[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
PRESIDENT'S FISCAL YEAR 2001 BUDGET
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
FEBRUARY 9, 2000
__________
Serial 106-96
__________
Printed for the use of the Committee on Ways and Means
__________
U.S. GOVERNMENT PRINTING OFFICE
67-025 WASHINGTON : 2001
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of February 2, 2000, announcing the hearing............. 2
WITNESSES
U.S. Department of the Treasury, Hon. Lawrence H. Summers,
Secretary, accompanied by Sylvia Mathews, Deputy Director,
Office of Management and Budget................................ 8
SUBMISSIONS FOR THE RECORD
Air Courier Conference of America International, Falls Church,
VA, statement.................................................. 74
Alliance of Tracking Stock Shareholders, statement............... 75
American Association for Homecare, Alexandria, VA, statement..... 78
American Bankers Association, statement.......................... 81
American Petroleum Institute, statement.......................... 84
American Society of Association Executives, Michael S. Olson,
statement...................................................... 90
Benson, David, Ernst & Young LLP, Global Competitiveness
Coalition 2000, joint statement................................ 124
Boom, Rev. Vada Ba, Bethesda, MD, letter......................... 95
Center for a Sustainable Economy, statement and attachment....... 97
Clark/Bardes, Dallas, TX, statement.............................. 102
Coalition for the Fair Taxation of Business Transactions,
statement...................................................... 106
Coalition of Service Industries, statement....................... 112
Committee on Annuity Insurers, statement and attachment.......... 115
Council on Foundations, Dorothy S. Ridings, statement............ 119
Equipment Leasing Association, Arlington, VA, statement.......... 121
Garrett-Nelson, LaBrenda:
Washington Counsel, P.C., statement.......................... 166
Global Competitiveness Coalition 2000, joint statement....... 124
Gasper, Gary, Washington Counsel, P.C., statement................ 166
Giordano, Nicholas, Washington Counsel, P.C., statement.......... 166
Global Competitiveness Coalition 2000, David Benson, Ernst &
Young LLP, and LaBrenda Garrett-Nelson, Washington Counsel,
P.C., joint statement.......................................... 124
Home Care Coalition, statement................................... 126
Independent Sector, statement.................................... 129
Leasing Coalition, PricewaterhouseCoopers LLP, statement......... 130
National Association of Real Estate Investment Trusts, statement. 140
Olson, Michael S., American Society of Association Executives,
statement...................................................... 90
Pierce, Benjamin R., Vanguard Charitable Endowment Program,
Southeastern, PA, letter....................................... 166
PricewaterCoopers LLP:
Leasing Coalition, statement................................. 130
Statement and attachments.................................... 144
Real Estate Roundtable, statement................................ 159
Ridings, Dorothy S., Council on Foundations, statement........... 119
Vanguard Charitable Endowment Program, Southeastern, PA, Benjamin
R. Pierce, letter.............................................. 166
Washington Counsel P.C:
Global Competitiveness Coalition 2000, joint statment........ 124
LaBrenda Garrett-Nelson, Gary Gasper, Nicholas Giordano, and
Mark Weinberger, statement................................. 166
Weinberger, Mark, Washington Counsel, P.C., statement............ 166
PRESIDENT'S FISCAL YEAR 2001 BUDGET
----------
WEDNESDAY, FEBRUARY 9, 2000
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:09 a.m., in
room 1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
February 2, 2000
FC-17
Archer Announces Hearing on
the President's Fiscal Year 2001 Budget
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
President Clinton's fiscal year 2001 budget proposals within the
jurisdiction of the Committee. The hearing will take place on
Wednesday, February 9, 2000, in the main Committee hearing room, 1100
Longworth House Office Building, beginning at 10:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from Secretary of the Treasury
Lawrence H. Summers. However, any individual or organization not
scheduled for an oral appearance may submit a written statement for
consideration by the Committee and for inclusion in the printed record
of the hearing.
BACKGROUND:
On January 27, 2000, President Clinton delivered his State of the
Union address. In it, he outlined numerous budget and tax proposals.
Among them was a proposal to set aside Social Security surpluses for
debt reduction, and a proposal to offer prescription drug coverage to
Medicare beneficiaries. Among the tax items was a proposal to reduce
the marriage tax penalty by increasing the standard deduction for two-
income couples filing jointly, a proposal for tax incentives for
retirement, and a proposal for relief from the alternative minimum tax.
Among other things, the President proposed a number of new tax credits
for a wide variety of purposes. His budget is expected to include
various other tax, fee, and revenue increases.
The details of these proposals are expected to be released on
February 7, 2000, when the President is scheduled to submit his fiscal
year 2001 budget to the Congress.
In announcing the hearing, Chairman Archer stated: I look forward
to receiving the President's budget proposals. The President has
already announced many of his ideas and it's appropriate we now review
them in complete detail. I'm sure they will raise important questions
for thoughtful discussion.''
FOCUS OF THE HEARING:
The Committee will receive testimony on the President's fiscal year
2001 budget proposals from Secretary Summers. The Secretary is expected
to discuss the details of the President's proposals which are within
the Committee's jurisdiction.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
February 23, 2000, to A.L. Singleton, Chief of Staff, Committee on Ways
and Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this
purpose to the Committee office, room 1102 Longworth House Office
Building, by close of business the day before the hearing.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. All statements and any accompanying exhibits for printing must
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1
format, typed in single space and may not exceed a total of 10 pages
including attachments. Witnesses are advised that the Committee will
rely on electronic submissions for printing the official hearing
record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the
name, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. This supplemental sheet
will not be included in the printed record.
The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press,
and the public during the course of a public hearing may be submitted
in other forms.
Note: All Committee advisories and news releases are available on
the World Wide Web at ``http://waysandmeans.house.gov''.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman Archer. Welcome, Mr. Secretary. We are happy to
have you before the committee.
Before I begin my prepared statement, I am going to discuss
a recent concern that is disturbing to me and I believe to all
members of the committee on both sides of the aisle. I refer to
the steady stream of news reports about computer hackers
disabling major Internet web sites and accessing consumer
credit information.
Obviously, our committee is concerned because your Treasury
Department computer systems must guard some of the most
sensitive records of the American people--the IRS records, the
tax records of all our citizens. I know the IRS and the
Treasury have world-class computer security measures in place,
and I am sure this is a top priority for you and Commissioner
Rossotti. I commit publicly to you that you have the full
support of this committee to help protect the privacy of the
American people.
Of course, this committee oversees other agencies that
protect similar information like Social Security wage
information, Medicare health records, and a host of other
personal records. We will focus on those areas as well. But we
must do everything we can to apprehend Internet hijackers and
put an end to this cyber terrorism.
Perhaps you would like to comment briefly before I make my
statement relative to the budget, which is before us today.
Mr. Summers. Mr. Chairman, we share your concern and I will
be speaking with Commissioner Rossotti about this question of
integrity of our systems. Frankly, privacy at the IRS has been
a top priority for us for a number of years. We have taken
steps, working with this committee, with respect to employees
who have made unauthorized use of the systems and issues of
that kind.
I might just say, Mr. Chairman, financial privacy generally
is something that is a very, very important issue for us. There
is both the question of what is illegal hacking and also the
question of what is absolutely legal in terms of the widespread
dissemination of information. As the President made clear in
the State of the Union Address, this is something on which we
will be suggesting legislation to the Congress this year to
further protect financial privacy. We welcome your interest in
this area.
Chairman Archer. It is important that we work together.
This is something that knows no party lines and something that
we need to cooperate fully on.
Having said that, I would like to turn to the President's
budget request.
After saying in 1998 that we should ``save Social Security
first,'' and saying in 1999 that we ``should save Social
Security now'', the President appears to have abandoned his
pledge in this budget request. He apparently told reporters
just last week that while he would like to save Social
Security--in his words--he can't. It is a little disappointing
when the most powerful elected official in the free world says,
``I can't.''
More disappointing and confusing, perhaps, is that the
President has changed his mind again on the idea that the
Federal Government should invest Social Security funds in
private financial markets. We went through that with the
original request and it was negated powerfully by Mr.
Greenspan, who sat in exactly the chair where you are, after it
was proposed. And the President then left it out of his October
Social Security proposal.
Now in the budget it is back in again. I am eager to know
why when there is massive concern on the part of people across
the country on a bipartisan basis of having the Federal
Government own corporations in this country.
I would also like to know why it is necessary to keep
raising taxes on the American people at a time when the tax
rate is at a peacetime high, we not only have balanced the
budget, we are paying down the debt, we are protecting every
dime of the Social Security surplus, and our fiscal house--I
think we both would agree--is on a solid foundation. Last year,
the President signed a tax relief bill that was funded largely
out of the non-Social Security surplus. Why does the White
House believe that we should push for tax hikes?
There are plenty of other items we need to discuss like
helping low-income seniors with the high cost of prescription
drugs, making health care more affordable and accessible,
continuing with the success of welfare reform, and creating
better jobs and growth here at home by opening markets
overseas.
These are some of the things I look forward to hearing your
thoughts on.
With that, I yield to Mr. Rangel for any opening statement
he might like to make.
