[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
SMALL BUSINESSES AND TAX REFORM
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MARCH 3, 2011
__________
Serial No. 112-SRM1
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
70-874 WASHINGTON : 2011
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected].
COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
PAT TIBERI, Ohio, Chairman
DEAN HELLER, Nevada RICHARD E. NEAL, Massachusetts,
PETER ROSKAM, Illinois Ranking Member
ERIK PAULSEN, Minnesota MIKE THOMPSON, California
CHRISTOPHER LEE, New York JOHN B. LARSON, Connecticut
RICK BERG, North Dakota SHELLEY BERKLEY, Nevada
CHARLES BOUSTANY, Louisiana
Jon Traub, Staff Director
Janice Mays, Minority Staff Director
C O N T E N T S
__________
Page
Advisory of March 3, 2011, announcing the hearing................ 2
WITNESSES
Dr. Robert Carroll, Principal, Qualitative Economics and
Statistics, Ernst & Young LLP, Washington, D.C................. 5
Ms. Patricia A. Thompson, Chair, Tax Executive Committee,
American Institute of Certified Public Accountants, Piccerelli,
Gilstein & Co. LLP, Providence, Rhode Island................... 18
Mr. Dennis Tarnay, Chief Financial Officer, Lake Erie Electric,
Inc., Cleveland, Ohio.......................................... 29
Dr. Donald B. Marron, Director, Tax Policy Center, The Urban
Institute, Washington, D.C..................................... 34
SUBMISSIONS FOR THE RECORD
Alvin S. Brown................................................... 67
National Association of Small Business Investment Companies...... 75
Small Business Legislative Council............................... 79
The National Association of Home Builders........................ 81
U.S. Chamber of Commerce......................................... 86
SMALL BUSINESSES AND TAX REFORM
----------
THURSDAY, MARCH 3, 2011
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The subcommittee met, pursuant to call, at 9:05 a.m., in
Room 1100, Longworth House Office Building, the Honorable Pat
Tiberi [chairman of the subcommittee] presiding.
[The advisory of the hearing follows:]
[GRAPHIC] [TIFF OMITTED] T0874B.001
[GRAPHIC] [TIFF OMITTED] T0874B.002
[GRAPHIC] [TIFF OMITTED] T0874B.003
Chairman TIBERI. Now that we have finished our
organizational meeting, I would like to call today's meeting to
order. I want to welcome our witnesses to the hearing to
discuss the taxation of small businesses and passthrough
entities as part of a broader discussion on comprehensive tax
reform.
I believe there is a window of opportunity to enact
comprehensive tax reform, and we must take advantage of it.
Last November, the American people sent a strong message to
Washington. They told Washington to stop putting off tough
decisions, start making the decisions that will ensure future
generations of Americans will prosper.
Whether it will be reducing the national debt, ensuring
entitlements will remain solvent, or reforming our Tax Code to
encourage economic growth, saying it is too difficult isn't an
excuse anymore. Our current system of taxation was written for
an economy that was very different from the competitive global
economy of today. It is time to enact a Tax Code that is
competitive with the rest of the world, that is fairer, and
that is simpler.
Small businesses must be included in comprehensive tax
reform. Reforming corporate taxes means only reforming roughly
10 percent of Federal revenues. That is not comprehensive. Many
small businesses pay taxes under the individual income tax
rates as passthrough entities, which we will hear more about
today.
The last thing we want to do as part of tax reform is
create a situation where we are putting small businesses at a
competitive disadvantage. I fear leaving them out of tax reform
will do just that. Small businesses are the engine of economic
growth in our economy. As we move forward with tax reform, the
question we must ask ourselves is how we reform the code in a
manner that empowers small businesses to grow and create jobs.
I look forward to hearing from our witnesses on those
issues today.
With that, I will yield to the ranking member, Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman.
And I want to thank you for calling this hearing this
morning. I hope that it will be the first of many on the topic
of tax reform.
Earlier, I commented on how this subcommittee always hears
diverse points of view, and certainly this morning is no
exception. We have one witness who is complaining that there
are too many special provisions for small businesses and that
the clutter is overwhelming. We have another saying that these
special provisions make for a code that favors small businesses
over large, and yet another tells us that we need to lower
income taxes on the upper-income to save small businesses.
But one thing that we can agree on is that the U.S. offers
some of the most flexible rules on structuring your business in
the developed world, offering limited liability without the
requirement of a corporate-level tax. As one witness tells us
today, we are second only to Mexico in the size of the
unincorporated businesses as a total share of business, and
that this self-help integration is a step toward reform.
While this hearing is intended to explore special tax
issues on passthrough entities, much of the discussion will
involve small-business incentives. We should note that the two
are not necessarily the same. As one witness tells us, less
than 1 percent of all passthroughs are large businesses with
more than $10 million in receipts but they accounted for almost
60 percent of the total revenues of all passthroughs.
Confucius noted that a journey of a thousand miles begins
with a single step. I want to thank you, Mr. Tiberi, for taking
that first step this morning on the road to tax reform. And we
hope the journey does not take a thousand hearings.
Thank you.
Chairman TIBERI. Thank you, Mr. Neal.
I ask unanimous consent that all Members' written
statements will be included in the record.
Without objection, so ordered.
Chairman TIBERI. We will now turn to our panel of
witnesses, whose bios are in your packages. I will introduce
them, and then we will begin after I have introduced them all.
Dr. Robert Carroll is from Ernst & Young. Ms. Patricia
Thompson is a tax partner at Piccerelli, Gilstein & Company and
chair of the AICPA Tax Executive Committee. Mr. Dennis Tarnay
is the CFO of Lake Erie Electric and a former board member of
the Ohio Society of CPAs and from the great Buckeye State. And
Dr. Donald Marron is director of the Urban-Brookings Tax Policy
Center.
Thank you all for joining us this morning.
Dr. Carroll, you may begin your testimony.
STATEMENT OF ROBERT CARROLL, PRINCIPAL, QUALITATIVE ECONOMICS
AND STATISTICS, ERNST & YOUNG LLP, WASHINGTON, D.C.
Mr. CARROLL. Thank you, Chairman.
Chairman Tiberi, Ranking Member Neal, and distinguished
Members of the Subcommittee, I thank you for the opportunity to
testify today regarding the taxation of flow-through businesses
and tax reform.
I have had the opportunity to consider the taxation of
flow-through businesses from a number of different perspectives
inside and outside of government in the context of broad reform
of the code and narrow reform of the business tax system. More
recently, I have been analyzing the flow-through sector in the
course of preparing a report on behalf of the S Corporation
Association. Today I would like to share my perspectives and
provide some preliminary results from the study on the flow-
through sector we are preparing for release in the near future.
Flow-through businesses, S corporations, partnerships,
limited liability companies, and sole proprietorships play an
important role in the U.S. economy. The vast majority of
businesses in the United States have chosen to organize as
flow-through businesses.
Today, flow-through businesses comprise more than 90
percent of all business entities, employ more than 50 percent
of the workforce, and report more than one-third of all
business receipts. Individual owners of flow-through businesses
report 40 percent of all business net income. These individual
owners also pay 43 percent of business taxes when filing their
individual tax returns.
The flow-through sector in the United States differs
markedly from other developed nations. The business forms
available in many other countries tend to push businesses
toward the corporate form in pursuit of limited liability,
whereas in the United States such limited liability is
attainable through various organizational forms outside of the
corporate sector.
This has resulted in a flow-through sector with
considerable flexibility in how they organize and how they
structure their operations. Businesses can choose between
several different organizational forms which may provide a
better match to their management needs and capital
requirements.
The unincorporated business sector in the United States is
also larger than in most other developed nations. Of the
countries responding to a 2007 OECD survey, the unincorporated
business sector was larger as a share of the total number of
businesses in the U.S. in all but one country.
With the increasing prominence of flow-through businesses,
it is important to carefully consider how the flow-through form
fits into the U.S. tax system and how any particular reform
might affect flow-through businesses.
Flow-through businesses are subject to a single level of
tax on the income earned and allocated to their owners. Thus,
it is the tax rates faced primarily by individual owners of
flow-through businesses that affect decision-making and the
economic health of these businesses.
In contrast, the income of C corporations is subject to two
levels of tax: first when income is earned at the corporate
level and again when the income is paid out to shareholders in
the form of dividends or retained earnings and later realized
by shareholders as capital gains, hence the phrase, ``the
double tax on corporate profits.''
The double tax affects a number of important economic
decisions: First, by increasing the cost of capital, it
discourages investment and, thus, economic growth and job
creation. Second, it leads to a bias in firms' financing
decisions between the use of debt and equity. And, third, it
distorts the allocation of capital within the economy. The
flow-through form provides an important benefit to the economy
by reducing these economically harmful effects of the double
tax.
Recent focus on the need to lower the corporate income tax
has also drawn attention to how flow-through businesses might
be affected by tax reform. With substantial evidence that the
U.S. corporate tax rate is out of step internationally,
corporate tax reform is an important component of an overall
approach to improving the current tax system.
As with any such endeavor, however, it is important to keep
in mind the potential for undesirable side effects. Corporate
reform that eliminates business tax expenditures would have the
unintended impact of raising the taxes of businesses organized
using the flow-through form without offering the benefit of the
lower corporate tax rate. Flow-through businesses would lose
the benefit of widely used and longstanding provisions such as
accelerated depreciation and the charitable-giving deduction.
In total, flow-through businesses use about 22 percent of the
roughly $100 billion in annual business tax expenditures.
Flow-through businesses are a large part of the U.S.
business sector and important contributors to the economic
vitality of the U.S. As reform progresses, it is important to
understand and consider all of these issues with an eye toward
bringing about the tax reform that is most conducive to
increased growth and job creation.
The path toward tax reform will need to take into account
many features of our tax system and strike a balance between a
number of sometimes conflicting and competing objectives. This
committee should be commended for holding this hearing to
better understand the role that the flow-through sector plays
in the U.S. economy.
I thank you, and I would be pleased to address any
questions the subcommittee might have.
