Back in December 2009, FASB Chairman Bob Herz called for ‘decoupling’ GAAP and Banking regulations.

Doing so could enhance the ability of both the FASB and the regulators to fulfill our critical mandates. We can continue to work with independence and an unwavering dedication to market transparency; at the same time the bank regulators can utilize their authority to take whatever actions are required to keep the financial system stable and healthy.

Well, bank regulations aren’t the only ones that might be coupled to financial reporting standards.  But it wasn’t until I saw this week’s reporting on the health-care related charges that I started thinking about tax-GAAP coupling again.

HBS Professor Mihir Disai is a fan of greater coupling of GAAP and tax law, as he discussed in his 2007 testimony to Congress:

Imagine if you were allowed to represent your income to the IRS on your 1040 in one way and on your credit application to your mortgage lender in another way. In a moment of weakness, you might account for your income favorably to your prospective lender and not so favorably to the IRS. You might find yourself coming up with all kinds of curious rationalizations for why something is an expense for the tax authorities but not an expense to the lender. You don’t have this opportunity and for good reason. Your lender can rely on the 1040 they review when deciding whether you are credit-worthy because you would not overly inflate your earnings given your desire to minimize taxes. Similarly, tax authorities can rely on the use of the 1040 for other purposes to limit the degree of income understatement given your need for capital. The uniformity with which you are forced to characterize your economic situation provides a natural limit on opportunistic behavior.

So, should we do this the easy way, and simply tax book income?  Lil Mills, our speaker for the next roundtable, has a different perspective on the benefits of taxing book income:

Proponents of taxing book income anticipate substantial gains in simplicity. However, because financial accounting and tax law serve two separate purposes, some argue that requiring strict conformity is a poor solution to replace accounting and tax enforcement. Mandatory conformity between book and tax accounting would limit the ability and effectiveness of Congress to reward or punish particular taxpayer behavior or to give tax favored treatment to particular business activities. Accounting rule changes would affect tax revenue independent of congressional action. Finally, using book income as the tax base could have unintended consequences in the capital markets by influencing the reporting decisions of firms.

This only hints at the problem, in my view.  Can you imagine the lobbying that would surround financial reporting standards if decisions on whether to recognize or disclose an item affected tax liability?  Join us for Tuesday’s roundtable and weigh in!