Without objection, each member will be permitted to enter
any written statements into the record.
Mr. Rangel?
Mr. Rangel. Thank you so much, Mr. Chairman.
Welcome again, Mr. Secretary. On behalf of the full
committee, we welcome Sylvia Matthews, the new Deputy OMB
Director. When you first started saying that you were
disturbed, Mr. Chairman, I took a deep breath because I did not
know where you were going to go with that. I was hoping you
were disturbed because there were reports that we were not
working closely together in a bipartisan way in order to do the
best for the Congress and the country.
There are many things I have problems with in the
President's budget. But I do hope and truly believe that it
would be helpful to both Democrats and Republicans if we can
get something done in this session because I am not convinced
that the voters are just going to blame the majority party.
They just might not be that sophisticated and take it out on
us, too.
So if we are concerned about Social Security, Medicare,
prescription drug benefits, patient bill of rights, and
education initiatives, it would seem to me that there was a
time when the President met with the House and Senate leaders
and that some of these things could be worked out--not to adopt
what the President's creative imagination would present to us--
but to select from those things that just made sense, whether
you are Republican or Democrat, to see whether or not we could
work together on it.
This type of thinking was shattered when I found out that
the Republican--shall I say, leadership--decided that the
marriage penalty relief would be the first thing coming out of
the Ways and Means Committee. I know how important it is for
the majority to get this thing done before Valentine's Day
because it is important that we send a message to the voters
for Valentine's Day that we love them and we want to give them
relief.
But how we can do this before we have a budget, I do not
know. And I know that you have abandoned the 792 tax cut bill,
and you have accepted the George W. Bush $1.3 trillion tax cut
bill. And I understand that instead of bringing it all to us at
once, since we cannot digest it any more than the American
people can, that we will be getting it in little slices. But at
some point, it adds up.
I think the first slice we get is the $182 billion marriage
tax penalty that benefits mostly people who do not have a
penalty. That does not bother me because I am just as
political, perhaps, as you are. But what bothers me is that
this is an opportunity to tell Mr. Summers and Ms. Matthews to
take a message back to the President that there are some things
that we want to get done, that we are going to select those
things, and we hope we work together because the majority does
not have enough votes to override the President.
So clearly, if we cannot override the President, we are
going to have to work with the President. As unfortunate as it
may seem sometimes, you may even have to work with me--the
Democrats. But if we are going to get anything done, we have to
stop taking shots at each other and suggest in a more positive
way how we can get something--no matter how small it may appear
to be--done.
I really think that the President has laid out for the
Nation a blueprint of exciting ideas, some of which we may not
be able to do. We may not be able to do it because we have
other priorities. Maybe we may not be able to because we won't
agree that it is the best way to do it. But out of two hours of
suggestions, many of which we were able to get the majority
party to give support at least in applauding, I would like to
believe that out of that meeting with the President--or
subsequent meetings--we can agree to do something.
And I do hope that the President is receptive to that.
First, it is important to the American people and the Congress.
Also, because both Chairman Archer and President Clinton will
not be returning. I would like to be a part of leaving some
type of legacy in being able to say that they have done
something that the country and the Congress will treasure.
I think we can do that and still have enough differences to
have a knock-down, drag-out fight in November to see which
team--the Democratic team or the Republican team--the American
people would want. I am convinced that there is not that much
difference between what we would want, it is just how we get
there.
I welcome you coming. I certainly will be working with you.
Of course, if we can't work together, there is another way to
do it, but I prefer to do it in a bipartisan way.
Thank you, Mr. Chairman.
[The opening statements of Mr. Matsui and Mr. Ramstad
follow:]
Opening Statement of Hon. Robert T. Matsui, a Representative in
Congress from the State of California
[GRAPHIC] [TIFF OMITTED] T7025.001
Opening Statement of Hon. Jim Ramstad, a Representative in Congress
from the State of Minnesota
Mr. Chairman, thank you for calling this important hearing
today to review the President's fiscal year 2001 budget
proposal.
The budget proposal before us today is a mixed bag--not as
good or bad as many of my colleagues will claim. There are
elements worth considering, as well as elements worth
disregarding.
I applaud the President's proposal to pay off the public
debt by 2013 because we must quit mortgaging the futures of our
children and grandchildren. However, I do not support the
President's excessive spending, at twice the rate of inflation.
As Chairman Greenspan has warned, Congress and the President
must keep federal government spending in check so we don't see
the return of soaring interest rates.
I am disappointed the President provides such little tax
relief, and at the same time, imposes significant tax hikes.
With a non-Social Security surplus of $2 trillion, Congress
should save Social Security, pay down the debt and provide
responsible tax relief.
As a Member of the Health Subcommittee, I am very concerned
that the President once again proposed to spend Medicare
dollars on new programs while, at the same time, cutting a
number of payments for current beneficiaries. In the BBA of
1997, we set out to save the Medicare system $115 billion, but
the Administration's implementation of it has almost doubled
that figure. In response, we restored $16 billion in funding in
1999 after providers predicted dire situations. Now the
President would take another $70 billion out of the system. It
certainly makes me wonder--is he not hearing the cries from
providers that every Member of Congress is hearing?
Instead of cutting payments and raising taxes through fees
to pay for new spending, Congress and the President should
modernize Medicare to reflect the advancements in our health
care system, including a targeted prescription drug proposal to
cover low-income seniors without displacing the coverage that
65% of our seniors already enjoy. I hope the President will
work with us on this important issue this year!
In addition, I am concerned about the President's return to
the idea of having the federal government invest Social
Security money directly into private financial markets--a
concept respected experts like Alan Greenspan and Rep. Bill
Frenzel have strongly recommended against.
Mr. Chairman, thanks again for calling this hearing. I look
forward to learning more of the details of the President's
proposal from Secretary Summers.
Chairman Archer. Mr. Summers, welcome again. We are happy
to have you before the committee. We will be pleased to hear
your verbal presentation. Without objection, your entire
written statement will be printed in the record.
STATEMENT OF HON. LAWRENCE H. SUMMERS, SECRETARY, U.S.
DEPARTMENT OF THE TREASURY; ACCOMPANIED BY SYLVIA MATHEWS,
DEPUTY DIRECTOR, OFFICE OF MANAGEMENT AND BUDGET
Mr. Summers. Thank you very much, Mr. Chairman, Congressman
Rangel. It is a pleasure for Ms. Matthews and I to be here to
discuss the President's fiscal year 2001 budget at a remarkable
moment in our Nation's economic history.
It was reported yesterday that productivity had grown at a
five percent annual rate in the third and fourth quarters of
last year, a performance that is nearly unprecedented, and
performance that suggests that we live in a moment of great
possibility.
The President's top priority in formulating this budget was
to preserve our progress and to build our future. Above all,
preserving our progress means maintaining budget surpluses and
continuing to pay down the debt at a rapid rate. It is the pay-
down of debt that makes room for the investments that allow us
to take advantage of the opportunities of this moment in
information technology, in biotechnology, in productivity
creating machinery and equipment.
The President's budget has five primary objectives. Let me
summarize them in turn.
First, debt reduction. This is a budget that provides for
the elimination of the national debt by 2013 and steady
reductions in its magnitude in the meantime. Debt reduction is
tantamount to a tax cut in two important respects. Because it
removes the burden on taxpayers of interest payments and
ensures that principal payments will not need to be made on
newly issued debt in the future, and because--as we have seen--
reducing Federal debt and expected Federal debt reduces
pressure on interest rates, allowing them to decline. Each
percentage point reduction in the interest rate over 10 years
results in an approximately $250 billion tax cut in the form of
lower mortgage costs for American families.
And budgeting for debt reduction has another important
benefit. It increases the resilience of our economy with
respect to the shocks and uncertainties that will happen with
respect to any forecast. Reloading the fiscal cannon gives us a
chance to respond to any future problems that may arise.
Creating valuable fiscal space allows us to address challenges
of an aging society.
The second objective of the President's budget is to meet
the needs of an aging society. Paying down debt will ultimately
eliminate the nearly $200 billion in interest costs that are
contained in this year's budget. The question naturally arises
of what is the best use of the fiscal space that is thereby
created. Here the President's budget gives a clear answer:
support for Social Security, funding of our existing obligation
to Social Security beneficiaries.
Mr. Chairman, the President's budget does provide for a
portion of those transfers to be invested in equities. That
reflects judgments that we discussed at some length when I
testified before this committee in early November about the
importance of allowing Social Security beneficiaries to take
advantage of the return the private market can provide and the
miracle of compound interest that we discussed. But it is our
judgment that this is best done within the context of a defined
benefit framework that does not transfer risk to Social
Security beneficiaries and one that conserves and minimizes
administrative costs.
The budget also calls for the modernization of the Medicare
program in three important respects. First, by providing
seniors with prescription drug coverage. If Medicare were
enacted today, it would surely include a prescription drug
benefit. Second, by providing a choice-based approach involving
competition, but an approach that encourages the selection of
lower-cost care alternatives, provides financial incentives for
seniors to choose those alternatives, but avoid--and this is
crucial--financial coercion that could interfere with existing
relationships between seniors and their caregivers.
