Schön argues that tax preferences will always be around, thereby making it difficult to narrow the book–tax gap. He says:
It has been argued that the introduction of these tax preferences should not be prohibited by comprehensive book-tax conformity. Yet these rules not only deviate from the financial accounting treatment, they also infringe the ability-to-pay principle. Therefore, there are good arguments to do away with exceptions, which distort the tax base and violate the equitable treatment of taxpayers in general.363
It is generally assumed that a small number of variables are responsible for the book–tax gap. Manzon and Plesko364 document that the book–tax income gap has increased over time, with a relatively small set of variables explaining this increase. Pre-1990 book–tax differences could
363 Schön, supra note 148 at 131. 364 Manzon & Plesko, supra note 273.
be explained by three factors: treatment of depreciation, foreign income, and employee
compensation. However, by the late 1990s, only less than half of the difference was explained by these three factors.365
According to Weiner, the existence of the book–tax income gap is not a problem.
However, there is a concern as to whether this gap is increasing over time. 366 The gap exists for several reasons. It may be due to the temporary accounting difference that can be reversed after the passage of time (timing differences), or it can be caused by tax sheltering activities. Weiner documents that in 1980, US companies reported book incomes that were 8% higher than their taxable incomes. By 2000, this gap grew to 50%, and in 2003, book income was almost twice as high as taxable income.367
Although complete alignment of book–tax income is not feasible, there is still a scope for some convergence. It is evident from various studies that increased conformity reduces tax avoidance.368 Porcano and Tran also opine that complete alignment is neither possible nor desirable. They say:
Having argued that a complete book-tax alignment is infeasible and undesirable in Anglo-Saxon countries, we do not mean that there is no scope for bringing two sets of rules closer to each other. Tax authorities (i.e., the legislature, the judiciary, and tax administrators) can selectively adopt some of the accounting principles and standards to provide a tax base which is clear and certain. … It is not that financial accounting rules should not be adopted for taxation purposes; it is only an indiscriminate adoption of all financial accounting rules for taxation purposes that will
365Desai, supra note 309.
366 Joann M Weiner, “Closing the Other Tax Gap: The Book-Tax Income Gap” (2007) Tax Notes 849 at 853 [Weiner].
367 Ibid at 851.
368 Tanya Tang, “Does Book-Tax Conformity Deter Opportunistic Book and Tax Reporting? An International Analysis” (2015) 24:3 European Accounting Rev 441. and T J Atwood et al, “Home country tax system
serve neither the needs of a good tax system nor those of a good financial reporting system.369
Tang also argues that while full conformity is not feasible, there are potential benefits of increased conformity. Her study provides evidence on the major perceived benefits of
conformity.370
Former US Treasury Assistant Secretary for Tax, Pamela F. Olson, argues that greater conformity does not mean eliminating excessive book–tax reporting differences. She favours making a few simple but comprehensive sets of differences that “could go a long way to fostering greater confidence in the number and respect for the tax system.”371
Accounting scholars such as Atwood, Drake, and Myers oppose the idea of conformity between tax and accounting systems.372 Their empirical study documented that increasing book– tax conformity would lower earnings quality and result in reported accounting earnings that are less persistent and less highly associated with future cash flows. They even suggested that any move toward partial conformity may result in reported accountings that are less persistent and less closely associated with future cash flows.
Another objection to more conformity is that it would increase the taxpayers’ compliance cost. In reality, the cost would likely be small compared with the benefits of more transparency for all stakeholders.
369 Porcano & Tran, supra note 203. 370Supra note 368.
371Amy Hamilton & Natalia Radziejewska, “Olson argues for eliminating some book-tax reporting difference” (March 31, 2003) Tax Notes at 1936.
372 T J Atwood, Michael S. Drake, & Linda A. Myers, “Book-Tax Conformity, Earning Persistence and the Association between Earning and Future Cash Flows” (2010) 50 J of Accounting and Economics,
I agree with Freedman that complete alignment is neither possible nor desirable. The best option is to implement more conformity and more disclosure. As Freedman says:
[I]n any tax system based on profit, the commercial accounts and tax accounts will almost certainly have the same starting place, so the
interesting question becomes one of the degrees to which there should be divergence rather than whether there should be divergence at all. In addition, to the extent that there is divergence, who should be the final arbiter of taxable profits in any given case? The matter could be one for the legislature, the courts or the accounting profession or, most probably, some combination of the three, but the relationship between these sources of definition will need management and regulation.373