Strategic Finance ...April 2012
It has been a long time since financial accounting has been a topic of discussion in Congress. But suddenly it is in vogue as the House begins to consider a corporate tax reform bill. Rep. Dave Camp (R-MI), chairman of the House Ways and Means Committee, held a hearing in February on how accounting rules affect corporate evaluations of potential changes to tax policy. This discussion generally devolves into a comparison of the financial accounting effects of lower corporate income tax rates versus their effects with regard to retaining accelerated depreciation or expensing. Those accounting effects are important because Corporate America is going to have to chose between lower rates and tax incentives. They can't have both.
Of course some tax incentives have stronger GAAP implications than others. "Like most companies, we are strongly influenced by tax incentives that improve our GAAP financial reporting metrics, such as our reported income, effective tax rate and earnings per share," states Mark Schichtel, senior vice president, chief tax officer, Time Warner Cable, Inc. He mentions the research credit and Section 199 domestic production incentive as examples.
But he adds, "Given the capital intensity of our business, we rely even more on timing incentives that do not impact GAAP financial reporting, such as expensing and accelerated depreciation, which significantly enhance our actual cash flows and our ability to invest."
Economists, however, cite financial accounting implications to dispute those who claim "timing incentives" such as accelerated depreciation should be valued above lower corporate tax rates. Thomas Neubig, national director of Ernst & Young LLP's Quantitative Economics and Statistics Practice, says a lower corporate tax rate would lower financial statement effective tax rates and increase book net income for most corporations. Accelerated depreciation offers only a timing benefit, and doesn't reduce corporations' financial statement effective tax rate or increase reported book profits. "Many corporate tax executives value permanent book-tax differences higher than temporary book-tax differences," Neubig emphasizes. "They also value the permanent benefit of a lower corporate tax rate more than a temporary cash-flow benefit. Reducing the corporate tax rate would immediately lower corporations' financial statement effective tax rates, thereby increasing their reported after-tax book profits."
Michelle Hanlon, associate professor of accounting and taxation at the Sloan School of Management at the Massachusetts Institute of Technology, argues that tax incentives aren't all they are cranked up to be anyway. She mentions bonus depreciation and the Section 199 deduction. For example, she explains that companies respond less than predicted to bonus depreciation partly because the tax savings are not reflected on a firm’s accounting income statement.