[The prepared statement of Mr. Carroll follows:]
[GRAPHIC] [TIFF OMITTED] T0874B.004
[GRAPHIC] [TIFF OMITTED] T0874B.005
[GRAPHIC] [TIFF OMITTED] T0874B.006
[GRAPHIC] [TIFF OMITTED] T0874B.007
[GRAPHIC] [TIFF OMITTED] T0874B.008
[GRAPHIC] [TIFF OMITTED] T0874B.009
[GRAPHIC] [TIFF OMITTED] T0874B.010
[GRAPHIC] [TIFF OMITTED] T0874B.011
[GRAPHIC] [TIFF OMITTED] T0874B.012
[GRAPHIC] [TIFF OMITTED] T0874B.013
Chairman TIBERI. Five seconds to spare. Impressive.
Ms. Thompson.
STATEMENT OF PATRICIA A. THOMPSON, CHAIR, TAX EXECUTIVE
COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS,
TAX PARTNER, PICCERELLI, GILSTEIN & CO. LLP, PROVIDENCE, RHODE
ISLAND
Ms. THOMPSON. Good morning, Chairman Tiberi, Ranking Member
Neal, and Members of the Subcommittee. My name is Patricia
Thompson. I am a CPA and chair of the AICPA Tax Executive
Committee. My testimony today is based on my experiences with
working with many small business clients. I am tax partner at
Piccerelli, Gilstein & Company LLP, a CPA firm in Providence,
Rhode Island, and have been with the firm for over 32 years. I
would like to thank this subcommittee for the opportunity to
appear today.
Chairman Tiberi, I would like to start by thanking you for
your work in trying to repeal the two 1099 provisions. As noted
in our written testimony, these are significant burdens on
small businesses.
Today's hearing focuses on the special burdens that the tax
law imposes on small businesses. Business tax reform cannot
merely change the corporate tax rates or other corporate
provisions if the desired impact is to help small businesses,
since many of them are not organized as corporations. I
understand the challenges inherent in drafting tax legislation
and appreciate your diligence in trying to do the right thing
for taxpayers.
My full written testimony discusses several burdens and
complexities facing small businesses. In my brief time with you
today, I would like to highlight just a few.
The first is tax simplification--depreciation is the best
example. Methods to compute depreciation are different for tax
and financial accounting purposes. Depreciation rates can vary
depending on the method. There are special types of
depreciation, such as bonus, special straight line, and Section
179. Plus, there is a different method for AMT. So businesses
have to maintain several different books of depreciation and
update them annually for each individual asset.
Let's say a client places several pieces of equipment in
service throughout the year. To determine the best depreciation
method, they need to run a complex analysis: When was it
purchased? Was it new? Was it used? What was the total amount
purchased? Depending on the purchase date, they may be entitled
to 50 percent depreciation; maybe it is 100 percent. If they
purchase too much equipment, Section 179 isn't available. If
they don't earn enough money, Section 179 is limited. The best
depreciation method may not be clear without extensive
analysis.
My second point is uncertainty in the tax law. Many of the
changes passed last year were designed to help employ more
workers, help small businesses improve cash flow, and improve
the economy. For example, the HIRE Act that passed last March
provided an incentive to hire unemployed workers. This
legislation was time-sensitive. If taxpayers did not know of
the new incentive, the tax-saving opportunity was permanently
lost.
The increased use of temporary provisions has also created
some uncertainty. While some measures may be appropriate for
the short term, temporary tax provisions and incentives have
become far too common. Often they are allowed to expire, then
they are revived after much debate, but only for another
temporary period. It is inefficient and ineffective to make
longstanding tax policy utilizing temporary provisions.
Additionally, when changes occur late in the year, small-
business owners have little time to evaluate the impact of
those changes on their businesses. It is even harder to plan
when the new tax law takes effect in the same year that it is
issued. In that case, a small-business owner can't do long-term
planning for growth, business development, or new hiring. It
can be difficult to change course in response to a new, short-
term expiring tax provision.
The third issue I would like to highlight is the need to
consider expansion of corporate provisions to help noncorporate
entities.
The Small Business Jobs Act passed last September expanded
an existing provision to allow 100 percent gain exclusion on
the sale of small-business stock if certain conditions were
met. There are several requirements to qualify for this
exclusion. It must be a C corporation of a qualifying business.
The stock cannot exceed a certain value and must be held for
more than 5 years.
The key here is that this provision only benefits C
corporations, so it excludes many small businesses that are
conducted as sole proprietors or passthrough entities. This is
an excellent example of a provision that was intended to help
small business that will likely not have the desired impact.
One final note: I would encourage you to review two of our
recent publications, one on alternatives for tax reform, and
the other is our report on penalty reform. Both are available
online, and links are provided in our written testimony.
Thank you again for the opportunity to testify, and I will
be happy to answer any of your questions.
[The prepared statement of Ms. Thompson follows:]
[GRAPHIC] [TIFF OMITTED] T0874B.014
[GRAPHIC] [TIFF OMITTED] T0874B.015
[GRAPHIC] [TIFF OMITTED] T0874B.016
[GRAPHIC] [TIFF OMITTED] T0874B.017
[GRAPHIC] [TIFF OMITTED] T0874B.018
[GRAPHIC] [TIFF OMITTED] T0874B.019
[GRAPHIC] [TIFF OMITTED] T0874B.020
[GRAPHIC] [TIFF OMITTED] T0874B.021
[GRAPHIC] [TIFF OMITTED] T0874B.022
[GRAPHIC] [TIFF OMITTED] T0874B.023
Chairman TIBERI. Thank you. Thank you, Ms. Thompson. And
you came in under time, as well.
Mr. Tarnay, welcome.
STATEMENT OF DENNIS TARNAY, CHIEF FINANCIAL OFFICER, LAKE ERIE
ELECTRIC, INC., CLEVELAND, OHIO
Mr. TARNAY. Chairman Tiberi, Ranking Member Neal, and
Members of the Subcommittee, thank you for inviting me to
appear before you today to discuss the issue of fundamental tax
reform, particularly as it relates to small businesses.
I am the chief financial officer and a minority owner of
Lake Erie Electric, a position I have held since 1987, and a
former board member of the Ohio Society of Certified Public
Accountants. I am speaking today on behalf of both Lake Erie
Electric and the OSCPA.
Lake Erie Electric, based in Cleveland, Ohio, is an
electrical contracting company that was first formed as a C
corporation in the 1950s to primarily serve industrial
customers in the automotive and steel sectors of the Midwest.
My company has seen many changes since its inception, both
in terms of its corporate structure and business strategies. In
1987, we modified the corporate structure of the company to a
passthrough Subchapter S corporation through the Federal tax
law changes that occurred at that time and because it was a
better fit for us. When Cleveland's industrial base contracted,
we transitioned our customer base to be more heavily weighted
to commercial businesses and the health-care sector.
The main message I want to deliver to you today, gentlemen,
is that simplifying the Tax Code for small businesses means
creating jobs in places like Cleveland, Ohio. Predictability
and stability within the Tax Code provides businesses,
particularly small businesses, which typically have tighter
profit margins, the necessary lens with which to make decisions
regarding growth, investment or reinvestment of capital, and
expanding new employee job opportunities.
Further, a simpler Tax Code means small-business owners can
spend less time on costly and burdensome compliance activities
and invest more of their time on innovation and growing their
businesses. Simplicity also helps to minimize taxpayer
confusion over exactly what liability is owed and helps with
financial planning for the future.
Tax reform for small business is about one thing in
America: jobs for all business sectors.
Subchapter S corporations are structured so that net income
or losses to the business are distributed to the shareholders
of the company and are reflected on the individual's Federal,
State, and even local income tax returns. The tax is assessed
at their individual income tax rates, meaning legislators
should be conscious that discussions of assessing higher tax
rates on individuals at the $200,000 level and families at the
$250,000 level will have a direct impact on the ability of many
small-business owners to reinvest in their businesses and keep
or grow their workforce.
In addition to Subchapter S corporations, other forms of
passthrough entities that will be similarly impacted are
limited-liability companies, partnerships, limited-liability
partnerships, and sole proprietorships. Roughly 75 percent of
small businesses are passthrough entities. As we know, the
primary reason there are so many passthrough entities is
because double taxation is eliminated, first at the entity
level as earnings and then again at the individual level as
dividend payments to shareholders.
This data leaves little doubt that, in order for a
significant economic recovery to take place, there must be a
tax structure in place that will give small businesses the
incentive to hire and thrive.
Tax law does matter to small-business passthrough entities
because they modify business practices to adjust for law
changes. In recent years, tax-law changes have become a
political tool, with revisions occurring far too often,
sometimes more than once a year and sometimes so late in the
year that it is retroactive in impact, causing business owners
to be confused and uncertain on how to proceed.
The frequency of tax-law changes affects small businesses
in particular because the unpredictability often slows or
discourages the hiring or rehiring of employees or investing in
new capital or other products and services. While certainly
businesses of all sizes are impacted by the frequency of tax-
law changes, they have a far greater impact on small-business
decisions because so many of them operate on very tight profit
margins.
Predictability helps to keep costs down, as fewer changes
equate to fewer compliance costs associated with changing
practices and procedures that, in many cases, are longstanding
and successful from a cost-benefit standpoint. Lower cost
equals greater ability to reinvest in company and future
growth.
The current structure of passthrough entities, such as
Subchapter S corporations, provides flexibility and control to
small-business owners and should be maintained in any tax
reform proposal. Going forward, tax reform should help small
business by reforming issues such as: simplifying compliance
rules regarding E-Filing and E-Verify; shifting the burden away
from being the watchdog for various government entities on its
employees; reforming the timing requirements for S-corporation
formations; increasing the amount a small businesses may
expense on the Federal tax returns; reasonable independent
contractor rules.
Gentlemen, the alternative minimum tax should be
eliminated. If it can't be eliminated, enact a more reasonable
and consistent threshold for the alternative minimum tax.
In a related matter, I do applaud your efforts to address
the expanded 1099 requirements currently on schedule to become
effective January in 2012. From a small-business perspective,
this is the classic example of a compliance cost on both
businesses and the Internal Revenue Service outweighing the
benefits derived.
