, "Well here's the items, please pay up." I don't think that's actually happened. I don't think people's worst nightmares had been fulfilled. Part of it is because UTP reflects not only the things that corporations are doing, but also there's uncertainty that just derives from tax law uncertainty. So with some things it's just not clear what the actual tax law is. For those you accrue a tax reserve and you disclose an uncertain tax position.
Steven Dean: So what do you think your conclusion means for the way we enforce tax laws?
Jeff Hoopes: So, I mean there's a lot of things you could take from the paper, one of which is that you might consider like who actually holds a corporation, right? You can be publicly traded, you can be privately traded, and the extent that there's some kind of latent behavior that is manifest in publicly traded companies more than privately traded companies, that is like the willingness to engage in tax planning. You might consider that as a tax enforcement agency.
Steven Dean: So you've done quite a bit of work focusing on corporate tax planning and the impact of public scrutiny. Can you explain what you found?
Jeff Hoopes: Yeah, so I teach a class called Taxes and Business Strategy that uses a textbook that has what we call like the three key points we're thinking about tax planning. You're supposed to think about all taxes, you think about all parties, but then you think about all costs, right? So if you engage in tax planning, there can be financial accounting related costs, meaning taxable income will be lower, but your financial accounting income will also be lower so you might not want to do that tax planning.
Jeff Hoopes: But another kind of key cost that has been a big focus of both tax directors, the literature that I think is super interesting, is the fact that if you just ask tax directors like, "Why don't you engage in more tax planning? What is it that keeps you from doing more tax planning?" The first thing they'll say is, "Well we could do additional tax planning but it would lack economic substance." But the second thing that tax directors worry about, and this is pretty good survey evidence we have on this, is they'll say, "We don't want to end up on the front page of The Wall Street Journal." There's this reputation effect to tax planning, and we're worried about that, and that's the reason we don't do more tax planning.
Jeff Hoopes: So again, we have good evidence just from directly asking tax directors, "Are you worried about public scrutiny, are worried about the reputational costs of tax planning?" And we actually have some relatively good evidence that tax directors and corporations generally those decision makers at corporations taking that into account. So they make disclosure decisions, they make tax decisions that are consistent with their reputational costs of tax planning. But to me the outstanding question is like, do these reputational costs actually exist?
Jeff Hoopes: So it seems very valid to me that if you're a tax director, all you think about is tax planning all day long. I mean, you certainly realize that the average consumer, for example, it doesn't think about taxes all day long. But you might think that they dedicate like one or 2% of their time to thinking about it. What I kind of, there's some evidence consistent with this, and I'm trying to kind of uncover more evidence is, it might be that the average consumer spends zero time thinking about corporate taxes. If they do, then at least through the consumer channel, there might be very little reputational cost of tax planning.
Jeff Hoopes: All right, so you can think about reputational costs in many different ways. You have a reputation with politicians, with customers, with suppliers, with employees. So there's all sorts of different channels. But from the consumer standpoint some of my work is focused on are companies afraid of consumers, as far as their tax planning goes. I think we find pretty good evidence that they are, that they make decisions consistent with the fact that they think consumers might actually buy less of their stuff if they engage in tax planning. But are consumers actually concerned about tax planning? There's kind of mixed evidence on that and I think it would be super fascinating to know the actual answer.
Steven Dean: No, I think it's a very interesting question and it's one of the very many interesting questions you ask in your work. Just do consumers care about whether corporations pay their taxes?
Jeff Hoopes: Yeah. I think the challenge is, is most people who ask that question, and most people who worry about that question, just naturally think about taxes. I mean, so I'm at UNC and part of the tax center, and the tax center's like slogan or motto or whatever you want to call it, is, "Exploring a world shaped by taxes." Like if I see something, I literally think, well how did taxes affect that? But most people don't think about taxes almost ever. So it's difficult for the question asker to come from a very different mental standpoint from the person that we're actually asking about. I think that might be why we might not necessarily be getting the answer right.
Steven Dean: No. It's super interesting and I'm so glad you're doing the hard work of looking into what the actual answers are. So just changing gears a little bit. Today, we live in a time when everything seems to be tracked and recorded, and there are lots of reasons to worry about that. But does, for example, the fact that we pay for everything with a credit card, at least make life harder for tax cheats?
Jeff Hoopes: It would seem that way. So I actually have a paper that looks at that. In 2010, the IRS was successful in getting the law changed, I guess Congress changed it, but the IRS was very in favor of the law, where you would have credit card companies and just generally electronic payment card companies that had to disclose to the IRS and to the state tax authority how much companies receiving in revenues due to credit cards. So you might think, as the IRS did well, well it seems very natural then that if you're kind of forced to report these credit card sales, you're going to end up reporting more in sales and paying more in taxes.
