Amid the current debate over tax policy in Washington, there is a bipartisan consensus on one issue: the corporate tax rate, which is currently 35 percent, should be reduced to roughly 25 percent. At the same time, budgetary pressures preclude any significant increase in the deficit to accomplish corporate tax reform.

In light of these competing demands, most corporate tax reformers advocate broadening the corporate tax base to pay for any rate reduction. Unfortunately, few politicians have put forth base-broadening measures that would generate revenue sufficient to significantly lower the corporate tax rate on a revenue-neutral basis.

In fact, revenue-neutral corporate income tax reform is likely to be very difficult, because corporate tax expenditures represent a relatively small portion of total corporate tax revenues. A preliminary analysis by the Joint Committee on Taxation suggested that the elimination of all corporate tax expenditures—except for the deferral of tax on foreign source profits, a provision whose repeal would be politically and economically infeasible—would allow for the corporate tax rate to be reduced to only 28 percent.

Therefore, if policymakers want to reduce the corporate tax rate on a revenue-neutral basis, they will likely have to adopt other types of reforms to broaden the corporate tax base. Ideally, those reforms should offer the potential for significant revenue gains and reduce economic distortions.

…continue reading: Corporate Tax Reform

There is a sensible compromise to the debate over money market fund reform that regulators should seriously consider: requiring a fluctuating share price for some money market funds owned by institutional investors, but not for those owned by retail investors. Currently, all money market funds may use a fixed share price – known as the “net asset value”, or NAV – at one dollar per share, subject to strict conditions.

Regulators have argued that a fixed NAV creates systemic risk in the financial system and misleads investors into thinking their investment is guaranteed. They believe that money market funds should instead calculate their NAV daily based on the market value of their investments, as stock and bond mutual funds do – meaning that the NAV may fluctuate from day to day. However, the fund industry argues that a fluctuating NAV would drastically undermine the utility of money market funds. Most investors use money market funds as an alternative to bank deposits, so most investors require the convenience and liquidity of a fixed-dollar account. Additionally, the industry points out that only two money market funds – both institutional – have ever caused any investor losses by “breaking the buck”.

…continue reading: Not All Money Market Funds Are Equal

I recently returned from a trip to Beijing, where I launched the Mandarin translation of a book that I co-authored with Theresa Hamacher entitled The Fund Industry: How Your Money is Managed.

The book was translated because the Chinese fund industry is expanding rapidly; Chinese mutual funds were introduced in 2001 yet held over $340bn in assets by the end of 2011.

However, the future development of the Chinese fund industry faces a stiff headwind. In China, most retail investors buy mutual funds hoping to score a quick short-term gain, rather than to generate long-term returns. The high turnover is usually costly to investors and stunts the development of the fund industry.

The short-term mentality of Chinese investors is reinforced by the fund industry, which spews forth an incredible number of new funds each year. Though fewer than 1,000 mutual funds exist in China, the industry launched 136 new funds in 2010 alone.

This flood of new funds is partly caused by large up-front commissions on fund sales paid to distributors, who also receive smaller fees on an annual basis. To collect these up-front commissions, distributors hype the new funds and investors rush to buy. But these investors hold for a relatively short time – until the next wave of new funds.

As a result, there are very few large funds in China that attract assets through long-term performance. One helpful reform would be to reduce up-front commissions on fund sales and put more emphasis on annual trailer fees that are collected only as long as shareholders remain in the fund.

…continue reading: Reform Needed in China’s Fund Business

In March, the Public Company Accounting Oversight Board held hearings about whether to require public companies to change — or “rotate” — their external auditor periodically. Meanwhile, the European Union is proposing to require mandatory rotation every six or 12 years, and the lower house of the Dutch Parliament recently voted to require auditor rotation every eight years.

At the PCAOB hearings, various investor advocates and pension funds argued in favor of mandatory rotation. They found fault with the lengthy relationships between many auditors and the companies they audit — the auditors of almost 36% of all companies in the Russell 1000 have held that position for 21 years or more. According to the supporters of auditor rotation, this coziness creates a potential conflict of interest: an auditor’s desire to maintain a good relationship with its client could conflict with its duty to rigorously question the client’s financial statements.

Mandatory auditor rotation could reduce this conflict. Since auditors would know that their engagement would come to an end after a fixed period, they would have less incentive to curry favor with management. At the same time, mandatory rotation could encourage existing auditors to perform more thorough audits, because the firm would fear that a new auditor would expose any previous errors or omissions.

…continue reading: Search for Auditors; Don’t Rotate

What is the critical factor for success in the U.S. mutual fund industry? Is it top-ranked investment performance, innovative products, or pervasive distribution? In our view, it is none of these factors, despite their obvious importance. Instead, the best predictors of success in the U.S. fund business are the focus and organization of the fund sponsor. We believe that the most successful managers over the next decade will be organizations with two characteristics: dedication primarily to asset management and control by investment professionals. Our view is based on research for the book The Fund Industry: How Your Money Is Managed (Pozen and Hamacher 2011).