And reflecting the rising size of the aging population, the
age of the aged population as life expectancy increases, the
President's budget also proposes to fortify the Medicare Trust
Fund with the savings from debt pay-down and allot several
hundred billion dollars for that purpose.
Third, the President's budget establishes a framework in
which it is possible to provide significant targeted tax cuts
and it proposes some $350 billion in tax cuts over 10 years in
a number of crucial areas. These include the promotion of
savings through a new program of retirement security accounts
that works with the grain of the existing employer-provided
pension system and private financial institution-provided IRA
system, but works to provide extra incentives to motivate 75
million Americans who do not have a pension or 401(k) to save.
Expansion of educational opportunity by allowing the
deduction of as much as $10,000 in higher education costs for
middle-income families. Steps to make health care more
affordable by tripling the long-term care credit and helping
those who have lost jobs to maintain continuity in their
insurance in a number of ways. Support for working families,
including crucially a reduction in marginal tax rates under the
earned income tax credit programs and targeted and appropriate
marriage penalty relief. Tax simplification through the
alternative minimum tax and increases in standard deduction.
There are also measures contained in the President's budget
to address the environmental concerns, to address the digital
divide, and to support philanthropy.
Let me highlight one area of the President's tax offsets,
and that is the area of corporate tax shelters.
In my judgment, there is ample room for reason and debate
about a variety of tax subsidies of various kinds that are
contained in the budget. But it seems to me that we all ought
to be able to agree that transactions that are devoid of
economic substance and are marketed in secret ought to be
curbed, revenue considerations apart, in support of the
maintenance of the integrity of the system. And yet it has
become increasingly clear to thoughtful observers of our tax
system that these transactions are increasing and are becoming
increasingly pervasive and a source of pressure on honest
taxpayers.
It would be my hope that wherever we come down on the broad
range of business subsidies, that we and the Congress can work
together to address this problem of abusive shelters, which it
seems to me is becoming a very serious problem in the same way
that the individual tax shelter problem became a very serious
problem in the 1980s, before legislative action was taken.
Fourth, spending targeted on key priorities. Let me
highlight one aspect of the President's budget. It is built
around a current services baseline. That baseline starts from a
Government that is smaller today in terms of public employees,
smaller today in terms of total spending as a share of GNP,
smaller today in terms of discretionary spending as a share of
GNP, and smaller today in terms of domestic discretionary
spending as a share of GNP than at any time since the 1960s.
And it shrinks the Government steadily over 10 years by each of
those measures. With this budget, the Government as a share of
GNP will be smaller than at any time since the middle of
President Eisenhower's term.
This is a conservative, prudent fiscal assumption in which
all of our initiatives are financed by changes in the pattern
of Government spending. To budget for a lower rate of growth
than this would be to count on slower growth in discretionary
spending than we had between 1981 and 1993 or slower growth in
discretionary spending than we have had since 1993. It would,
it seems to me, take a great risk of relying on cuts that
ultimately would not come, thereby putting our fiscal progress,
our debt reduction--which is so crucial to the maintenance of
prosperity--at substantial risk.
Within this restricted current services envelope, the
President's budget includes a number of initiatives: health
care initiatives to substantially expand coverage, education to
reduce class sizes to enable a million more children to
participate in HeadStart by 2002 and to repair the Nation's
classrooms, and law enforcement where among other things we are
proposing the largest ever expansion in our efforts to
prosecute firearms violations involving 300 more agents, 200
more inspectors, and 1,000 more prosecutors.
Let me finally highlight an area that I know is of great
concern to you, Mr. Chairman, and that is our international
engagement. At a moment of such economic strength for our
country, we must always remember that as Chairman Greenspan
once testified, we cannot forever be an oasis of prosperity in
a troubled world. That is why it is crucial that we find a way
to move together to support an open global trading system,
including the passage of the Permanent Normal Trading Relations
Bill that is essential for China's entry into the WTO, and the
African Growth and Opportunity Act and the Enhanced CBI.
In our judgment, it is also particularly important in this
year that we do our part to include support for the poorest
countries, including continued funding of the highly indebted
poor countries, and debt relief initiatives. I would highlight
something that is of particular concern to me. Our proposed
measures include a tax credit to accelerate development and
delivery of vaccines for infectious diseases such as AIDS,
malaria, and tuberculosis that kill more than a million people
each year.
To conclude, we are at a special moment in our national
economy. But above all, it is not a moment for complacency. We
cannot assume that without proper choices we will always enjoy
this good fortune. Indeed even with the proper choices, we may
not always enjoy this good fortune. That is why it is crucial
that we act responsibly this year to continue paying down debt,
prepare for the liabilities of an aging society, to prudently
assure that we can continue to fund core Government, and then
provide tax benefits to American families to meet some of their
most important needs. We can do all of that working together.
[The prepared statement follows.]
Statement of Hon. Lawrence H. Summers, Secretary, U.S. Department of
the Treasury
Mr. Chairman, Mr. Rangel, Members of the Committee, it is a
pleasure to speak with you today about the President's FY 2001
budget. Let me start by thanking this Committee for your hard
work in helping bring about the enviable position in which we
now find ourselves.
At the outset of this Administration, the President
established a three-pronged economic strategy based on strong
fiscal discipline, investing in people, and engaging in the
international economy. Partly as a consequence of that strategy
we have achieved the first back-to-back unified budget
surpluses in more than 40 years.
It is no coincidence that this month the US economy also
achieved the longest expansion on record. This historic
accomplishment is a tribute to the hard work and
entrepreneurial qualities of our workers, businesses and
farmers. But without the budget agreements of 1993 and 1997
between the President and Congress, the economic expansion
would not have been as impressive or as enduring.
Last year's surplus of $124 billion was the largest in our
history. Even using conservative assumptions, the budget will
move still further into the black this year. By the end of
September, we expect that Federal debt held by the public will
be $2.4 trillion less than was projected for that date in 1992.
This represents scarce national savings that have been freed up
for private sector investment in the productive economy: in
American businesses, workers and homes.
In 1992, the Federal budget posted a record deficit of $290
billion--almost 5 percent of our gross domestic product. Since
then we have achieved not only a unified budget surplus--
comprising both the operating budget and the Social Security
budget--but also a small surplus in our on-budget account. In
other words, for the first time since 1960, all of last year's
Social Security surplus was used to improve the government's
balance sheet.
This dramatic improvement in our fiscal situation reflects
some hard choices. Federal spending has fallen below 19 percent
of GDP, a sharp drop from the 22 percent level that prevailed
when the Administration came into office. And we have reduced
the Federal civilian payroll by more than one-sixth in that
period, a reduction of 377,000 full-time equivalent employees.
As a result of this discipline, we are now in a position to
eliminate the debt held by the public by 2013, on a net basis.
Paying down the remaining $3.6 trillion of Federal debt will
help to intensify the remarkably positive interaction that we
have witnessed between the budget and the economy over the last
several years, whereby what was once a vicious cycle of more
debt, higher interest rates, a weaker economy and still more
debt has been replaced with
A virtuous circle of declining debt, lower interest rates,
and a stronger economy, in turn producing still less debt,
further downward pressure on interest rates, and stronger
growth.
As a result, unemployment is at its lowest rate in 30
years, more than 20 million new jobs have been created,
productivity growth has increased even this far into the
expansion, home ownership rates are at an all-time high, and
real wages are rising across the board including for those at
the bottom of the income ladder.
At the same time, our fiscal position also provides us with
a rare opportunity to focus on crucial national priorities. Let
me set out the five basic objectives of this budget before
discussing each item in turn.
Reducing Federal debt to safeguard our economic
expansion.
Meeting the needs of an aging society by laying
the foundations for the secure retirement of the baby boom
generation.
Providing new incentives through the tax system to
strengthen our communities and encourage people to work and
save more.
Pursuing well-targeted initiatives that invest in
health, education and other national priorities.
Redoubling our commitment to opening markets and
sustaining American leadership in order to bolster
international economic opportunities for America and strengthen
our national security in an uncertain world.
OVERVIEW OF THE FY2001 BUDGET
I. Safeguarding Our Economy by Reducing Federal Debt
For decades, Treasury's discussions with its Borrowing
Advisory Committee centered on how we could finance growing
budget deficits and whether the market would have the capacity
to absorb the huge volumes of government debt that we needed to
sell. In this new era of rising projected budget surpluses, our
discussions now focus on how we can maintain liquidity in the
market while reducing the volume of debt outstanding.
According to OMB and Treasury projections, this challenge
will become even more apparent in the years ahead. Until now,
debt reduction has been accomplished solely by retiring
Treasury securities when they fall due. But from now on, we
will have another tool available to help us manage the process
of reducing the debt held by the public--namely, the ability to
buy debt back from the public that has not yet matured. Using
this tool, we can both reduce debt and bolster liquidity in our
key ``benchmark'' issues. In the April to June quarter of this
year, we expect that Treasury's net borrowing will result in a
record pay down of $152 billion worth of bonds. This puts us on
track to pay down more debt this year than in 1998 and 1999
combined.