Jeff Hoopes: The challenge with that is companies don't pay taxes based on sales. They'd pay taxes based on taxable income, and while the amount of sales was disclosed to the IRS, the amount of the tax deductions that companies have were not right. So when we looked at this, so this is amongst sole proprietorships, so it was relatively small companies that we were looking at in this study. We basically found that even though we had credit card reporting for revenues, that companies could still report whatever expenses they wished to report, and it'd result that income didn't necessarily change.
Jeff Hoopes: So I think on an ongoing basis as we become even more and more digital, it might be conceivable that in some way expenses would be reported to the IRS. That was actually legislated into the law, and then subject to what I'd like to call legislative infanticide. It was taken out of place before it was actually mandated to start their reporting process. But if we saw the reporting of expenses that would facilitate this kind of tracking, and you might get a different answer than just reporting sales.
Steven Dean: But even with, knowing everything about what happened in terms of the credit card payments they received, what you're saying is there was still an ability for taxpayers to manipulate what wasn't being observed? So unless you're observing everything-
Jeff Hoopes: So unless you're ... and I hate to use the word manipulate, and what we show in the paper is that sales went up, but expenses went up by about the same amount and we look at what line items went up by the same amount, and the line item that went up by the same amount was most commonly the line item other. So I mean, I guess listeners can draw their own conclusion about whether that's manipulation or not, but just empirically on the ground there are a lot more other expenses reported after that now.
Jeff Hoopes: No, this is not at all to say that this wasn't a policy that was desirable, right? So this is just kind of the deterrence effect that companies just initially filed tax returns with more other expense. For sure, knowing those credit card payments could be very helpful in an audit. It could be helpful kind of after the fact to enforce the tax law. The paper, to be clear, just looks at the kind of the deterrent effect of the initial disclosure.
Steven Dean: So businesses often say that they make investments or provide benefits to their employees in response to tax changes. What does your research show about the link between changes like the new 2017 tax laws and corporate behavior?
Jeff Hoopes: Yeah, so I have a recent paper about this. So in 2017, we cut the corporate income tax from 35% to 21% and by we, I don't mean we, I mean Republicans in Congress unilaterally changed it, which you might love or you might hate. But they did. So most businesses were in favor of this, especially large corporations were in favor of at least the tax rate cut. So right after the law passed, and actually in some cases a couple days before the law actually was passed and signed by president Trump, we saw many companies, many hundreds of companies saying we're going to pay, for example, an employee bonus because of tax reform, right? So we have all this new cash, we're going to have a lower tax rate, we can repatriate money from abroad because of other changes in the tax law. We're going to give us some of these tax benefits to our employees in the form of these employee bonuses.
Jeff Hoopes: So you had two different aisles politically, you people on the right there were saying this is like ex post evidence that tax reform worked. I mean we had a few senators that went around, I saw one that had a slide, "The proof was in the paycheck," that like we are seeing bigger paychecks, we're giving these bonuses, the individual tax cuts are cut. This was a great thing. So people on the right we're very proud of these tax reform bonuses. On the other side, people on the left were basically saying, "This is all just like marketing. It's a gimmick. These aren't big numbers, these are trivial amounts as far as the actual bonuses being paid. There's not that many firms doing it and it's all just marketing by corporations trying to make tax reform look better than it actually is."
Steven Dean: So what did the data show?
Jeff Hoopes: So what we looked at is basically the two different explanations would be, you would expect if there was actually some economic benefit to tax reform that filtered through to employees, the corporations that benefited the most from tax reform, are going to be most likely to pay the employee bonuses? And that's exactly what we find. So if you have a larger drop in your effective tax rate due to tax reform, you are much more likely to end up paying these employee bonuses. But we also find that if you were a corporation that donated more money to a Republican political action committee, then you were also more likely to pay these employee bonuses.
Jeff Hoopes: So I mean you can take that in two different ways, right? You could say, well maybe your Republican corporations are just more generous and pass through is more complete with Republican led corporations. Or you could say the kind of the skeptical view that was common on the left right after tax reform is that it was just political advertising, we had corporations trying to lobby for this to pass, and then they want to make this bill look as good as possible ex post.
Steven Dean: So just taking a step back from many of the interesting studies you've conducted. I just want to get a sense of what you think we might learn from all this. So I'll ask you something, what do you think is the best way to get businesses to pay their taxes?
Jeff Hoopes: That's an excellent question. I think a lot of the problems that we have with the tax code right now or are that it's too complex. I mean, the fact of the matter is when the IRS goes in and audits, there's a nontrivial portion of corporations that actually receive a negative audit adjustment, meaning they actually pay money back to the IRS because they simply didn't know what to do. Certainly there are a lot of corporations that are gaming the system that are trying to pay as little as possible through perhaps legal, perhaps non-legal means. But I think if the corporate tax code were simpler, that would enable those who just want to comply, to comply much easier, and not make the kind of errors that end up in negative audit adjustments.