Chairman TIBERI. Mr. Tarnay, if you can wrap up----
Mr. TARNAY. I am right now.
Chairman TIBERI. Thank you.
Mr. TARNAY. Meaningful tax reform that focuses on
simplicity, predictability, and fairness that includes an
emphasis on the related cost and compliance burden to small
businesses is critically important so that we, as small-
business owners, do our part to grow the economy.
On behalf of both Lake Erie and the Ohio Society of CPAs, I
appreciate the opportunity to share my concerns and would
welcome any questions you have.
[The prepared statement of Mr. Tarnay follows:]
[GRAPHIC] [TIFF OMITTED] T0874B.024
[GRAPHIC] [TIFF OMITTED] T0874B.025
[GRAPHIC] [TIFF OMITTED] T0874B.026
Chairman TIBERI. Thank you.
Mr. Marron.
STATEMENT OF DONALD B. MARRON, DIRECTOR, URBAN-BROOKINGS TAX
POLICY CENTER, WASHINGTON, D.C.
Mr. MARRON. Chairman Tiberi, Ranking Member Neal, Members
of the Subcommittee, thank you for inviting me to appear today
to discuss the tax system and small business.
America's tax system is needlessly complex, economically
harmful, and often unfair. Because of a plethora of temporary
tax cuts, it is increasingly unpredictable. And it fails at its
most basic task, which is raising enough money to pay our
government's bills. For all those reasons, the time has come
for fundamental tax reform.
Such reform could have far-reaching effects on every
participant in the economy, including small businesses. To
provide a foundation for thinking about these effects, my
testimony discusses basic facts about the relationships between
tax policy and small business.
I make six main points.
First, today's Tax Code generally favors small businesses
over larger ones. Provisions such as Section 179 expensing,
graduated corporate tax rates, and special low capital gains
taxes benefit businesses that are small in terms of investment,
income, or assets.
Second, many small businesses also benefit from the
opportunity to organize as passthrough entities. S
corporations, limited-liability companies, partnerships, and
sole proprietorships all avoid the double taxation that applies
to income earned by C corporations.
Third, the benefits of organizing as a passthrough are not
limited to small businesses. Some large businesses adopt these
forms, as well. Although these large firms account for a tiny
share of passthrough entities, they represent a substantial
fraction of passthrough economic activity. For example, only
0.3 percent of S corporations had revenues above $50 million in
2005, but they accounted for more than a quarter of S-
corporation income. The situation is even more extreme with
partnerships. Only 0.2 percent of partnerships had revenues
above $50 million, but they accounted for 57 percent of
partnership income. Lawmakers should therefore take care not to
assume that all passthroughs are small businesses.
Fourth, small businesses face disproportionately high costs
in complying with the Tax Code. They are also more likely to
understate their income and underpay their taxes. High
compliance costs thus disadvantage responsible small
businesses, while the greater opportunity to evade taxes can
advantage less responsible ones.
Fifth, an ideal tax system would collect enough revenue to
pay for government services while minimizing distortions to
economic activity. To the extent possible, economic
fundamentals, not tax considerations, should drive business
decisions about organizational structure. By treating
passthroughs and C corporations differently, our current tax
system deviates from that ideal.
Sixth, and finally, in discussing reform proposals, it is
important to distinguish between businesses--a broad category
that includes passthroughs--and corporations, which generally
means C corporations. Many tax reform proposals would reduce
business tax preferences and use the resulting revenue to cut
corporate income tax rates. Such revenue-neutral reforms could
lessen the disparity in tax treatment between passthroughs and
C corporations. Passthroughs would see their tax burden
increase since they would lose some tax preferences but not
benefit from the rate reduction, while C corporations would, on
average, see their taxes decline.
Thank you. I look forward to any questions.
[The prepared statement of Mr. Marron follows:]
[GRAPHIC] [TIFF OMITTED] T0874B.027
[GRAPHIC] [TIFF OMITTED] T0874B.028
[GRAPHIC] [TIFF OMITTED] T0874B.029
[GRAPHIC] [TIFF OMITTED] T0874B.030
[GRAPHIC] [TIFF OMITTED] T0874B.031
[GRAPHIC] [TIFF OMITTED] T0874B.032
[GRAPHIC] [TIFF OMITTED] T0874B.033
[GRAPHIC] [TIFF OMITTED] T0874B.034
[GRAPHIC] [TIFF OMITTED] T0874B.035
Chairman TIBERI. Thank you.
Mr. Tarnay, in your written testimony and briefly in your
verbal testimony, you mentioned a couple of things I would like
you to expand on, if you could. You mentioned simplifying
compliance rules regarding E-Filing and E-Verify. And you also
mentioned shifting the burden away from small businesses to be
the watchdog for government on their employees.
Can you expand on both of those issues?
Mr. TARNAY. E-Verify--in our business sector, since our
labor force comes from the unions, we have employees that come
and go during the course of the year. And every time they come
on, we have to E-Verify.
So you can have an employee, an electrician, for example,
that comes on the payroll for, let's say, 3 weeks, 4 weeks, 3
months, and then goes back to the labor force because we don't
need that employee anymore. Well, the next time he comes on, we
once again have to go through the E-Verify process, and we have
to do that within 3 days of him being on the payroll. But when
we do that, and since we have roughly 400 or 500 electricians
and they rotate, we could have that same employee being E-
Verified 3 or 4 times a year.
It is time-consuming, and it takes away from other
opportunities.
Chairman TIBERI. And the other issue?
Mr. TARNAY. E-Filing? We haven't had much to do with E-
Filing. But I know for small businesses it can be very
difficult, simply because many of the small businesses are not
that, I am going to call it, technologically--have those
technological abilities.
Chairman TIBERI. And your point about being a watchdog,
small businesses being a----
Mr. TARNAY. Well, that isn't just at the Federal level.
That is at all levels of government. Garnishments,
withholdings----
Chairman TIBERI. 1099s.
Mr. TARNAY [continuing]. Child support. It goes throughout.
It is a tremendous burden.
Chairman TIBERI. Thank you.
Dr. Carroll, if Congress decides to reduce business tax
expenditures and cut the corporate tax rate, what are some ways
that we could mimic a corporate tax rate cut for noncorporate
businesses?
I would note, and I know you are aware, for example, that
the House Republican Pledge to America proposes a 20 percent
deduction for small-business income, which would, I believe, be
a similar rate cut from 35 percent to 28 percent for small
businesses.
Can you give us some thoughts on that?
Mr. CARROLL. Yeah, sure. I think there are a couple of ways
that that could be accommodated in our current tax system. One
approach would be to put in place a separate rate schedule,
similar to dividends and capital gains. Another approach would
be to put in a deduction for a certain fraction of flow-through
income.
One of the complexities in extending a deduction or a lower
rate to flow-through income might be trying to split up the
return to labor and return to capital associated with that
income.
For S corporations, it is fairly--it is more
straightforward, I would say. S corporations are required to
pay the owners a reasonable level of compensation. But for
other organizational forms, such as, you know--one would have
to address that issue. Some of the Nordic countries have tried
to split up the return to labor and return to capital, but they
have come up with very, very complicated approaches for that.
Chairman TIBERI. Last question, if you could all just
comment on this. Some have said that if we can lower the rate
and broaden the base and get rid of some of the other stuff
within the Tax Code to simplify it--Ms. Thompson, starting with
you--what would be a ballpark figure that you think you could
lower rates for passthrough entities and get rid of some of the
things that might benefit some passthrough entities but not
all?
Ms. THOMPSON. The AICPA actually doesn't take a position on
the best alternative to come up with. But what they have is the
report talks about reform alternatives for the 21st century.
And what they think about when evaluating the tax reform
proposals, they would want to look for simplicity within the
measure; whether it is fair; whether it has economic growth and
efficiency; its neutrality; whether it is transparent to
everybody; whether or not it is minimizing the noncompliance,
because we all know that that is a significant issue, and the
easier you make something, the more compliant people will be;
whether it has the ability to have cost-effective collection
and the impact on the government revenues; whether there is
certainty in it; and whether there is payment convenience.
So the AICPA really, at this point, doesn't have a
position, to answer your question, on it. But as proposals come
up, we could take a look at them and see what----
Chairman TIBERI. We could probably move your bill right
now, actually. I think everyone agrees with what you have said.
Mr. Tarnay.
Mr. TARNAY. Simplicity and predictability for a small
business is essential so that they know what to do, moving
forward. As we all know, in small businesses, it is usually the
owner that leads it, and he is not necessarily the key in
financial decision-making. That is why, many times, the CFO is
known as an ``OFO,'' the ``only financial officer.''
If you make it simple and predictable, a small-business
owner begins to understand it, and he can make decisions in his
structure, in his decision-making, so that he can expand his
business. It is as simple as that.
Chairman TIBERI. Mr. Marron.
Mr. MARRON. I was quite impressed with where the
President's fiscal commission came out. I served on the
parallel Domenici-Rivlin commission.
Both of those did full-scale tax reform, individual and
corporate at the same time. And in both of those, they came out
in roughly the same place, saying that we should aspire to a
system where both the top corporate rate and the top individual
rate are the same and begin with a ``2,'' and it is 27, 28,
somewhere in there.
Chairman TIBERI. Thank you.
And, finally, Dr. Carroll?
Mr. CARROLL. Just following on Mr. Marron's comments, both
the fiscal commission and the Rivlin commission got down to
about a 27, 28 percent. They would eliminate most, if not all,
business tax expenditures, depending on the plan. They kept a
few things.
If you go back to the 2007 Treasury competitiveness report,
we were able to get the rate, at that time, down to about the
same. If you eliminated all business tax expenditures, you
could get the rate down to about 27, 28 percent. And that
includes getting rid of provisions like accelerated
depreciation, and so some provisions that are longstanding and,
certainly, widely used.
And one of the things I think you need to also consider is,
when you add in the State rates, even if you got the business
rate down to 28 percent for corporations and for flow-throughs,
when you add in State rates you would still have a rate on the
order of about 33 percent, combined rate, for the U.S., which
would still place us at a rate above the OECD and the G-7.