As I have explained, under the President's proposals we
will eliminate the debt held by the public by 2013 on a net
basis. This will generate substantial further gains for the
American economy. Reducing Federal debt functions like a tax
cut in two respects. First, it removes the burden of interest
and principal payments from the American taxpayer. Second, it
maintains downward pressure on interest rates, and thereby
helps reduce payments on home mortgages, car loans and other
forms of consumer credit. We estimate that a 1 percentage point
reduction in interest rates results in roughly a $250 billion
reduction in mortgage interest expense over a decade.
Debt reduction also creates fiscal space, widening the
range of choices available to us, and giving us greater
capacity to respond to unforeseen problems. Today, the Federal
Government is spending more than $200 billion a year on
interest payments that would be eliminated under our proposals.
The President proposes that resources not paid in interest be
used to help ease the burden of the Social Security and
Medicare costs that will arise once the baby-boom generation
begins to retire.
II. Meeting the Needs of an Aging Society
As we create more fiscal space through continued fiscal
discipline, we face a fundamental choice about how best to
utilize that space. In this context, it is a vital objective of
this budget to improve our ability to shoulder this country's
obligations to its seniors.
Let me focus on two central elements: strengthening Social
Security and modernizing Medicare.
1. Extending the solvency of Social Security to 2050 and beyond
It is a central tenet of our strategy that we will use all
of the surpluses from Social Security to improve the
government's net financial position. Compared to an alternative
scenario, in which we merely balance the unified budget, the
President's framework generates an increasing amount of savings
on interest that would otherwise be paid to holders of the
debt. Beginning in 2011, we propose to transfer these interest
savings into the Social Security trust funds. These transfers
would extend the solvency of the trust funds until 2050.
At the core of the President's proposal is a high level of
fiscal discipline. In the Administration's framework, every
dollar added to the trust funds is ``backed'' by a dollar's
worth of pay down of the debt held by the public, and hence a
dollar's worth of contribution to national savings. These are
serious steps, and constitute important preparation for the
retirement of the baby boom generation.
In line with private sector practice, we also propose to
invest a sensible and measured proportion of the trust funds in
the equity market with the safeguard that such investment be
limited to 15 percent of the value of the trust funds. This
would further extend the solvency of the trust funds to 2054.
2. Modernizing Medicare
Since Medicare was launched 35 years ago, accessible and
affordable health care has dramatically improved the lives of
Americans over the age of 65. But there is now a very broad
consensus that it is time to reform Medicare to meet the
challenges of the new century.
By extending competition
The President put forward a detailed Medicare reform
proposal last year, and he remains committed to enacting
comprehensive reform in this Congress. A key element of this
proposal is the move to full price and quality competition
between traditional fee-for-service Medicare and managed-care
plans.
By letting consumers realize most of the cost savings from
choosing more efficient health plans, genuine competition will
give all health plans a strong incentive to deliver the most
value for money. At the same time, our proposal would ensure
that seniors who move to lower-cost plans do so out of choice
and not because of financial coercion. We look forward to
working with the Members of this Committee to achieve these
important objectives.
By providing coverage for prescription drugs
A second central element of Medicare reform is a voluntary
prescription drug benefit that is affordable to all Medicare
beneficiaries. Drug treatment has become an increasingly
important part of modern health care, and no one would design a
Medicare program today that excluded prescription drug
coverage. Yet, roughly 3 out of 5 Medicare beneficiaries do not
have dependable drug coverage today, and a majority of the
uninsured have incomes greater than 150 percent of poverty. The
Administration's proposal would provide a 50 percent subsidy
for all seniors who choose to purchase the new Medicare drug
benefit, with additional subsidies for lower-income seniors.
The budget also includes a reserve fund of $35 billion for 2006
through 2010 to be used to design protections for beneficiaries
with extremely high drug spending.
And by extending the solvency of Medicare
A third aspect of responsible Medicare reform is the
addition of new resources into the Hospital Trust Fund. In the
coming decades we expect to see a doubling in the number of
Medicare beneficiaries, and continued advances in the ability
of modern medicine to improve the length and quality of
seniors' lives. We cannot meet the rising future demands on
Medicare through our structural reforms alone. But by enacting
the combination of reforms and transfers in the President's
budget, the projected solvency of the Medicare program could be
extended to 2025.
III. Using Tax Cuts to Strengthen Our Communities
The President's budget creates room for prudent and
targeted tax cuts totaling $250 billion on a net basis over the
next decade and $350 billion on a gross basis. These tax
initiatives would advance a broad range of national priorities,
including: reducing poverty and stimulating the creation of
small businesses in our deprived communities; strengthening
incentives to work and to save; and making it easier for
families to care for chronically ill relatives. The proposals
would also close unfair tax loopholes and eliminate tax
shelters.
Let me highlight briefly some of the most important tax cut
proposals in the President's budget.
Retirement Savings
Almost one in five elderly Americans has no income other
than Social Security; two-thirds rely on Social Security for
half or more of their income. Half of all working Americans
have no pension coverage at all through their current job. It
is very clear that steps need to be taken to help Americans
take greater responsibility for their own financial security in
retirement, and new incentives should be targeted to moderate
and lower-income working families.
The President proposes to address this situation by
creating a new, broad-based savings account, Retirement Savings
Accounts. These accounts would give 76 million lower-and
middle-income Americans the opportunity to build wealth and
save for their retirement.
Under our plan, individuals could choose whether to
participate, on a strictly voluntary basis, either through a
retirement plan sponsored by their employer, or through a
special stand-alone account at a financial institution. The
employer or the financial institution would match each
individual's contribution and then recover the cost of the
match from the Federal government in the form of a tax credit.
Individuals could contribute up to $1,000 per year. Low-
income individuals would qualify for a two-for-one match on the
first $100 contributed, and a dollar-for-dollar match on
additional contributions. Higher income participants could
qualify for a 20-percent match, in addition to the tax
incentives that apply to pension or IRA contributions. A person
who participated in this savings program for his or her entire
career could accumulate well over two hundred thousand dollars
for his or her retirement.
In addition, the President proposes to make small employers
eligible for new tax credits to help them set up or improve
their retirement plans. Related proposals include measures to
increase pension security and portability, and to improve
disclosure to workers. Overall, the cost of these initiatives
to expand retirement savings would total $77 billion over ten
years.
Helping Working Families
The Earned Income Tax Credit has proved one of the most
effective means of rewarding work and lifting people out of
poverty. In 1998 alone, the EITC raised the income of 4.3
million working people above the poverty level. But many
families still remain in poverty. The President proposes to
help more families work their way out of poverty by increasing
the Earned Income Tax Credit for the larger families that are
most apt to be poor and relieving the marriage penalty under
the EITC. The increases in the EITC would total $24 billion
over the next ten years.
Under the budget plan we would also reduce the marriage tax
penalty, strengthen work incentives, and cut taxes for the 70
percent of families who claim the standard deduction. To
address the marriage penalty in a targeted way, the President
proposes to make the standard deduction for two-earner married
couples twice the standard deduction for singles. In 2005, when
it is fully phased in, this proposal would raise the standard
deduction for two-earner married couples by $2,150. Starting in
2005, the proposal would also simplify and reduce taxes for
middle income taxpayers by increasing the standard deduction
for single-earner married couples by $500 and for singles by
$250. The proposal would make the child and dependent care tax
credit refundable and raise the maximum credit rate to 50
percent.
Revitalizing our Communities.
By expanding the New Markets tax credit the budget would
help spur $15 billion in new investment for businesses in inner
cities and poor rural areas. The budget also proposes to extend
and expand incentives for businesses to invest in empowerment
zones.
Health
Last year the President proposed a tax credit that
compensated families for the cost of looking after chronically
ill relatives. But at $1,000, the credit was insufficient
compensation for the rising burden that these families face.
The President's FY2001 proposal triples the credit to $3,000.
We also propose to provide tax credits for workers between jobs
who purchase COBRA coverage from their old employers.
Education
The budget proposes to save taxpayers $30 billion over ten
years through the College Opportunity Tax Cut. When fully
phased in, this new tax incentive would give families the
option of taking a tax deduction or claiming a 28 percent
credit for up to $10,000 of higher education costs. This would
provide up to $2,800 in tax relief to millions of families who
are now struggling to afford the costs of post-secondary
education. We also put forward a tax credit to help state and
local governments build and renovate their schools.
Tax Simplification and Fairness
Although the Alternative Minimum Tax was originally
intended to ensure that high-income taxpayers could not use tax
breaks to avoid income tax altogether, we recognize that it is
increasingly eating into the take-home pay of middle-income
taxpayers, especially those with large families. We propose to
redress this problem by allowing taxpayers to deduct all of
their exemptions for dependents against AMT. By 2010 when it is
fully phased-in, this change would halve the number of
taxpayers affected by the AMT.