Jeff Hoopes: But also a simpler tax code is also one that's much less manipulable. The problem with that of course, is that the simpler you make the tax code, the less kind of incentives that you can have in it. You can either think about that as a good thing, in that Congress has less ability to manipulate the way corporations act, and just let the market dictate what corporations should do. Or you could think about it as a bad way and that Congress is somehow this all-knowing body that's going to fine tune the economy to get corporations to produce better outcomes than the free market would.
Steven Dean: So you're not a tax lawyer, but you obviously know a lot about tax law. How does understanding the tax law help you do your work?
Jeff Hoopes: So what's interesting about tax research in general is that there's a lot of people who engage in tax scholarship. You have economists, you have lawyers, you have accountants, and you have other people as well. You have finance people. So all of these different parties kind of bring to bear different things. I mean knowing the tax law is essential to what I do, but knowing the tax law and how it interacts with other things, for example, how firms think about things, as far as their just strategic economic behavior, about how they think about their financial accounting is important. So I'd say knowing the tax laws is very important to what I do, but more important is knowing how it interacts with all the other systems and influences that public corporations are subject to is essential.
Steven Dean: Okay. Thank you Jeff, and thanks for joining us here today. I'd like to close with what I can think of is as the pencil question. I have here a brand new NYU Law Graduate Tax Program pencil. That's the sort of the stakes we have here, and I'm going to ask you a question. You get it right, you get the pencil, you get it wrong, no pencil.
Jeff Hoopes: It's a very nice pencil by the way. So just so everybody knows, the stakes are very high. I'm looking at this pencil, coveting it as we speak.
Steven Dean: I'm sorry, I don't mean to be a sort of cruel in sort of taunting you with a pencil, but I think you should know what we're about here.
Jeff Hoopes: Yeah, it's there, I can see it.
Steven Dean: All right, so you, you thought a lot about why corporations pay taxes and what Congress is doing. So I'm going to ask you about, I talked about simplification. In 1990, Ed McCaffrey wrote in "The Holy Grail of Tax Simplification", about one example of how our laws get complicated, and I'm going to ask you about that. So he wrote, "One such example of a highly tailored tax division is the so-called blank amendment. It's not a blank amendment, but I'm going to leave out the name, which carved out a major exception to the application of the generation skipping tax imposed by the 1986 tax reform act." This exception, it's available mostly for only wealthy tax payers.
Steven Dean: So this was a benefit that was targeted at a specific wine maker. So I'm going to give you three choices. It's either referred to as the Cupola amendment, the Gallo amendment or the Ditka amendment.
Jeff Hoopes: B. Most certainly B.
Steven Dean: You actually knew the answer, didn't you? Okay.
Jeff Hoopes: No, I didn't actually.
Steven Dean: You didn't know? You got ... Wow. Okay. So the pencil-
Jeff Hoopes: Multiple choice, you go with the middle.
Steven Dean: Okay. You got me, the pencil is yours. Thank you very much Jeff. So as Professor McCaffrey writes, "In 1986 the Gallo amendment named after the wealthy California and who sponsored it acted to exempt the $2 million per grandchild from the portion of the estate tax." I also am going to give a hat tip to Bridget Crawford who mentioned this Gallo amendment to me. I do want to just mention that I did not make up that Mike Ditka is in fact in the wine business, you can pick up, if the internet is to be believed, the coach Cabernet Sauvignon or the Player Merlot. I don't know where you can find these, but I bet-
Jeff Hoopes: For all the players out there.
Steven Dean: Absolutely. You could probably pick these up in Chicago. I would assume that's a place where you could get them. So I want to thank you Jeff. Jeff Hoopes from the UNC Kenan-Flagler Business School. I also want to thank Patrick Kelly, Joe Rivera, Greg Addison, Jill Rachlin and Anthony Pietrangelo. Thank you for listening to the Tax Maven. The NYU Law Graduate Tax Program has been the premier place to learn about tax law for the past 75 years. So please visit us on the web. Visit our graduate tax program website to see the different programs we offer both in person and online, both for lawyers and non-lawyers. Take a look at we offer and I hope you consider joining us.
Steven Dean: Now we like to end each of our episodes with a quote about taxes read by one of our students, Nicholas from New York, New York, who is going to read as a quote from Charles Dickens.
Nicholas: The adage as free as air has become obsolete by act of parliament, neither air nor light have been free since the imposition of the window tax. We are obliged to pay for what nature supplies lavishly to all at so much per window per year, and the poor who cannot afford the expense are stinted in two of the most urgent necessities of life.
Steven Dean: Please email us at info at taxmavenpodcast.com if you have any questions or comments or suggestions, and if you are a student and want to email us a recording of your favorite tax quote, please email it there as well. Thanks for tuning in.