Chairman TIBERI. Thank you. Thank you all.
I will yield for questioning to the ranking member, Mr.
Neal.
Mr. NEAL. Thank you, Mr. Chairman.
Dr. Marron, both you and Dr. Carroll discussed the problem
with eliminating business tax preferences as part of an effort
to lower the corporate rate. In fact, Dr. Carroll's testimony
highlights the annual cost of these preferences and which ones
are used equally by both corporations and passthroughs.
Since base-broadening, though, seems to be the best way to
accomplish reform, how do you think that Congress should
address this real concern?
Mr. MARRON. I would start with broad principles. And from
the security of being a think-tank economist kind of guy, the
number-one principle I start with is a leveling the playing
field. That the first order, the goal of our tax system should
be not to play favorites among different types of activities,
different organizational forms. And that when you have business
tax preferences that are clearly skewing the field in one
direction or another, that those are ones that ought to get
close attention.
A second one--and this one I want to highlight just because
it doesn't come up as much. We often talk about a strategy of
rolling back tax preferences, and lowering rates as a strategy
for doing corporate reform and business reform. There is
another strategy, which is to keep favorable depreciation
policies, possibly even move toward expensing, but then pay for
that by walking back the deductibility of interest.
And an attraction--I would recommend that as a strategy to
keep in mind, because the attraction of that is that it would
eliminate some of the distortions in our current system that
favor leverage and favor debt. And, in principle, it could be a
way that it would have favorable business incentives but in a
paid-for way.
Mr. NEAL. Uh-huh.
Dr. Carroll.
Mr. CARROLL. Yeah, I think the challenge is--there has been
some discussion of corporate reform focused on trying to bring
the corporate rate down, primarily due to the pressures from
abroad, with the corporate rates coming down quite a lot over
the last couple of decades among our major trading partners.
And I think, you know, tax reform--I think business tax reform
needs to be somewhat more broadly considered.
I think it is very hard to lower the corporate rate and pay
for that by repealing all business tax expenditures or some set
of business tax expenditures for both flow-throughs as well as
C corporations. I think one needs to pursue not just reform of
the corporate income tax but, more broadly, reform of the
business tax system and look at that in a more holistic
fashion.
And the tax system is very intertwined. There are a lot of
interrelationships between, as I have discussed in my written
testimony, between C corporations and the flow-through sector,
but also in the taxation of investor-level income, in the form
of capital gains and dividends. You have the part of the double
tax on corporate profits.
These things are very interrelated, and I think it is very
difficult to take a small piece of the Tax Code and try to
reform that in isolation. I think pursuing it in a much broader
way is more constructive.
Mr. NEAL. Uh-huh.
Off-script for a moment: But a few moments ago in your
comments, you spoke to depreciation allowance. While I think,
in my own instance, having rejected the idea, the theology that
tax cuts pay for themselves, I do subscribe to the notion, as
Chairman Tiberi offered at the outset, that the use of the NOL
last year was very important, further suggesting that, at
certain times, some tax cuts are better than others.
And I think there is some evidence over the years that
acceleration of depreciation allowance has worked, in terms of
changing behavior in an economic downturn. Are you prepared to
suggest that that ought to be eliminated as a possibility?
Mr. CARROLL. Yeah, I am not really here to suggest what
should be eliminated or kept.
With respect to accelerated depreciation and expensing, I
think it is a pretty common view among economists that
expensing and accelerated depreciation are constructive
provisions that help encourage investment. Both in times of
economic downturns--the bonus depreciation and 100 percent
expensing enacted in late December can be very constructive to
help stimulate business investment during periods of economic
weakness--but it is also, I think, very helpful in terms of
longer-term tax policy. Accelerated depreciation and expensing
help to reduce the tax on capital income in the economy, which
can help encourage capital formation and promote growth in the
longer term.
Mr. NEAL. And, Ms. Thompson, it was dizzying just to read
your client scenarios with all the complex depreciation
options, but I am sure you understand that Congress was trying
to help small business, even though the result was a patchwork
of generous rates and confusing expiration dates.
And I share the argument that the four of you seem to be
unified around, with respect to the need for predictability, in
our tax rules. That is a given.
But since you mentioned how tax accounting here differs
from financial accounting, is conformity a recommendation that
you would make?
Ms. THOMPSON. We are not really saying that the tax rules
need to be the same as the financial accounting rules. But what
we are thinking is that it is just one area that could be
analyzed to see if it can be made easier and it can be more
predictable. Because, as we had said, during 2010 there were
quite a few tax provisions that came in and actually were
changing depreciation. So it just adds to the complexity of it.
I don't think that anybody is opposed to accelerated
depreciation; my small-business clients aren't. But they would
like to know ahead of time so that they could have time to plan
for it. So that is really what they are asking for.
Mr. NEAL. Just lastly, Rep. Phil English and I, at one
time, worked on that, as you know. And there was substantial
evidence that it was an effective approach. And, certainly, tax
receipts were up, based upon that initiative.
Chairman TIBERI. Thank you, Mr. Neal.
Mr. Heller is recognized.
Mr. HELLER. Thank you, Mr. Chairman. And I appreciate your
comments and holding this hearing.
I appreciate all of you being here.
I am from Nevada. So when you think of Nevada, a lot of
times you think of gaming properties, and I can understand
that. But I think the fact remains that small businesses make
up almost 96 percent of the employers in Nevada.
And just some other statistics, only because I think Nevada
is a microcosm of what is going on economically in the country
as a whole. In 2004-2005, it created nearly 68,000 new small-
business jobs. In 2005 to 2006, we created 77,000, so an
increase of nearly 10,000. But in 2006-2007, going from 77,000,
it was reduced to 40,000 new small-business jobs. And, clearly,
economic factors have everything to do with it.
In 2009, Nevada averaged 3,300 new small-business startups
each quarter. The down side is that we averaged 3,700 small
businesses being closed each quarter. So, clearly, those that
are closing are unfortunately outpacing those new jobs that are
being created.
In the Obama fiscal year 2012 budget, he raises taxes on
small businesses. He does it in three ways: He raises the top 2
individual income tax rates from 33 percent to 36 percent and
then from 35 percent to 39.6 percent. He reinstates the
personal exemption phaseout and the Pease limitations on
itemized deductions. And, finally, he raises taxes on dividends
and long-term capital gains, hoping to raise in his budget $709
billion.
Now, the theme--and I appreciate Mr. Tarnay's comments
about what businesses need--and I think it has been a theme for
all of you, and that is predictability, stability, and
simplicity.
I guess my question, Ms. Thompson, since you alluded to
these issues and the importance of planning, long-term
planning, as you know, last year we extended the 2001-2003 tax
cuts for only 2 years. And you were talking about the ability
of a small business to be able to plan long-term, a 5-year
plan, a 10-year plan.
With these potential increased taxes of $709 billion and
the extension for only 2 years, the 2001-2003 tax extension,
how does a small business today put together a 5-year plan or
put together a 10-year plan?
Ms. THOMPSON. They don't. Or, they can't. Because you are
absolutely right, it was very helpful that the 2001 tax rates
were extended for a 2-year period. But what we would like to
see is to know either this year or as soon as we can what the
rates are going to be beyond 2012 so it will help that small-
business owner know what his tax liability is going to be in
the future. Because if he knows that his taxes are going to
increase, it is going to have an impact on his cash flow. If it
has an impact on his cash flow, there are going to be
potentially cuts in other areas, and, unfortunately, that might
be workers. It is hard to say.
But they will definitely need to know what their tax
liability is going in the future to make business decisions
now.
Mr. HELLER. Mr. Tarnay, since those were your words,
``predictability, simplicity, and stability,'' how does a
business today plan under the current tax rates that we have?
Mr. TARNAY. I would agree it is very difficult, because for
years, for decades, it used to be we understood what the tax
rates were, what the law was moving forward, accelerated
depreciation, the whole nine yards. Then I would say, in the
past 10 to 15 years, laws changed annually, sometimes retro. It
is very, very difficult for small businesses to do that. They
have to bring in their experts, their tax advisors, and that is
costly.
If small-business owners understood what it is going to be
for a 5-year period, a 10-year period, they can plan. That is
what they are good at. That is what we need.
Mr. HELLER. The President's deficit-reduction commission,
is there anything that you disagreed with? There were a lot of
tax structural changes talking about deductions and removing--
Dr. Marron, you are talking about moving forward with a
different type of tax structure.
What in the President's deficit-reduction commission--were
there any principles in there that you agreed or disagreed
with? You said you sat on a similar commission yourself.
Mr. MARRON. Yes. So, in terms of things agreed with, I very
much endorse the idea that, if you are going to do reform, A,
it makes sense to do the whole tax system at once, if you
possibly can politically, to take into account all of the
interactions. That there are a lot of tax preferences out there
that really look a lot like spending programs; they have just
been dressed up to appear as tax cuts. And that, as a result,
if someone is interested in making the government smaller,
there are actually some things you can do that will be recorded
as tax increases that actually are functionally the reduction
of spending, from any sort of economic or budget point of view.
And that, as a result, there are ways, basically, to increase
revenues that, you know, are not that troubling, frankly.
I am very much encouraged by the idea of bringing down
rates, kind of broaden the base, lower the rates. As Dr.
Carroll mentioned, a little bit of concern that the plans do
raise dividend rates and capital gains rates. And so there is
an issue that, while for the corporate form you are reducing
rates with one hand, on the other hand you are raising rates,
and you are not getting as much of a net incentive for
investment as you might get with a slightly different form.
Mr. HELLER. Thank you.
I have run out of time. Thank you, Mr. Chairman.
Chairman TIBERI. Thank you.
Mr. Roskam is recognized for 5 minutes.
Mr. ROSKAM. Thank you, Mr. Chairman.
Well, the good news is we all agree on something, and we
all agree that the status quo has to change. There is no voice
here on this panel and there is no voice among the witnesses
that says, let's stick with the status quo. And that is,
actually, good news. I mean, there is this shared premise that
we can move forward from.
What I am interested--you know, we are all products of our
environment, and we are all reflecting our districts today. Mr.