Corporate Shelters and Tax Havens
The proliferation of corporate tax shelters presents a
growing and unacceptable level of abusive tax avoidance that
reduces government receipts and consequently raises the tax
burden on compliant taxpayers. Corporate tax shelters breed
disrespect for the tax system--both by those who participate in
the tax shelter market and by those who perceive unfairness. A
perception that well-advised corporations can and do avoid
their legal tax liabilities by engaging in these tax-engineered
transactions may cause a ``race to the bottom.''
The President's FY 2001 Budget again contains a
comprehensive approach to addressing this problem. This
approach is intended to change the dynamics on both the supply
and demand side of this ``market,'' making it a less attractive
one for all participants--``merchants'' of abusive tax
shelters, their customers, and those who facilitate these tax-
engineered transactions. The main elements of the legislation
include: requirements aimed at substantially improving the
disclosure of corporate tax shelter activities; provisions to
raise the penalty where there is substantial understatement of
tax owed; and the codification of the economic substance
doctrine. Enactment of corporate tax shelter legislation,
combined with the efforts of the restructured IRS, will go a
long way towards deterring abusive transactions before they
occur, and uncover and stop these transactions when they do
take place.
Another area that raises similar concerns is the growing
use of tax havens. These jurisdictions, through strict bank
secrecy and other means, facilitate tax avoidance and evasion.
Curbing this harmful tax competition should help businesses to
compete on a level playing field and encourage investment
growth and jobs. Our budget includes several provisions
intended to reduce the attractiveness of tax havens and to
increase access to information about activities in tax havens.
Other Provisions
There are a number of other important proposals that I
would like to mention. These include: incentives to increase
philanthropic donations; tax credits aimed at bridging the
``digital divide'' by encouraging investment in technology in
deprived communities, and measures to help reduce pollution and
emissions of greenhouse gases.
IV. Investing in Health, Education and Other National Priorities
The spending proposals in the President's budget are based
on two fundamental principles.
The first principle is that we use realistic projections of
the level of spending needed to maintain core government
functions. To meet this requirement, we begin with a ``current
services'' baseline under which discretionary spending is held
constant on an inflation-adjusted basis.
Our budget policy would maintain defense spending at this
baseline and reduce non-defense discretionary spending slightly
below it, meaning that existing domestic programs would need to
be trimmed by more than enough to finance new initiatives. In
1999, non-defense discretionary spending was a smaller share of
GDP than at any point in at least 40 years; under our policy,
it would represent a yet smaller share over the coming decade.
Moreover, total outlays as a proportion of GDP would decline in
2001 and they would continue to decline on this basis for the
rest of the decade.
The second fundamental principle of the President's
spending proposals is to focus on critical national priorities,
including health care, education, law enforcement, and
technology. By focusing our initiatives in these and other key
areas, we can meet people's needs in a fiscally disciplined
way.
Let me briefly summarize our proposals in these four areas.
Health Care
The President has proposed a bold initiative to reverse the
disturbing increase in the number of Americans without health
insurance. Through the combination of targeted spending
proposals and tax incentives, we can expand health coverage to
millions of uninsured Americans.
A central part of this initiative is an expansion of the
State Children's Health Insurance Program, known as S-CHIP,
which was introduced two years ago with broad bipartisan
support. In the FY2001 budget we would build on the success of
this program by extending it to cover the parents of eligible
children, most of whom are uninsured. Another important element
of this initiative is providing a Medicare buy-in option for
people close to the Medicare eligibility age. This year, to
make this option more affordable, our budget includes a tax
credit to offset some of the premium.
Education
Education is another key priority in the President's
budget, as has been true since the beginning of this
Administration. For next year we are proposing an additional $1
billion for the Head Start program and almost $150 million for
Early Head Start, which would put us within reach of serving
one million children by 2002. We are also proposing sufficient
funding to take us almost halfway to the President's goal of
hiring 100,000 new teachers in order to reduce class sizes.
Law Enforcement
Turning to law enforcement, the budget includes significant
new resources to enforce our nation's gun laws. Last Friday we
released a report from the Bureau of Alcohol, Tobacco and
Firearms showing that 1 percent of gun dealers account for well
over half of all crime guns traced last year. The information
from gun tracing will help us target our enforcement efforts,
but we also need more agents and inspectors at the ATF and more
prosecutors -and our budget will provide them.
At the same time we are requesting funds that would pay for
recruiting and training of 50,000 new police officers, and
funds that would strengthen the National Money Laundering
Strategy. Money laundering is a growing international problem,
and we need this budget allocation to strengthen U.S.
leadership in fighting this problem.
Technology and the Environment
Another important national priority must be investment in
the science and technology that will spur economic growth and
improve people's lives in the 21st century. The President's
budget includes a nearly $3 billion increase in crucial
investments, including a $1 billion increase in funding for
biomedical research for the National Institutes of Health and a
rise in funding for the National Science Foundation that is
double the previous largest increase. These investments will
enable Americans to continue to lead the world in many areas of
science and technology, including biomedical research, nano-
technology, and clean energy.
The budget also contains $42 billion for high-priority
environmental and natural resource programs, an increase of $4
billion over last year's enacted level. This includes $1.4
billion in discretionary funding for the Land's Legacy
initiative to expand and protect our open spaces, an additional
$1.3 billion to support farm conservation, and an additional
$770 million to help combat global climate change.
V. American Leadership in the World
As we enter this new century, it is crucial that we
continue to learn the lessons of the last one by working to
build an ever-widening circle of more prosperous and more open
international economies. This enables us to enjoy the benefits
of peace and the spread of our core values. And we benefit more
directly in the millions of high-paying jobs that exports
create and the competition and innovation that openness to
imports can promote. In short, globalization is not a zero sum
game but a ``win-win proposition'' for America and its trading
partners.
Let me outline several areas where we can strengthen this
process while also enhancing our national security.
China
One of the President's top priorities this year is to seek
Congressional approval for the agreement we negotiated to bring
China into the World Trade Organization, by passing Permanent
Normal Trading Relations with China as soon as possible. I
firmly believe that China's entry into the WTO, under the terms
of the trade agreement that we reached last November, is in our
economic and national security interest.
First, this is a good deal for American workers,
farmers and businesses since the concessions all run one way,
in our favor.
Second, by integrating China into the rules-based
world trading system, we will help promote reform within China
and reduce the security threat that an isolated China can pose
to America and the rest of the world.
Mr. Chairman, we will need your support to prevail, and
look forward to working with you on this issue in the weeks and
months ahead. We also look forward to working with you to
implement the Caribbean Basin, African Trade, and Balkans Trade
Initiatives.
Multilateral Development Banks
Obtaining adequate funding for U.S. participation in the
MDBs remains a Treasury priority. Every dollar we contribute to
the multilateral development banks leverages more than $45 in
official lending to countries where more than three-quarters of
the world's people live. These programs are the most effective
tools we have for investing in the markets of tomorrow. This
budget's request for $1.35 billion is $40 million less than we
requested last year, yet it would fully cover our annual
obligations to the MDBs as well as paying down some of our
arrears to a global system that we were instrumental in
creating.
Highly Indebted Poor Countries Initiative
I would like to thank Congress for your efforts in the
FY2000 budget to provide broader, deeper and faster debt relief
to the world's poorest and most heavily indebted nations. As a
result, progress has been made. Writing off debts owed by
countries that will never be able to repay them is sound
financial accounting. It is also a moral imperative at a time
when a new generation of African leaders is trying to open up
their economies.
The President is asking for an additional $210 million this
year and $600 million over the next three years to support
multilateral and bilateral debt relief for countries under the
Highly Indebted Poor Countries initiative. In doing so he is
asking Congress to finish the enormously important work we
began last fall.
Vaccines
The budget also contains requests that would help fulfill
the President's Millennium Initiative for vaccines. By
allocating $50 million to the Global Alliance for Vaccines and
Immunization, we could save many children's lives and at the
same time help protect the health of American citizens. The
President has also proposed a new tax credit that would help
stimulate development of vaccines for malaria, HIV-AIDS and
tuberculosis.
VI. Concluding Remarks
I began my remarks today by focusing on the link between
fiscal discipline and the performance of our economy over the
last seven years. Having worked hard to help bring us to the
remarkable economic moment that we are now enjoying, the
Members of this Committee know well the value to our economy
and our country of further paying down the national debt held
by the public. If we can act to reduce the debts we bequeath to
our children, while continuing to fund our obligations to
seniors and pursuing the vital purpose of making the economy
work for all our people and communities, then we can maximize
the extraordinary opportunities with which we are now
presented. I look forward to working together with this
Committee and others in Congress to turn these high-class
challenges into even higher-class solutions. Thank you. I would
now be happy to respond to any questions that you might have.
Chairman Archer. Mr. Secretary, thank you for your succinct
presentation.
Does Ms. Matthews wish to make a statement?
Ms. Matthews. No, thank you, Mr. Chairman.
Chairman Archer. We are happy to have you with us.
This problem that you mentioned toward the end of your
presentation is a very serious one. If FSC, which is one of our
few tools to help exports, is negated by the Europeans, then it
will fall very heavily on the good jobs that have been created
for exports. I am glad you mentioned it, because we need to
work together in every possible way to find some relief from
this.
I am constrained to say that there is one easy answer, and
that is to abolish the income tax and go to a consumption tax.