Dedicated asset managers—firms deriving a majority of their revenues from investment management—dominate the industry, as shown in Table 1. The table ranks U.S. fund families by assets under management in 1990, 2000, and 2010 and shows dedicated asset managers in boldface. At the end of 2010, 8 of the top 10 firms were dedicated to investment management, as were 14 of the top 25 firms. Dedicated firms have held this dominant position for the past 20 years; in 1990, 13 of the top 25 firms were dedicated to asset management, only 1 fewer than in 2010.

…continue reading: Leadership in the Fund Industry

The current system for taxing the income of controlled foreign subsidiaries of U.S. corporations — foreign-source income — makes no sense for U.S. multinational companies or the U.S. Treasury. In theory, foreign-source income is taxed at the standard U.S. corporate tax rate of 35 percent; in practice, Treasury generally receives no taxes on foreign-source income as long as it is held overseas. In fact, U.S. corporations now hold abroad an estimated $1.5 trillion in cash, which the current system encourages them to deploy by acquiring foreign companies and building overseas facilities.

In response, some U.S. multinationals are lobbying for a tax holiday on repatriation of their foreign-source income, similar to the one enacted in 2004. Such a tax holiday would reduce the effective tax rate on those repatriations to 5.25 percent for a limited time period, for example one year. This proposal for another tax holiday is reportedly gathering steam in some circles of liberal Democrats.

Another tax holiday for repatriated foreign profits would be a transition to nowhere. It does not address the fundamental problems of the current tax system. Indeed, it reinforces the incentives for U.S. multinationals to keep their foreign profits in overseas accounts — waiting for the next tax holiday.

…continue reading: A Two-Pronged Approach to Reforming International Corporate Taxes in the U.S

House Speaker John Boehner recently joined the chorus of notables calling for corporate tax reform in any deficit-reduction package. Both Democrats and Republicans want to reduce the corporate tax rate from 35 percent to 25 percent, in return for eliminating the tax credits and deductions available primarily to U.S. corporations.

The rationale behind the proposal is sound in theory — a lower tax rate would help all profitable corporations. By contrast, Congress often bestows tax benefits on industries that are perceived as potential winners or those wielding political clout.

In theory, this proposal would also be revenue-neutral. The rate reduction would decrease U.S. tax revenue by approximately $600 billion during the next five years, but this would be offset by the additional tax revenue gained with the elimination of corporate tax “loopholes.”

But the chances of this proposal passing Congress on a revenue-neutral basis are slim. Most of the corporate tax benefits that would need to be repealed have both a significant positive effect on economic growth and deep political support among powerful constituencies. Moreover, repeal would hurt many non-corporate entities, such as local governments and partnerships running operating businesses, that would gain nothing from a lower corporate tax rate.

…continue reading: The Myth of Corporate Tax Reform

The current system for taxing foreign source income of U.S. corporations makes no sense. In theory, income earned by controlled foreign subsidiaries of American companies is taxed at the U.S. corporate rate of 35 percent; in practice, the Treasury receives no taxes on that income as long as it is held overseas. U.S. corporations now have overseas cash holdings of almost $2 trillion, which they are encouraged to deploy by acquiring companies and building facilities outside the U.S.

As an alternative, business lobbyists have advocated a so-called territorial system under which foreign source income would be taxed only in the country where it is earned. These lobbyists correctly argue that almost all advanced industrial countries now follow this system, though many don’t allow tax havens to take advantage of it.

This alternative is based on the premise that foreign source income is being taxed once somewhere, at a reasonable rate by a credible tax-enforcing government such as Germany. But this premise doesn’t apply to tax havens, like the Cayman Islands, where the tax rate is minimal, or a reasonable official rate isn’t enforced.

…continue reading: A Plan to Tax the Foreign Income of U.S. Companies

During the financial crisis, investors learned the hard way about financial liabilities of many institutions that were not previously disclosed. For example, many banks had large contingent liabilities to off balance sheet entities that they had sponsored. The extent of these liabilities surprised investors when the banks were forced in late 2007 and 2008 to take on their books these off balance sheet entities.

Outside directors on the audit committees of these banks were also surprised by the scope and size of these off balance sheet liabilities. To paraphrase Donald Rumsfeld, these directors did not know what they did not know. Their blissful ignorance shows that the SOX reforms for audit committees have not been effective and that a different approach is needed.

…continue reading: What Audit Committees Don’t Know

Robert Pozen and Theresa Hamacher’s The Fund Industry: How Your Money is Managed provides keen insights into the evolution of the money management industry. Pozen and Hamacher offer readers a comprehensive roadmap toward understanding the various types of funds offered for investors. Beneficial both for experienced investors looking to refine their understanding of how the funds they invest in operate and beginning investors looking to make informed decision about the suite of investment products available to them, The Fund Industry provides easily readable and relevant information on this rapidly evolving industry.

Pozen himself brings to the book his perspective both as Chairman Emeritus of MFS Investments as well as Senior Lecturer at Harvard Business School, offering valuable insights as an experienced practitioner and educator. Hamacher also brings three decades of experience in the money management business to light in offering her wisdom for readers.

…continue reading: The Fund Industry: How Your Money is Managed