Heller talked about Nevada. I am from suburban Chicago, and my
district has an extraordinary number of manufacturers, small
manufacturers, tool-and-die types that are selling into foreign
markets and are selling around the world, selling to the
Caterpillars of the world and so forth.
Illinois has a unique dynamic that I am concerned about. It
is nothing that we are going to do anything about today. It was
a bad decision, I think, that was made. But it is having an
impact on this larger conversation about passthroughs.
Let me just give you a couple of quick facts on Illinois.
Illinois just raised its taxes, right? So the individual rate
went from 3 to 5 percent, a 67 percent increase. The corporate
income tax rate went from 7.3 to 9.5, a 30 percent tax
increase. Illinois now has the fourth-highest combined
national-local corporate income tax rate. And according to The
Tax Foundation, we have dropped from 23 to 36 in the country
among States.
Now, that is not your problem; that is my problem, because
I am an Illinois resident. But it is also the problem of a lot
of companies and businesses that I represent.
So if we are making changes at a macro level, in terms of
U.S. tax policy, that have an impact on driving more businesses
into a corporate structure, you see what that does to the
employers that I represent. They are jammed, right? They have
to go into this position. And what we don't want to do is move
them so that they have to go that route.
Dr. Carroll, I am interested in your perspective. A lot of
times, when we talk about corporate tax rates and, sort of,
corporate tax conversations or general tax reform, we tend to
shun passthroughs as a little bit of a sideshow.
You mentioned three key points, and I just want to yield
you some time. Could you go through those key factors on the
distortions within the marketplace, the debt equity distortions
and so forth? Because I think that is an important part of the
calibration that this subcommittee needs to take into
consideration as we move forward.
RPTS MERCHANT
DCMN MAGMER
[10:00 a.m.]
Mr. CARROLL. Yeah. As I mentioned in my oral statement and
explained in some detail in the written testimony, one of the
major differences between the taxation as a C corporation and
as a flow-through is the double tax on corporate profits, the
notion that a dollar investment in the corporate sector, the
return to that investment is first subject to the corporate
income tax and then taxed again at the individual level, either
when it is paid out as a dividend or if the return is retained
then it would be taxed as a capital gain eventually when the
shareholder disposes of the stock. So when you combine those
two levels of tax you wind up with a double tax, and that
distorts economic decision-making in a couple of ways.
Dr. Marron had mentioned that economic fundamentals should
drive decision-making, not tax considerations. One of the
things that the corporate tax does, because it is tax on equity
financed investment, interest expenses are deductible but
dividends are not, and so it is tax on equity finance
investment which creates a bias or adds to the bias for debt
finance investment, increases the overall leverage within the
economy to the extent that firms are more highly leveraged.
Because of this tax bias, they are going to be more susceptible
to financial distress during times of economic weakness. So
that is one of the distortions. The tax bias for debt finance,
the tax bias for greater leverage, that is an issue.
Another issue is you have a different treatment of
investment in the corporate sector versus elsewhere in the
economy, in the noncorporate, in housing, other sectors in the
economy, and that causes a misallocation of capital within the
economy. Again, you have investment decisions throughout the
economy being made for tax considerations, not economic
fundamentals. When you have that misallocation of capital, the
capital stock will not be allocated to its best and highest
use, and that is going to reduce economic growth.
And then, third, it raises the cost of capital. The double
tax and corporate profits, you know, it is another layer of tax
on capital formation, that that higher cost of capital
discourages capital formation and investment and, again, would
reduce the overall growth rate of the economy.
Mr. ROSKAM. Thanks, Dr. Carroll.
Thanks, Mr. Chairman.
Chairman TIBERI. Thank you.
Mr. Thompson, you are recognized for 5 minutes.
Mr. THOMPSON OF CALIFORNIA. Thank you, Mr. Chairman. Thanks
for holding this hearing and thanks to all the witnesses for
being here. I concur with everyone else who said that this is
an issue that we all agree on. We just need to figure out how
to get there.
Just a real quick question, Ms. Thompson. On the 1099 issue
that you raised, do you have any suggestions on how this
Congress should deal with the underlying issues that brought
the 1099 matter to the forefront? And that is, the $30 billion
or $25 billion worth of tax evasion that is going on, how do
you address that?
Ms. THOMPSON. I think that would probably be on enforcement
side, which the IRS does have the ability to----
Mr. THOMPSON OF CALIFORNIA. But they don't have the data.
You can't put an IRS person at every point of purchase.
Ms. THOMPSON. I think that the existing rules that are in
place cover services, and I don't think that everybody is even
in compliance with that one. So we might start working on that
area first.
I think the way the legislation is written right now it is
covering goods and it is covering corporations, and that is not
realistic on how you are going to solve the problems. The
example that everybody is talking about is if a small business
owner goes into Staples and purchases their office supplies and
they happen to spend more than $600 in a year, they are going
to be required to send a 1099 to Wal-Mart and Staples, and it
just doesn't seem like it is the right target that you are
looking for.
Mr. THOMPSON OF CALIFORNIA. A couple of you have raised the
whole issue of complexity, and for those of us who were in the
meeting that we had in the full committee when we got a
briefing on the U.S. tax structure it is pretty hard to argue
that the system isn't just overwhelmingly complex.
In another life, I chaired a tax committee in the State
legislature in California, and I had business people tell me
just, you know, lower the heck out of our taxes. We understand
things need to be revenue neutral, and that you need money to
do all the things that government does. But the lower our tax
rate is, the more people we will hire, the higher wages we will
pay, the better off everybody will be. Get it at the employee.
We are paying them well. They should pay taxes. Do you think
that is a pretty accurate approach?
To any of you, do we have too many tax options for
business? I think Mr. Neal said it earlier, that everything
that is there that makes it complex was there to address a
certain issue or, in most cases, to help business. Do
businesses have too many tax options on the table?
Mr. TARNAY. The answer is yes. Also, the answer is, if it
can be done so that the law is something that people can
understand for a significant period of time, as opposed to
things changing year-to-year or less than 5 years, people can
plan that. I can plan it. My company can plan that. We
understand that. We can move forward. Okay? That is the
difficulty that we have.
And the other thing is, simply law changes that are
retroactive. When you hear that, you don't do things because
you don't know when that retroactive application is. If we knew
that, we can plan. That is what we need.
Mr. THOMPSON OF CALIFORNIA. So if there were fewer options,
if you didn't have the LLC, didn't have the corporate election,
and you had just a business tax?
Mr. TARNAY. Well, I am not saying the type of entity. I am
saying within that type of entity that you understand what the
law is. It is simple. It is fair.
Mr. THOMPSON OF CALIFORNIA. I get that part.
Mr. TARNAY. That is it.
Mr. CARROLL. I guess I would say that I think one of the
distinguishing features of the U.S. business tax system is we
do afford businesses with different choices on how to organize
themselves, and I have always thought of that as a virtue. It
allows companies to make the choice that best fits and suits
their capital requirements and their management needs. It is
probably one of the many distinguishing features of the U.S.
economy in comparison to our major trading partners. That
flexibility probably adds to the dynamism of the U.S. economy.
Mr. THOMPSON OF CALIFORNIA. To follow up on that, Dr.
Carroll, are there certain anti-avoidance measures that would
have to be put in place if you were to devise a system that
pushed the rate down and lessened the options?
Mr. CARROLL. Yeah, that is a very, very interesting
question, and it is kind of an extension of your earlier
question in some sense in terms of how tax rates affect
decision-making.
Typically, from an avoidance or a compliance perspective,
one would think higher tax rates would encourage greater
avoidance and noncompliance activity. Because the benefit of
avoiding and the benefit of not complying to the taxpayer is
greater with the higher rates. So one of the benefits of
lowering rates generally would be that you would help mitigate
and reduce avoidance behavior.
Chairman TIBERI. The gentleman's time has expired.
Mr. Thompson, just a side note we tried to find Grandma
Thompson to come testify. When we couldn't, we had Ms. Thompson
instead.
Mr. THOMPSON OF CALIFORNIA. That is why I cautioned you,
you better lay off the Grandma Thompson jokes today.
Chairman TIBERI. Mr. Paulsen is recognized for 5 minutes.
Mr. PAULSEN. Thank you, Mr. Chairman. It is nice to be
having a hearing that is focused on small business entities,
and I appreciate your testimony here today.
Knowing that we are in a very globally competitive economy,
absolutely, and, you know, today we have to have a Tax Code
that has not only the predictability in the long-term thinking,
but, I mean, I really do believe it also has to spur
innovation, spur the whole idea of entrepreneurship, and also
capital formation and investment. I think there are a lot of
staff people in the administration or even Members of Congress
that don't understand the allocation of capital, and that is
really what this is about, how you allocate capital in the
global environment.
One of my concerns with the administration's proposal on
tax reform is that it is centered more on the corporate tax
side, at least in the President's State of the Union proposal,
and he talks about having a revenue-neutral basis for corporate
tax reform. I want to make sure that is not going to be an
expensive trap for small business entities and pass-through
entities such as S corps, LLCs, sole proprietorships,
partnerships, et cetera.
If that is the track that is ultimately pursued and a lot
of our Nation's employers are going to see tax increases
because we eliminated certain tax business, the expenditure
side like deductions for depreciation, et cetera, which you
talked about, you know, what would be some of the ramifications
of that from the standpoint of--while there might be not be any
offsetting benefit, in essence, for small employers--and, on
top of this, we also heard Secretary Geithner actually, just
last week I think, float the idea of having some pass-throughs
be pushed more into the C corporation model, actually, ensuring
they would also be hit with this inefficient double tax.
So let me ask Mr. Carroll first maybe, if the purpose of
tax reform is to actually make the U.S. government more
competitive or our economy more competitive, I should say, and
encourage job creation, does it make sense to push more people
into the C corporation tax model?
Mr. CARROLL. My view is that that is problematic. As I
already discussed, we have a double tax on corporate profits.
It distorts decision-making in some fairly fundamental ways. It
is kind of widely recognized among economists in the policy
community that the double tax on corporate profits is a
significant problem. It contributes to the leverage among
businesses. It misallocates capital, and it raises the overall
cost of capital for the economy.