I wish that I could have intrigued the President to join me in
pushing for that, but apparently that will be for a later day.
That in one fell swoop would take care of the problem, not only
the disadvantage, but give us a fair advantage under the world
trading rules.
I think ultimately we must come to it, because otherwise we
are going to see--as we heard testimony from witnesses last
year--more and more American corporations being merged to
become foreign corporations. We saw it with Chrysler. Our tax
code single-handedly forced Chrysler to become a German
corporation at the end of the merger. That testimony is in the
record from a Chrysler executive.
Bankers Trust is now Deutsche Bank because of our tax code.
Amoco is now BP because of our tax code. And we will see more
and more and more of that if we do not get serious about
eliminating the massive negative impact of the way that we tax
foreign source income. This FSC part is only one small part of
that entire problem. I will work very, very aggressively with
you in trying to find an answer to it.
Mr. Secretary, there are so many things that I would like
to ask about. I am going to limit it to a couple and then the
other members, of course, will want to have their turn in the
questioning.
You provide significant increases in spending, but you do
not talk about how we can eliminate wasteful spending. We just
found out that the Defense Department's records are so bad that
we cannot even have an audit to determine missing billions of
dollars. The same is true of the Department of Education where
billions of dollars have been unlocated.
It seems to me that we should start talking about
eliminating wasteful spending before we start talking about
increases in spending.
Let me go on to the debt. I am looking at the figures in
your budget relative to the aggregate debt of this country. If
I read them correctly, they go up every year from 2000 through
2013, necessitating an increase in the debt ceiling. Yet you
say that you are going to pay off the debt. Obviously, you are
not paying off the debt if we have to have an increase in the
debt ceiling. It is almost like a shell game. You are
transferring debt being held from one group to that being held
for another group, but the aggregate is going up. And, that is
still money that future taxpayers are going to have to pay off.
Those debt service charges continue to go up. They are going to
have to be paid.
I think we ought to be very forthright with the American
people, both the Republicans and Democrats because we both get
involved in this. Neither party is not paying off the debt. The
debt is going up. And debt service charges, depending on what
interest rates are, are going up, too. That is a very serious
factor for this country.
Then finally I would ask you to comment on why you believe
that you need to have $14 billion of extra revenue coming into
the Federal Government at a time when the tax take is the
highest in peacetime. Your budget, integrating all the revenue
items and all the tax reduction items, is a net $14 billion by
your numbers. It may be different by CBO and Joint Committee--
we haven't had time to get those numbers yet. But by your
numbers, it is an increase of $14 billion that will be taken
into the Federal Treasury on a net basis.
For the life of me, I cannot understand why the
productivity and the people of this country are going to have
to put more money into the Treasury at a time when revenues are
skyrocketing. I would be happy to have your comments on that.
Mr. Summers. Mr. Chairman, I am glad you have given me the
opportunity to address three important issues.
First, with respect to Government waste, we have over the
years taken management to the Government very seriously. That
is why the civilian labor force in the Government is one-sixth
smaller than it was in 1993. Treasury, for example, has reduced
its work force by 10 percent, even though there are a lot more
tax returns and a lot more people crossing the border than
there were. We think that represents real progress, although
there is a lot more to do.
You are absolutely right in raising the concern about funds
that cannot be fully accounted for. When these programs began
taking on the task for the first time of accounting for all
Federal assets as a result of legislation we worked together
with Congress on in the mid-1990s, there was far more in the
way of unaccounted for assets. Year after year we have improved
the quality of financial controls. That is a crucial task for
us all to continue.
But let's recognize that we are making progress in
improving our financial control. We are making progress in
shrinking Government. We are making progress in shrinking
civilian Government for the first time in a very, very long
time.
Chairman Archer. Mr. Secretary, very quickly--yes, so much
more to do and so little time.
Mr. Summers. There is a great deal to do. The establishment
of a fully satisfactory set of controls is not something that
is going to happen this year. It may not be something that
happens in the next several years. But we are getting much
better controls on these expenditures, and we are doing much
more with much less for the first time in a long time.
With respect to the debt, it is the convention of
economists, of financial analysts--almost all experts that look
at these issues--to focus on the issue of publicly-held debt.
They focus on the publicly-held debt because that represents
the obligation of the Government to its citizens and to net out
the intra-governmental debt much as in looking at the financial
position of my family, one would net out any debt obligation
between me and my wife. It was the publicly-held debt figures
to which I was speaking. It is that which reflects pressure on
credit markets and the unified deficit. I would argue very
strongly that experts of both parties would agree that it is
the publicly-held debt and the net interest flow of the Federal
Government that is relevant for analyzing the Government's
fiscal position.
The third issue is an important one, and that is the
question with respect to the gross versus the net tax cut. As I
indicated, the President's budget has $350 billion in gross tax
cuts. It has $100 billion in tax offsets, such as the tax on
corporate shelters that I referred to in my testimony.
It also includes a number of other measures that generate
revenues for the Federal Government. Some of those are measures
such as user fees, which do generate receipts but which we do
not think of as a tax. A large part of those represent tobacco
policy, which we feel is the best way of stopping a fraction of
the 3,000 kids who start to smoke each day, a thousand of whom
will die, from starting to smoke. We think that is an
appropriate public health investment in our country's future.
It is a judgment on which one can disagree, but the motivation
for it is very clearly not generation of revenue, it is the
protection of the public health.
Chairman Archer. Mr. Secretary, again I compliment you on
the succinctness of your responses, which the committee
appreciates.
A tax is a tax is a tax. A tax on cigarettes means that
those people who use cigarettes are going to have less money to
spend on other things. It is highly aggressive. It hits very,
very hard the lowest income people. It has not been proved to
be a deterrent, but it is a tax and it is raising more money
out of the economy.
User fees--and you tried to reclassify certain things from
a tax to a user fee--but a user fee technically is only
something which is voluntary. If you want to use a service,
then you pay a fee. That is the technical definition of whether
it is a fee or a tax. I would say that what you are calling
fees will not pass muster in most cases under that definition.
But in any event, you are raising--by your own figures--$14
billion more out of the economy net than is currently being
raised today, at a time when revenues are burgeoning already.
We just have a disagreement about whether that is an
appropriate thing to do.
Mr. Summers. I think we may.
Let me just emphasize that a large share of the tobacco
policy represents a penalty on tobacco companies if they are
not sufficiently successful in reducing the incidence of youth
smoking. So it seems to me that a fine for failing to achieve a
public health objective as a policy--one could argue both
sides--it does not seem to me best to think of it as a tax.
And of course, nobody has to pay any of this who chooses
not to smoke. So by your voluntary criterion--which I am not
sure I would agree with--but by that criterion, one could
distinguish the tax.
I would like to bring up one other point. It is sometimes
suggested that taxes are at some kind of high level at this
point. I would hasten to observe that if you look at the tax
burden on a family with half the median income, the median
income, or twice the median income, it is lower than it has
been at any time in the last two decades. It is true that taxes
relative to GNP are at a high level. That is a reflection of
two things. It is a reflection of the fact that income is at a
high level relative to GNP because of the strength of the stock
market and all of that, and it is a reflection of the fact
that--something we are working to try to address--the income
gains over the last two decades have gone heavily to those who
are in higher tax brackets and heavily in the form of profits
that are particularly heavily taxed.
Those two considerations account for the tax to GNP ratio
having risen. But I think we do need to be clear to anyone who
is listening to this hearing that if you measure the tax burden
on a family with the given median income, that tax burden at
the Federal level for either income taxes or income plus
payroll taxes has fallen over the last two decades.
Chairman Archer. No matter how you spin it, Mr. Secretary,
the take out of our economy is at the highest percentage of GDP
than at any time in peacetime history. that money is coming out
of the productive private sector into the Government. And the
danger is that will perhaps be a magnet to pull up the total
spending level which may become entrenched at the highest level
of GDP in history and which then would be difficult to maintain
if you have a change in the economy.
I would love to discuss this more with you. You are the
economist and I am not.
Mr. Rangel?
Mr. Rangel. Thank you, Mr. Chairman.
I find intriguing that the cigarette tax is not a tax but a
penalty because I have been wrestling with the Republican
marriage penalty tax relief. They are giving the relief to
people who have no penalty and indeed have a bonus. So it would
be good if we could have a course between the White House and
the Congress in what worries me.
But I like the word penalty instead of taxes. [Laughter.]
Mr. Rangel. Let's see what we are up against.
When the President met with the congressional leaders, were
you present?
Mr. Summers. Yes.
Mr. Rangel. It has not been shared with us in the minority,
but do you have some guideline as to where the Republican
leadership is taking us with the tax bill?
Mr. Summers. I think it is best to let the Republican
leadership state their own intentions. I would rather not be
put in a position of trying to characterize or predict their
judgments. I am happy to speak for the Administration.
Mr. Rangel. Was this a secret meeting you had? This was a
meeting to determine if we could cooperate--I thought--between
the Congress and the Executive Branch. I assume they wanted to
work with the President.
