Suppose the state police want to crack down on speeding, which the public is complaining has become rampant. But the police have a problem with enforcement. Some savvy entrepreneur has developed an anti-radar gun that blocks the ability of radar guns to measure speed. And separately, a court has ruled that their radar guns are inaccurate and cannot be presented as evidence in traffic court.
To address the public's concerns the state legislature passes a law that applies penalties to drivers in situations where speeding is likely. One of the rules is that a vehicle on the road cannot have "excessive horsepower." Now this is rough justice because there are many vehicles with excessive horsepower that do not speed and there are many vehicles without excessive horsepower that do. But because radar guns are not working well, the legislature thinks this rule will help their cause without too much hardship on the rights of drivers.
The legislature basically defines excessive horsepower as a lot more horsepower than a driver needs given the functions carried out by the vehicle (e.g., towing a trailer) and the weight it must carry (e.g., a large family). This would be what lawyers call a "facts and circumstances" determination that would vary from case to case. It would be very hard to administer and clever drivers would figure out ways around the rules (e.g., by mounting a trailer hitch to the back of the vehicle to "prove" the vehicle is used for towing).
I would say that lawmakers have not addressed the issue effectively because they are replacing one poor enforcement device (radar guns) with a poor enforcement standard that is difficult to enforce (the "excessive horsepower" standard).
In the current debate about international tax reform a somewhat analogous situation has developed. There are several proposals now being floated (including one in the president's budget (Treasury "General Explanation" of FY 2013 Budget, p. 88) and Options A and C of Ways and Means Committee Chair Dave Camp's Discussion Draft ("Section-by-Section" summary pp. 32-35) that try to backstop our inadequate transfer pricing rules by subjecting foreign income to U.S. tax if that income is from an intangible asset (e.g., patents, trademarks, trade names). It well known in the international tax community that income from these assets is often inappropriately shifted into tax havens.
To relate this to our little story, our ineffective transfer pricing rules are like the poorly functioning radar guns and the targeting of intangible income is like the targeting of vehicles with "excessive horsepower." The new standard is difficult to enforce and susceptible to abuse. We are trading one method of enforcement that works poorly in practice for another.
If the police need more rules to help them fight speeding, it is better to develop rules that are easy to enforce and easy for citizens to understand. For example, prohibit driving by youths unaccompanied by adults under the age of 21 after 10 p.m. In the international arena, I would suggest Congress develop formulaic rules to target situations where transfer price abuse is likely. Two indicators that also have been suggested by the president and Chairman Camp are low levels of foreign tax and high rates of return. Any backstop to our current transfer pricing rules should target income that is subject to low tax and is generating high returns. Mechanical rules can be developed for each of these standards. This would result in far less uncertainty and far fewer administrative difficulties than a facts and circumstances determination.