Most other developed nations have provided some relief from
the double tax on corporate profits in some way. They have
shifted a little bit in the last 10 years in how they do that,
whether they do it at the shareholder level, whether they do it
at the corporate level, the mechanism in which they deliver it.
But the U.S. tends to have fairly--even after the lower rates
on dividends and capital gains were enacted in 2003, we still
have a fairly high double tax on corporate profits such that a
dollar of investment in the corporate sector that is paid out
as dividends is taxed pretty highly relative to most other
things.
I think that is a problem. It kind of complicates--and I
think it really complicates if you try to redraw the line
between the flow-through sector and the C corporation sector.
To raise more revenue to lower the corporate rate, I think it
would make the double tax problem larger, not smaller.
Mr. PAULSEN. And, Ms. Thompson, I am just curious, what
would happen to your clients if they got pushed into a C corp
model?
Ms. THOMPSON. I think it is really too early to say what
would happen if they moved into the corporate form because it
hasn't been worked out on what all the details of that are. Are
there going to be changes to the expenses? Is there going to be
a double tax? So it is really too early to answer that
question.
Mr. PAULSEN. Mr. Chairman, I follow up in a different angle
to what Mr. Carroll--I know that you looked at the economic
issues that are associated with S corporations and with the
subset of S corporations, namely, employee owned or ESOP S
corporations, in particular. These are companies essentially
that are employee owned and they fared much better in tough
economic times in terms of actually growing their companies
during these trying times and also putting people back to work,
providing retirement security, actually, for their employees.
If the administration's proposal to move and eliminate some of
those pass-throughs on S corps became a reality, for instance,
what would this mean for privately employee-owned companies
potentially? Who would be affected by such changes within those
organizations?
Mr. CARROLL. Yeah, I think the S corp ESOP structure is
very interesting. The employee ownership aspect is very
interesting, and the performance of those companies based on
some work that I have done suggest that those companies
performed better during the economic downturn than the rest of
the economy in the sense--although it is not a huge segment of
the economy, they did in effect provide, in some sense, a
backstop during the economic downturn. They tend to pay their
workers higher average wages, and they tend to provide a fairly
high level of retirement security. So the ESOP provides that
benefit as well.
Mr. PAULSEN. Thank you, Mr. Chairman.
Chairman TIBERI. Thank you.
Mr. Berg is recognized for 5 minutes.
Mr. BERG. Thank you, Mr. Chairman. I appreciate you being
here.
As a small businessman, it is kind of over the years going
through the 1986 tax reform and everything else, small business
tends to make decisions, first of all, on the economics, but
they are really influenced by the taxation. And it seems to
me--I enjoyed the OFO, only financial officer. I think that is
what a lot of these small businesses are.
And when there is laws that are passed, they are either
convoluted or complicated. They are trying to look at that and
figure that out. And the point of having a third party analyze
this for the business, I mean, those are things that, again,
specifically help at little moments in time but I think overall
really cause a lack of focus in what maybe a small business
should be focused on.
So one of the things that I heard you saying that
potentially when you eliminate some of the accelerated
depreciation and other things that you could probably bring the
rate down to 28, 27 percent. I wonder if you ever looked at
just the silo of pass-through entities. If you said just
looking at this group of pass-through entities, if we
eliminated, again, or changed this to simplify it, what could
that overall rate be brought down to? Would that be the 28
percent? Whoever would like to----
Mr. CARROLL. I think if you were looking at just the flow-
through sector by itself, I haven't done the calculations in
terms of how low the rate could be brought down. As I
mentioned, flow-through entities use about 22 percent of the
business tax expenditures, and they report about 40 percent of
the net income and pay about 43 percent of the business taxes.
So, in that sense, the C corporations kind of make somewhat
greater use of business tax expenditures. So that might give
you some sense of kind of the relative reduction of the rates.
But I would point out that if one tried to just do
corporate reform and tried to draw a line in the various
business tax expenditures or business tax provisions so that
they would only be reduced or eliminated for C corporations or
did the same for pass-throughs, I think that would be a very,
very complex, complicated system. Trying to make those
distinctions on something like accelerated depreciation that is
probably available to all business forms in trying to have one
system for C corporations and another system for flow-throughs
I think would be an extraordinarily complex system.
Mr. BERG. Ms. Thompson, you had mentioned the 100 percent
gain exemption, and that was a little bit new to me. Could you
explain that briefly and how that could benefit if it were
implemented for pass-through entities?
Ms. THOMPSON. The provision is that if you have a gain on
the sale of a small business stock you can exclude 100 percent
as long as you purchased the stock between September, 2010, and
December, 2011; and starting in January, 2012, it is going to
drop down to 50 percent gain exclusion.
But what happens with that provision right now is it is
only available to C corporations; and, as we had talked about,
most of the small businesses are running as pass-through
entities. And so if that is a C corporation provision, it
automatically excludes everybody who has been running this
small business as a pass-through entity. The value has to be
less than $50 million, and it has to be in certain types of
businesses, and it can't be any type of personal services. It
can't be restaurants, hotels, motels, those types of things. So
it is really very narrow, and it is even more narrow because it
is only C corporations, which most of the small businesses
aren't.
Mr. BERG. Thank you.
The other issue that has come up time and time again is the
uncertainty and unpredictability. I mean, I think whatever our
tax rates were, whatever our deductions were, if they were set
in stone for 15 years, that would be a good thing for small
business and probably all business, as long as it is
competitive. And so I guess looking at that--and I am asking
myself--what are the taxes out there that are on like a short-
term trigger that need to be renewed that create this
uncertainty out there? In our current Tax Code, as it relates
to the pass-through entities, what are those either deductions
or what are those things that you are aware of that creates
that uncertainty that could be addressed in this Congress?
Again, I am not, I guess----
Ms. THOMPSON. The first one could absolutely be the tax
rate. Because we do know that they are set until the end of the
next 2 years, through 2012. But then once you get beyond that
depreciation we do know that this is a business incentive that
you put in place more when the economy isn't really good. But
having that come in and out as frequently as it does, that is
causing quite some challenges.
Mr. BERG. Thank you.
So tax rates and depreciation. Is there anything else?
Ms. THOMPSON. From the small business perspective, I think
those are the major ones that we come across.
Mr. BERG. Dr. Carroll.
Mr. CARROLL. I think if you look broadly at the tax system,
you have a large fraction of the Tax Code that is really in
flux from year to year. You have the sunset of the Bush tax
cuts at the end of 2012 which raises a considerable
uncertainty, and you also have the various expiring provisions,
including the R&D credit that is used by small businesses as
well as large businesses, and that expires periodically. There
is a long list of expiring provisions. All of these things
create a lot of uncertainty and instability in the Tax Code and
make it very, very difficult for both individual and business
taxpayers to make decisions.
Mr. BERG. Thank you.
Chairman TIBERI. Thank you. Thank you, Mr. Berg.
Dr. Boustany is recognized for 5 minutes.
Mr. BOUSTANY. Thank you, Mr. Chairman, and thank you for
holding this hearing. This is a very important hearing.
Some time ago, I was back home doing a town hall meeting
and I was talking about American competitiveness and the need
to lower the corporate tax rates so we could compete in the
global economy. And after some lengthy discussion about all of
that, I had a small business owner who I had happened to know,
a gentleman by the name of Paul Fontana, who owns an
occupational therapy business, and he stood up and he said,
what about me? What does this get me? And it got me to thinking
and I said, well, you know, you are right, because you have a
pass-through entity.
And as we go through this discussion it becomes apparently
clear to me that we really have to focus on our small
businesses and pass-through entities as we do tax reform.
Otherwise, I think we will be negligent in the approach.
Dr. Carroll and Dr. Marron, the administration is talking
about reducing the corporate tax rate, which I think we all
agree we need to do, and we are looking at targeting it down
into the 20s, you know, 20, 25 percent, if we can get it down
that low, to be really competitive. But, at the same time, the
administration is talking about raising the top level for pass-
through entities, the top rate for pass-through entities and
individuals to almost 40 percent. So what is going to be the
economic consequence if that is allowed to go through? Dr.
Carroll.
Mr. CARROLL. Yeah. I think our corporate tax system is very
much out of step in the global economy. Most other developed
nations within the OECD have lowered their corporate tax rates
significantly over the last--certainly since the mid-1980s, and
we now have the second highest corporate tax rate exceeded only
by Japan. Japan is likely to reduce their corporate tax rate in
April, in which case we will have the highest. So that kind of
provides a backdrop for why there is an interest in corporate
tax reform. You know, we want the U.S. to be able to compete in
a global economy, and the world has really changed. It is very
different now than it was.
Mr. BOUSTANY. What is the economic consequence here in the
U.S. with this disparity if we have a top rate of almost 40
percent for our pass-throughs and for individuals as we lower
the corporate tax rate?
Mr. CARROLL. I think it is a very problematic. I think it
is very problematic. The flow-through sector, as I said, is a
very large segment of the economy, employs 54 percent of the
private labor workforce, and to have a very different treatment
of pass-throughs relative to C corporations is a problem.
Mr. BOUSTANY. Thank you.
Dr. Marron.
Mr. MARRON. Again, I would go back and reference what the
fiscal commission came up with, the Domenici-Rivlin Commission
came up with. There was a reason they chose in the end to try
to have the top rates on the individual side and the corporate
side be the same, and one of those key reasons is to avoid all
the distortions that would arise. If you have one rate that is
40 and you have another that is 25, you have created a gigantic
incentive for creative people to think about how do I exploit
this to best advantage, and that is thinking that would be
better deployed doing something else in the economy.
So if you can do fundamental reform of the entire system,
that means touching all sorts of other tax preferences that are
purely on the individual side and have nothing to do with
business, much better to end up with rates being--you know,
they don't literally have to be identical but close to each
other.
Mr. BOUSTANY. Close. Thank you.
One of the common refrains I hear from small business
owners is about the issue of accelerated depreciation, and we
saw this after the hurricanes. It was probably the single most
important thing Congress did to spur the Louisiana economy
after hurricanes Katrina and Rita; and I appreciated your
comments earlier, Dr. Carroll, about both the short-term and
long-term consequences that are positive with this type of
approach.