Mr. Summers. I think there is a sense that we would like to
work together. We in the Administration would certainly like
very much to work together with the Congress, both houses and
both parties, to try to accomplish the key things I have been
talking about: paying down the debt, helping health, helping--
Mr. Rangel. No, it is clear where the Administration is
coming from. But we do not have a budget from the Republicans,
so we do not have a blueprint to work with. I assume that
nothing was given to you to share with us.
Social Security--we don't have a bill in the House. Was
that discussed with the President to see whether we could work
together on that? It doesn't bother me that they don't talk
with me, but did they talk with the President about a bill on
Social Security?
Mr. Summers. Certainly there is no specific private
proposal of which I am aware.
Mr. Rangel. I would hate to see this year go by without us
really dealing with the question of education initiatives. It
is so important that our country be prepared to keep up with
the advancements in technology. I know many of my Republican
friends would want to support some initiatives there.
Certainly the earned income tax credit provisions is just
the equitable thing to do with so many people becoming
instantly wealthy. This would give an opportunity to pull hard-
working people out of poverty.
The Speaker has said that he shares the new market
initiatives working with the private sector. Have people talked
with you about how we have to work this thing together,
especially the tax portion of it?
Mr. Summers. My hope would be, Mr. Rangel, that coming out
of this hearing we could move toward trying to establish a
framework for the budget this year into which some of the
crucial tax components could fit. In addition to the earned
income tax credit, school construction, and the digital divide
you have mentioned, I would highlight the alternative minimum
tax and the retirement savings questions as areas where I very
much hope that we can work together.
Mr. Rangel. It is clear that many objections are going to
be raised from the points of view of you, the President, and
the Administration. I am trying desperately to find out if you
got a sense of any areas in which the majority can work in
positive ways with the President, or are we just talking about
your hopes and the President's hopes?
Mr. Summers. I think it is best for me not to hold myself
out as a spokesman for the majority, Congressman Rangel.
Certainly I think we have all seen and welcomed statements
indicating a desire--such as the one the chairman expressed
today--to work together on a range of issues. My hope would be
that this would prove to be possible.
Mr. Rangel. Now that you have all these hopes on the table,
there is a bill coming to the Floor tomorrow, a marriage tax
penalty bill.
Did the Republicans discuss this with the President? It was
included in his State of the Union, and while it is a
dramatically different approach, did they reach out to you to
try to work something out on this issue?
Mr. Summers. No, I have communicated my view in a letter to
both you and Chairman Archer with respect to that proposal.
Mr. Rangel. What is your view in respect to this proposal?
Mr. Summers. I have written indicating that the President
believes that it is important to address marriage penalty
issues, but it should done in the right way, in the right
framework, at the right time and expressing the judgment that I
and the President's other senior advisors would not be able to
recommend that he sign the current legislation because of an
absence of an overall framework for a tax cut of this
magnitude.
Mr. Rangel. I have been used as an interpreter for White
House language, and I have been telling my friends that you not
recommending that the President sign means veto, but I
understand that you cannot say that.
If you are going to veto the bill, and they are still going
to push the bill, then it seems to me that your hopes for
cooperation in taxes are not well founded.
Mr. Summers. I am an optimist. I think there are real
opportunities this year. It seems to me that there is a great
deal of consensus on the idea of paying down debt. I have been
encouraged by the number of people who have shared the view
that we need to provide that prescription drug benefit, by a
number of people who recognize that choice in Medicare is
possible without financial coercion, and who see that really in
the tax area the priority is helping middle class families at
crucial points in their lives and particularly helping those
who have been left behind. I think there are an increasing
number of voices who are recognizing that.
My hope would be that it would be possible to work together
to do things that will strengthen our national economy because
it won't always be this strong. This is a moment when we have a
real opportunity to work together.
Mr. Rangel. Your inspiring presentation has given me now
hope. So I am going to hope that the majority would put the
Archer-Shaw Social Security concept into some type of
legislative language so that we could get the Administration to
look at it. I am going to hope that the death penalty
provisions and the tax cuts that have been placed on the
patient bill of rights and that the Republican retirement
savings incentives and the tax cuts that are on the minimum
wage bill and the exciting education saving accounts and the
community renewal and the repeal of the Social Security earning
test--I am only up to $1.4 trillion, but this is still part of
an overall concept the Republicans have put together in small
parts.
We only have the first slice of this trillion dollar
package for tomorrow. But if you have hope, I am going to have
hope that one day the majority would come to us with the rest
of these very important issues to see whether we can work
together with you and the President. But if that doesn't
happen, you might want to pick out the most important things,
like the vaccine and the trade bills, and then maybe we will
operate on plan two.
But I am going to have hope, too.
Mr. Chairman, I hope you were nearly as inspired as I was
by the Secretary's eternal desire and hope that you and I work
more closely together.
Chairman Archer. I am always inspired by your comments, Mr.
Rangel. [Laughter.]
Chairman Archer. Mr. Crane?
Mr. Crane. Fist I would like to remind Mr. Rangel that
Congress makes policy. The function of the White House is to
administer policy.
Let me touch on one other thing that is a major concern
because it can have a profound impact on our ability to remain
competitive in world markets.
Our chairman talked about how his consumption tax would
eliminate that disadvantage that potentially we are confronted
with. I pushed for a flat tax for 30 years that would eliminate
any tax on business whatsoever on the grounds that they don't
pay taxes in the first place. That is a cost like plant,
equipment, and labor. You have to pass them through and get a
fair return. Either one of those approaches would eliminate
that problem that we are facing.
One other issue you touched on, Mr. Secretary, is the
tobacco tax. Are we contemplating taxing sugar, too?
Mr. Summers. I am not aware of any proposals the President
has put forward.
Mr. Crane. Because excessive consumption of sugar puts on
all that fat, and that is injurious to your health. Shouldn't
we punish people for going down that path?
Mr. Summers. That is not something--let me emphasize the
thrust of the President's policy in the tobacco area. It is
focused on kids. It is focused on people below what we normally
take to be the age of consent, who become addicted before
reaching the age of 18. I don't remember the precise figure,
but it is something like three-fourths of smokers have become
addicted before the age of 18.
So it becomes a rather different kind of context than a
number of other issues.
Mr. Crane. If you will yield, Mr. Secretary, putting that
huge tax on a pack of cigarettes--that is going to discourage
that teenage from going to the market because he can't lay his
hands on all that money. Is that it?
Mr. Summers. Let me just say that there is an extensive
body of evidence that on another occasion, if the committee is
prepared to take this issue up seriously I would be pleased to
come present to the committee documenting the price
responsiveness of cigarette demand, particularly among young
people to the level of prices. That evidence comes from cross-
State comparisons. That evidence comes from inter-temporal
comparisons. That evidence comes from international
comparisons. It is corroborated by the work of Nobel Prize
winners like Gary Becker.
There are a number of aspects to the tobacco question that
one can debate, but the proposition of price elasticity in
response to the tax I think is one of the better established
facts in empirical microeconomics.
Mr. Crane. I hope it doesn't encourage any young kid who
has a breakdown in terms of moral standards to engage in
increased theft and stealing to finance that bad habit.
Now let me turn to another subject that is of major concern
to me, and it has to do with trade. Given the failed outcome at
Seattle, how have our objectives changed for achieving further
trade liberalization, and what is the Administration's strategy
for achieving those objectives?
Mr. Summers. Congressman Crane, we are engaged in quite
active consultation with a number of countries around the world
to try to establish a basis for consensus that would allow a
new round of WTO to move forward. Crucial issues include
agriculture, the treatment of services, the definition of what
kind of rules will apply to investment--if that is going to be
a subject that is going to be treated--and of course, what
kinds of discussions are going to take place with respect to
issues of environment and labor.
The President spoke in considerable detail to the U.S.
position in his address in Davos and made what I think is the
central point, which is that there is no alternative to a free
trade open market approach, but that for such an approach to be
sustainable and successful, it is essential that it be
complimented by efforts to address the other consequences of
global integration. Much has taken place as interstate commerce
increased in the United States in the first part of this
century.
I would say that in terms of starting the round, in terms
of moving ahead with trade, the most important decision that
will be made in the United States will be the decision as to
whether Congress gives impetus to the global trading system by
passing China's entry into the WTO and by passing the Africa
and CBI initiatives. My hope would be that it would be possible
for us to give in to that system through those two pieces of
legislation.
Mr. Crane. I have one quick question. Many foreign
delegations and others expressed concern over the President's
remarks regarding labor standards and trade sanctions in
Seattle. With those comments still echoing in the minds of
delegates, how can we take the next steps to create an
atmosphere of cooperation?
Mr. Summers. We have been speaking to countries all over
the world. I had a chance to discuss these questions on my
visit to India and Indonesia. I think there is an increasing
recognition that it is absolutely unacceptable for labor and
environment to be used as cloaks for protection. But at the
same time, if we are all coming together in a smaller world, we
have to find approaches to address what everyone agrees is a
real problem.
Children who are working in mills rather than being in
schools, and environmental problems that cross international
borders--we are going to have to work to find a formula. I
think there is now considerable agreement on ends, and the
question and issue really goes to means.
