Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Giving Life to LIFO: Adoption of the LIFO Method of Inventory Valuation by the Income Tax Code
Stephen C. Lessard
In April 2006, amidst escalating gasoline prices, record oil industry profits, and mid-year electioneering, Senate Republicans proposed a plan “expected to draw significant opposition from the oil industry and perhaps the business community at large.” The plan proposed to remove the “Last-In-First-Out” method of inventory accounting, popularly known as LIFO, from the Code in order to fund $100 rebates to taxpayers suffering from high gasoline prices. Coming under “immediate fire from retailers and manufacturers who said they’ve come to rely on this accounting method,” the plan was abandoned by Senate leaders within one week. Republican Senator John Sununu, certain that accounting standards are more appropriately regulated by the Financial Accounting Standards Board (FASB), found the proposed rejection of LIFO by Congress “a dangerous precedent and a foolish idea.” Just one year earlier, the Senate considered a one-year moratorium on use of the LIFO method by oil companies but backed away in the face of stiff opposition from those companies and a threatened veto from the White House.
The propriety of a LIFO convention has attracted vigorous public debate since the decision was made, early in the last century, to utilize inventory accounting in the determination of taxable income. Why the tax law first embraced LIFO has been buried in archived Treasury documents, and the legislative history reveals little of the story. Commentators have written extensively about the mechanics and effects of LIFO but not about how the method came into existence. A look beyond conventional sources of legislative history, however, reveals that adoption of the LIFO method was initiated by big business’ interests, impacted by the economic realities of the Depression and New Deal tax policy, and mediated through the professional aspirations of accountants and policy experts within Congress and the Treasury Department. That the Securities and Exchange Commission (SEC) collaborated with the accounting profession from the Commission’s earliest years is well known. Adoption of LIFO as a permissible tax accounting method reflected an equivalent collaboration among significant tax policy players.This Comment examines the circumstances that led to the incorporation of the LIFO method into the tax law in 1938 and 1939. An understanding of why the LIFO method was adopted after decades of initial opposition by revenue officials may lend perspective to the current policy debate. The LIFO issue also presents a case study of the way in which interest groups, professionals, and state actors within government combine to make tax policy. Part I of this Comment looks at the two decades prior to adoption of the LIFO method, defining the environment that prompted and enabled Congress to act on the issue. The roles played by business, the press, and the accounting profession are examined. Part II analyzes the legislative process during the period of 1936 through 1939, which culminated in the adoption of the LIFO method into the tax law. The importance of unique actors and the influence of economic and political events, particularly in the context of the undistributed profits tax supported by Franklin Roosevelt’s administration, are explored. Part III discusses the factors contributing to the Treasury Department’s reversal of its initial opposition to the LIFO method, the interplay of the LIFO method and the undistributed profits tax, and the important role played by the accounting profession in the accommodation process. Finally, Part IV highlights the expanding use of LIFO over the past 70 years.