And, Ms. Thompson, in your testimony you highlighted a
number of the complexities, the varying in rules and everything
else, which I read with great interest; and I am going to look
at the report that you all have as well. But how could tax
reform simplify some of these rules related to capital
investment that would allow for small businesses to actually
see capital formation?
Ms. THOMPSON. I think the best thing you could do with the
depreciation is have it for a longer period of time and put it
in place prior to the time that you are thinking about it.
For example, if you wanted it to be effective January 1,
2011, put it in place, if you could, in 2010 and don't have it
just for a 1-year period, have it for a much longer period of
time. Then that gives the ability to the small business owner
to plan their investments better, their purchases, and that
would really add a lot to the simplification of the system
because everybody does like the accelerated. It is just that it
comes in too frequently at various times during the year. It is
just challenging.
Mr. BOUSTANY. Does anyone else want to comment on the issue
of depreciation versus expensing and, you know, the concerns
about debt financing before we conclude this?
Mr. MARRON. If I could just second something I said before,
is I am sympathetic to approaches that would move towards
expensing if at the same time you think about walking back the
deductibility of interest. Otherwise, you accidentally end up
in a system where, if interest is deductible, you can have a
situation in which we effectively have negative tax rates on
capital investment, which I think is going too far. But if you,
you know, keep accelerated depreciation and move towards
expensing but then think about rolling back interest
deductibility, you can have a system that reduces that debt
equity distortion and provides incentives for investment.
Chairman TIBERI. Anybody else care to answer?
The gentleman's time has expired.
Mr. BOUSTANY. Thank you.
Chairman TIBERI. Ms. Berkeley, recognized for 5 minutes.
Ms. BERKLEY. Thank you very much, Mr. Tiberi, and thank you
for holding this hearing. I thank all the witnesses. I have
learned a lot this morning, and I appreciate that.
I agree with my colleagues that reforming the tax system is
critical to the long-term health of our economy. I don't think
you need to be a genius to figure out that the Tax Code is
bloated and it is very complex. It adds unnecessary costs to
business operations and distorts business investment decisions.
That the Code is unnecessarily complex is a complaint that
I hear often from my constituents in Las Vegas, and I worry
that it poses an additional hurdle to my district getting back
on its feet economically. We are in a world of hurt in Nevada,
particularly in Las Vegas, which is the community that I
represent. Half of the businesses--although I know everybody
thinks of Las Vegas as the glitz and the glitter and the big
hotels, and in fact that is part of our persona and has served
us well until the latest economic crash--about half of the
people that are employed in the State of Nevada are employed by
small businesses. So what we are talking about today is very
important. I know that this is the beginning of a very long
process.
In the State of Nevada, pass-through entities outnumber C
corporations by almost three to one. So what we are talking
about here today is very important to the people I represent.
There are a number of questions that I have. The first one
is just some musings. I know that we are all talking about
budget neutrality and if we could bring down the corporate
rates to 27, 28 percent across the board, get rid of all the
tax extenders, the tax breaks, the tax credits, it would add to
predictability and simplicity, which everybody believes would
be better for small businesses. If you know what is happening,
what you can plan for 10 years from now, 5 years from now,
obviously, it impacts on your business decisions and gives you
an opportunity to make better ones.
But having been through the tax extender debate and having
everybody that I knew that owned a business of some kind coming
into my office and asking for an extension of their tax break,
no matter what business they are in, if it is propane gas or
speedways throughout the United States, I am wondering how
willing businesses are going to be to give up these tax breaks
that we have extended over the years?
And I would imagine that if we lowered the tax rate--and I
agree with you, when you look at our tax rate on paper in
comparison to other industrialized countries, it seems very,
very high. But when you factor in all the tax breaks, tax
credits, tax extenders, I think it generally lowers our overall
corporate tax rate dramatically.
I can tell you in my congressional district, without naming
names specifically, I have one gaming company that pays overall
about 8 percent after they take advantage of all their tax
breaks, and I have another that pays over 30, and they are both
pretty big companies. Now, I wonder how the company that is now
paying about 8 percent of their taxes is going to feel when we
pass legislation that kind of stabilizes everybody at around
27, 28 percent while eliminating the tax breaks. Can you
comment on that?
Mr. CARROLL. Yeah. A lot of points that you have raised
there that are all I think very important. One point is, you
know, how do we compare to other nations? And there are
different ways of measuring that. We do have a high statutory
corporate tax rate. We also have a high--what economists call a
marginally effective tax rate relative to other nations. There
is a recent study that was released by an academic in Canada,
Jack Mintz, that makes that point.
We also have a very high effective tax rate and measured on
a financial statement basis based on some work by an academic,
Doug Shackleford down in North Carolina.
There are a number of ways of thinking about effective tax
rates or tax rates generally, and which tax rate you look at
really depends on which question you are asking. But by a
number of different metrics the U.S. looks like it is pretty
out of step relative to other countries. So that is I think one
point to keep in mind.
Ms. BERKLEY. Mr. Marron, you pointed out in your testimony
the connection between the complexity of the Code and the
tendency of small businesses to underpay their taxes. Can you
share with us some areas of the Tax Code where simplification
would have the highest effect on boosting compliance?
Mr. MARRON. Well, in my remarks I was very careful to use--
what was the word I used--responsible and irresponsible just to
distinguish small business as a whole, vast array of different
kinds of firms, some of which face very high compliance burdens
and try to pay the taxes they do; and then, unfortunately,
there are other ones who are able to avoid.
You know, unfortunately, I don't have any good
recommendations for you. I mean, again, some of these things
have to do with, you know, cash transactions which are hard to
monitor. It is just sort of a fundamental nature of some of
these transactions that they are going to be more difficult to
reach to.
There was the effort with the 1099 which has gotten a lot
of understandable pushback, and that is that the burden it
placed on folks seems to be disproportionate to the additional
revenue it is going to raise.
Maybe some of my colleagues have some suggestions for you,
but I do not, sorry.
Chairman TIBERI. The gentlelady's time has expired, but any
of the other witnesses care to answer her question?
Ms. BERKLEY. So no suggestions on how we can, in fact--what
we can do with the Tax Code where simplification would have the
highest effect on compliance? No help?
Chairman TIBERI. The gentlelady's time has expired.
We are going to one more round, if the witnesses would care
to indulge us, for just one question from each of the members,
if they wish. I will start out by asking all four of you--well,
two of you--a question; and then I will follow up with the
other two.
Earlier this week, in a publication called Tax Notes, an
article, a gentleman by the name of Marty Sullivan, who the
minority actually invited as a witness a couple of weeks ago on
tax reform, argued that double-taxing on corporate income is
bad economic policy; and let me quote what he wrote in the
article: We should recognize that the movement from double
taxation to flow-through taxation is a step in the direction of
sound policy. Tax reformers and professors will tell anyone who
will listen that all business income should be taxed on a flow-
through basis.
I would like to get opinions from Dr. Carroll and Dr.
Marron on Dr. Sullivan's point that double taxation on business
income is bad for jobs and the economy, and good policy means
moving toward taxing business income once. Do you agree or
disagree or and why?
Mr. CARROLL. I do agree with that. As I have already
alluded to or stated in my comments, the double tax on
corporate profits distorts economic decision-making in a number
of very important ways. It leads to a higher degree of leverage
in the economy, which is problematic; it leads to a
misallocation of capital throughout the economy, which is
problematic; and it raises the cost of capital, which
discourages capital formation. That is also problematic.
Using something Donald said earlier, you know, economic
fundamentals, not tax considerations, should drive decision-
making, and the double tax I think violates that principle.
Chairman TIBERI. Thank you.
Dr. Marron.
Mr. MARRON. I agree as well. There are lots of plans over
time that said, you know, if you could go back to the beginning
and redesign a tax system from scratch, how would you want to
design it? And there are different ways of doing it, but they
all have this feature that you eliminate the double tax.
Chairman TIBERI. Mr. Tarnay, if you were forced to go and
become a C corp, how would that impact your ability as a CFO to
create jobs from your current tax system?
Mr. TARNAY. I think it would diminish it greatly. A small
business owner thinks one way: I made a dollar. I should pay
tax on that dollar. Not a dollar and then, after I get some
money from it, then pay tax at the individual level. This is
how they think. One-time tax on that earnings. Flow-through
entities allow for that.
Chairman TIBERI. Ms. Thompson, you had mentioned that you
do tax returns for a variety of clients, a lot of small
business owners. How would a majority of your clients be
impacted if we forced all businesses to pay at a C corp rate?
Ms. THOMPSON. Without knowing all of the details of the tax
reform and if you were purely to say everything is going to
stay in place except you are now going to be corporations and
you are going to need to double-tax employees, they would be
hurt tremendously. I have had clients who have been C
corporations in the past who, when they went to sell their
business, they end up paying more than 50 percent in taxes, and
it was overwhelming to them. So it would really hurt them
significantly if they had to go a C corp level tax and pay
double.
Chairman TIBERI. Thank you.
I will yield time to Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman.
Dr. Carroll, you mentioned that ESOP entities tended to do
better in the recession in terms of retirement savings, and you
know that is something I have in interest in.
Mr. CARROLL. Yeah. In a number of different metrics, based
on some analysis that I have done, it looks like the ESOPs did
fare better during the recession than--S corp ESOPs fared
better during the recession. They grew at a faster rate. They
added more jobs. Generally, they have higher average wages;
and, generally, they have a greater retirement security.
Mr. NEAL. Let me follow up on the point Mr. Thompson was
making to you about anti-abuse rules. You pointed out that if
the corporate tax was significantly lowered, that the lower
rates don't usually foster abuse, I think what he was trying to
get at was that abuse might arise if the corporate rate was at
15 percent and the highest individual rate was at 35 percent.
In this scenario, would you see some movement of earnings to
the corporate form?
Mr. CARROLL. Oh, there is movement between--at a high
level, there is movement between the flow-through sector and
the C corporation sector, depending on the relationship of the
individual tax rate and the corporate tax rate. We saw that
after the 1986 Act with the repeal of the general utilities
doctrine and as well as the change in the relationship of the
rates, we saw a movement that, some research that I did a while
back, ascribed to the change in the rates. Austan Goolsbee has
done some research in the area as well that has found that the
number of businesses or the level of activity within each
sector is sensitive to the relative taxation.
Mr. NEAL. Thank you, Mr. Chairman.
Chairman TIBERI. Thank you.
Mr. Paulsen is recognized.
Mr. PAULSEN. Thank you, Mr. Chairman.
And maybe I will just follow up with Mr. Tarnay. I didn't
get to ask you a question before, but you listed several items
as a part of your testimony that were important for tax reform
to be in consideration. And, you know, we all agree tax reform
is necessary. You have got the corporate component, you have
got the pass-through entities which we are talking about today,
but can you just discuss in greater detail a couple of the
items or maybe the top handful of the most important issues
that should be focused on that would be the best--I mean, the
absolute best, actually, to help spur economic growth and
capital formation and investment, if there is just sort of a
top wish list that should absolutely be focused on.
Mr. TARNAY. I think the timing in the requirements of an S
corporation, because it is complex because of the levels of--if
you have certain stock structures, you can't be an S
corporation, certain number of shareholders, you couldn't be--I
think that could be simplified. I don't agree with the
alternative minimum tax, but I think that if you can't take it
away then I think it needs to be revised and simplified.
Mr. PAULSEN. Okay.
Mr. TARNAY. Those are the two.
Mr. PAULSEN. Do you have any idea how many small business
entities end up falling into sort of the alternative minimum
tax because of their pass-through income? And maybe, Mr.
Carroll, you may know. You kind of nodded your head.
Mr. CARROLL. I actually don't know the answer to that
question, but it is a very interesting question.
Mr. PAULSEN. Okay. Well, Mr. Chairman, if we can somehow
have tax staff to look into that, too. Because I know the
alternative minimum tax is something that keeps trapping more
and more people, and a lot of these people--small businesses
that pay also under the individual rates obviously would get
trapped in that. So I yield back.
Chairman TIBERI. Thank you.
Mr. Berg is recognized.
Mr. BERG. Thank you, Mr. Chairman.
We have seen a lot of statistics that show our corporate
rate relationship to other countries across the world. My
question is, tell me about the pass-through entities in these
other countries; and, again, maybe, Dr. Carroll, you could
start.
Mr. CARROLL. Yeah. A lot of other countries push businesses
into the corporate form in pursuit of limited liability. That
is one of the distinguishing features I think between the U.S.
and other countries, is it is much easier to get limited
liability in this country because of the flow-through form and
the various organizational forms in that sector. And so that is
one of the reasons we have a much larger flow-through sector
than most other nations.
You know, I think that is--one could also do a comparison
of the kind of the tax rates that the flow-through income
received by individuals in the U.S. is subject to as compared
to other nations. I am less familiar with those statistics.
Mr. BERG. Mr. Chairman, my question, kind of here in
America we are trying to keep those two rates pretty close. I
argue that we should look at the net rate and not the gross
rate. But my question related to other countries, is their
pass-through rate similar to their corporate rate or is there a
disparity in these other countries that we are aware of?
Mr. CARROLL. I think there does--without having looked at
the data in detail, my sense would be that there tends to be
some disparity. The corporate tax rates tend not to be
particularly high relative to individual tax rates. There are a
few countries that have tried to apply, in a sense, separate
tax systems, particularly in the Nordic countries where they
treat partnership income, you know, very differently than the
income of wage earners in order to coordinate the corporate
sector tax and the flow-through sector tax.
Mr. BERG. Let me, Mr. Chairman, wrap up just--my question,
when that nets out to the individual, the stockholder, where we
are competing with another country that has a low corporate
income tax, are they paying a very high personal income tax so
that net that that person is paying, you know----
Mr. CARROLL. Yeah. So looking at it a different way, if you
look at kind of the net after-tax amount received for a dollar
invested in the corporate sector abroad, you know, kind of what
is the sum total of the double tax on corporate profits, for a
dollar paid out as dividends, that tax bite when you look at
both levels, the corporate and individual level, tends to be
higher abroad than here. The U.S. tends to have a higher level
of tax on a dollar invested in the corporate sector and paid
out as dividends than our major trading partners. And if the
rate were to go up, the dividends and capital gains rates were
to go up, then that difference would become fairly substantial.
Mr. BERG. Thank you. Thank you, Mr. Chairman.
Chairman TIBERI. Thank you, Mr. Berg.
Ms. Berkeley is recognized.
Ms. BERKLEY. Thank you, Mr. Tiberi.
I kind of caught something, Ms. Thompson, that you said,
and I just wanted to make sure that I understand it completely.
Secretary Geithner has suggested that some pass-through
entities are--in fact, very large firms, not the traditional
small businesses, at least I think of it--these large firms
have revenues in the tens of millions of dollars. Mr. Paulsen,
I think, asked you what the impact of being taxed as a C
corporation would be on your clients. Could you share with us
what percentage of your clients are of the size that Secretary
Geithner was referring to?
Ms. THOMPSON. That is not the level of my clients. My
clients are very small businesses. They have probably four to
six members and revenues are probably----
Ms. BERKLEY. You mean employees or members?
Ms. THOMPSON. No, owners of the company. So you are talking
about either C, S, or pass-through entity owners. There is
probably four to six of them. So they are very small from the
measure of owners. As far as revenue, they are probably, I am
going to say, $25 million or less.
Ms. BERKLEY. Okay. So the comments that Secretary Geithner
made would not----
Ms. THOMPSON. It is not typical of my firm.
Ms. BERKLEY. All right.
And, Mr. Marron, in your opinion, what percentage of pass-
throughs are of the very large size that Secretary Geithner was
referring to?
Mr. MARRON. It is a very small percentage of the population
but a significant fraction of the economic activity.
Ms. BERKLEY. Please say that again.
Mr. MARRON. If you do it by counting the number of firms or
the number of businesses, the number that are in that size
range appears to be very small. But because they are large,
they account for a fairly large fraction of the economic
activity, whether it is assets or revenues or income that are
accounted for by pass-throughs as a whole.
Ms. BERKLEY. All right. Thank you very much.
Chairman TIBERI. Thank you.
Dr. Boustany is recognized.
Mr. BOUSTANY. Thank you, Mr. Chairman.
Dr. Marron's testimony talked about partnership activity
conducted through large partnerships and not small businesses,
but aren't many of these large partnerships actually joint
ventures whose partners happen to be corporations themselves?
Dr. Carroll.
Mr. CARROLL. Yeah. There is a significant fraction of
partnership income where--stated a different way, the owners of
partnerships can be individuals or corporations, unlike, say,
an S corporation where there is a restriction. Only individuals
can own an S corporation. A sole proprietor, by definition, is
an individual. But for partnerships, based on the statistics I
have seen, roughly 50 percent of partnership income results
from partnerships that have corporate owners. So you could
think of two companies that engage in a partnership, a joint
venture to do something, build a project, and then they
distribute the income to the two corporate owners. So about
half of the partnership activity seems to be owned by
corporations.
Mr. BOUSTANY. So if we were to tax those entities, those
large partnerships or joint ventures like C corps, then in
effect we are subjecting them to triple taxation; is that
correct?
Mr. CARROLL. Yeah. If you did that, there is a long
tradition of having flow-through treatment of partnerships for
that very reason that, you know, if they are owned by the other
businesses, just as if a C corporation owned another C
corporation, then you wouldn't want to kind of have multiple
layers of tax in the same activity. There is usually a
dividends-received deduction associated with income that flows
from one part of a complex business unit to another.
Mr. BOUSTANY. So, in effect, a joint venture is being
taxed, the corporate partners are being taxed, and then the
shareholders of the corporate partners would be taxed. So, in
effect, really triple taxation.
Mr. CARROLL. Right, that was the change.
Mr. BOUSTANY. Thank you. I yield back, Mr. Chairman.
Chairman TIBERI. Thank you, Dr. Boustany.
Thank you all, all the witnesses who are here today; and
members are advised that members may submit written questions
to our witnesses. Those questions and the witnesses' answers
will be made part of the record of today's hearing.
Again, thank you to the four of you for appearing today. It
has been an educational discussion, and I hope just the
beginning, and it is hopefully helpful in moving the
conversation forward on comprehensive tax reform.
This hearing is adjourned.
[Whereupon, at 10:42 a.m., the subcommittee was adjourned.]
[Submissions for the Record follow:]
[GRAPHIC] [TIFF OMITTED] T0874B.036
[GRAPHIC] [TIFF OMITTED] T0874B.037
[GRAPHIC] [TIFF OMITTED] T0874B.038
[GRAPHIC] [TIFF OMITTED] T0874B.039
[GRAPHIC] [TIFF OMITTED] T0874B.040
[GRAPHIC] [TIFF OMITTED] T0874B.041
[GRAPHIC] [TIFF OMITTED] T0874B.042
[GRAPHIC] [TIFF OMITTED] T0874B.043
[GRAPHIC] [TIFF OMITTED] T0874B.044
[GRAPHIC] [TIFF OMITTED] T0874B.045
[GRAPHIC] [TIFF OMITTED] T0874B.046
[GRAPHIC] [TIFF OMITTED] T0874B.047
[GRAPHIC] [TIFF OMITTED] T0874B.048
[GRAPHIC] [TIFF OMITTED] T0874B.049
[GRAPHIC] [TIFF OMITTED] T0874B.050
[GRAPHIC] [TIFF OMITTED] T0874B.051
[GRAPHIC] [TIFF OMITTED] T0874B.052
[GRAPHIC] [TIFF OMITTED] T0874B.053
[GRAPHIC] [TIFF OMITTED] T0874B.054
[GRAPHIC] [TIFF OMITTED] T0874B.055
[GRAPHIC] [TIFF OMITTED] T0874B.056
[GRAPHIC] [TIFF OMITTED] T0874B.057
[GRAPHIC] [TIFF OMITTED] T0874B.058
[GRAPHIC] [TIFF OMITTED] T0874B.059