Chairman Archer. The gentleman's time has expired.
Mr. Thomas?
Mr. Thomas. Thank you, Mr. Chairman.
Welcome, Mr. Secretary.
I was pleased to see in the written testimony you provided,
on pages four and five, that you focused on modernizing
Medicare. However, in the first paragraph you say, ``But there
is now a very broad consensus that it is time to reform
Medicare.'' So my assumption is that modernizing is also
reform. I would not want to get into a semantic squabble about
what is going on.
I am also pleased because in that first paragraph, in
talking about the President's interest in extending
competition--that was one of the core interests of the Medicare
Commission--I was pleased that the President chose you and your
Department to put together a competitive market structure for
future service.
I think the majority is ready to sit down and talk about
competitive models both for fee for service and for managed
care. Some of the President's proposals we think are forward-
looking and positive. Obviously there are some items that have
been presented to both Democratic and Republican Congresses and
simply have not been accepted. But the core of working together
is there.
Should I read anything at all into the fact that the White
House chose the Treasury Department to put together a
competitive model on Medicare rather than using the Health Care
Finance Administration, which is currently charged with the
responsibility of running the old-fashioned structure of
Medicare?
Mr. Summers. Let me just say, Congressman Thomas, that I
appreciate the kind words about the Treasury Department, but I
would hasten to point out--as is the case with virtually all of
the proposals that the Administration puts forward that reflect
the hard work of an interagency process overseen by a
principle--
Mr. Thomas. I understand that, but I have a short period of
time, and my question would be: Was there any discussion, or
are you at liberty to be able to tell us?
In looking at the models the Treasury Department put
together, from my perspective it was not inconceivable that you
could have simply then added a little frosting on top of that
nice cake you baked for competition saying we should use a new
entity to oversee the competitive model.
We, of course, on the Commission would have called it the
Medicare Board. You can call it anything you want as long as
Treasury is the one that proposes the structure.
Is that an area you think we could work toward modernizing
and reforming Medicare?
Mr. Summers. The Administration has real concerns about
making sure that there is full political accountability with
respect to any mechanism that is established for overseeing
competition. But we very much want to be in discussion with the
Congress to find the right approach to choice.
Mr. Thomas. I appreciate that.
So if I have the Thesaurus that the gentleman from New York
has where you won't say ``veto'', you didn't say ``no''. So my
assumption is that is an area in which we can work, and I
appreciate that response.
One of the concerns in terms of reform in the next
paragraph on prescription drugs--it is still a kind of stand-
alone proposal which isn't integrated. Frankly, prescription
drugs as part of the tool chest for medicine today really does
tend to integrate the use of drugs with other more traditional
medical practices. I would hope that we have the ability to
move forward on looking at perhaps an integrated prescription
drug program along with more traditional Medicare.
I also noticed that the President changed the proposal from
last year because I know there was major criticism along the
fact that it wasn't a very good structure you proposed because
you had to have a certain level to get your money back at the
front end, and then at the $2,000.00 amount people were paying
100 cents on the dollar. I wish I could have seen some
structure to this $35 billion proposal, but I assume that is
going to come out.
Last question. I assume you folks did not recommend a veto
to the about $16 billion adjustment to Medicare called the
Balanced Budget Refinement Act. The President signed the bill.
So my assumption was that where we placed the money--especially
for hospitals, outpatient, for skilled nursing facilities, and
for home health care--that all of us were concerned that
seniors were going to be denied services because the original
package in 1997 did not have as finely crafted tools that we
would have liked to adjust the marketplace.
CBO is now telling us--and I am anxious to see what OMB's
numbers are--that from just the last baseline estimate to
today's revision we are going to be getting about $62 billion
over five years of ongoing Medicare savings. In light of those
numbers, why would the Administration recommend cutting
Medicare by an additional $70 billion over 10 years when you
just voted last year to put $16 billion back in?
Mr. Summers. Congressman Thomas, we will be getting new
information on the long-run baseline when the actuaries prepare
their report on Medicare in April or May. The Administration
certainly did hear the same voices the Congress heard in
passing the Balanced Budget Refinement Act last year. Our
proposals do contemplate certain economies that we believe are
still possible within the Medicare program, but does so in a
rather more limited--
Mr. Thomas. I am sorry. Did I read the budget wrong? There
isn't $70 billion of reduced payments which are extenders for
the BBA? Did the budget not contain that?
Mr. Summers. I indicated that it does, but I indicated that
those proposals were scaled back from the proposals that had
been contained in last year's budget and--
Mr. Thomas. So instead of $109 billion in cuts, you scaled
them back to $70 billion in cuts. That still doesn't answer the
question of why you voted to put money in last year and you are
still on a track of--albeit reduced cuts--$70 billion over 10
years of cutting back on Medicare when we are trying to get it
right.
I guess my response to you would be, I would love to sit
down and work on the competitive model. I think we can save
some money over projection and that we ought to take any
surplus that we are now getting from Medicare and reinvest it
so that we can create a better Medicare, but not go back to the
old-fashioned cutting of Medicare, which to a very great extent
is what the President's program offers. If we can make savings,
then we don't have to make that massive transfer in the
President's program to argue that we can get to 2025. We know
we are going to make it to the teens, and there can be some
mid-course corrections so that if Medicare is saving money, we
can reinvest it to build a better Medicare, include
prescription drugs, and more importantly take care of low-
income seniors.
I really don't understand why the President offered $70
billion of Medicare cuts over 10 years.
Mr. Summers. Could I turn that to Ms. Mathews?
Chairman Archer. Ms. Mathews, as quickly as possible,
please. The gentleman has exceeded his time.
Ms. Mathews. I will be brief.
Our proposals get back to something the chairman raised in
his first presentation about waste, fraud, and abuse and
assuring that we make appropriate payments. We believe that the
proposals this year are not extenders as we did last year,
simply taking a policy and extending it, but instead we are
looking at areas such as competition and other places where we
believe there are inappropriate or double payments or those
sorts of things.
Mr. Thomas. So last year you were cutting back on potential
benefits, this year you have tweaked it a little bit and the
$70 billion in reductions are not in fact squeezing Medicare
under extenders? You are saying that there are no BBA extender
positions in the President's budget?
Ms. Mathews. In the policy last year--
Mr. Thomas. The question was, Are there no Medicare
extenders in the President's budget which would cut Medicare?
Ms. Mathews. In the President's budget there are some of
the things that were included in last year's package.
Mr. Thomas. And that is why this year's is less than last
year's because you are simply cutting from the $100 billion
plus to the $70 billion?
Chairman Archer. The chairman is constrained to transfer
further discussion of this into the hearings of the Health
Subcommittee, which will I am sure be voluminous this year.
Mr. Thomas. Mr. Chairman, I would love to have the
Secretary there, but they never send him.
Chairman Archer. Maybe you can get Ms. Matthews to come.
Mr. Matsui?
Mr. Matsui. Thank you very much, Mr. Chairman.
I would like to make three observations and then ask one
question, Secretary Summers.
First of all, I want to thank you and Ms. Matthews for
being here.
I appreciate very much the fact that you mentioned the
three trade bills, the CBI, the African Trade Bill, and China's
entry into the WTO. I think the fact that you mention this in a
budget hearing shows the commitment of the Administration to
pass all three of these this year, obviously with the
cooperation of the House and Senate.
Secondly, I would like to discuss briefly the comment the
chairman made with respect to the President's resolve in terms
of Social Security. He said that the President can't deal with
this issue this year.
The President certainly is willing and wants to complete
Social Security and have a reformed package across his desk
this year. The problem is that it is in our hands--Congress--at
this time. The President came up with a proposal in the form of
the Bradley-Rangel Bill last year. The Administration in its
budget package has come up with a proposal. It gives a 50-year
life to Social Security. Now the issue is, How does the
Congress deal with it?
We can continue to keep pressing the President, but he has
a proposal and now it is really up to us.
Lastly--and I don't need a response on this right now in
terms of my comments--Mr. Rossotti is doing a very good job in
terms of management of the IRS, but there is a concern,
according to press reports, about enforcement and collections.
I really hope that you in the Treasury Department will really
get into this issue. I know Mr. Rosetti is trying to address
it. But nevertheless, I am afraid that if we allow this process
to continue on for an indefinite future, we could find
ourselves as we were in the early 1980s where collections were
down and morale was down and obviously we had a huge
underground economy--tax reform somewhat brought it back.
But I know the direction. We don't want abuse, but on the
other hand, we want to make sure that the principal focus of
the IRS is collecting taxes that are legitimate.
The last thing I want to ask you a little bit about is
FISC. I think the chairman raised that issue.
We did have DISC, as you know. That was declared
ineffective or inappropriate by the GATT in the early 1980s,
and then we came up with the DISH. We appealed the loss we had
and I understand the decision should be sometime in the next
few months. Under the WTO's ruling, we have to come up with a
final approach to this issue by October 1st of this year.
This is obviously a major incentive for U.S. corporations
to export. If we lose this opportunity by the third quarter of
this year, it could have a significant impact on our
competitiveness.
It is being appealed now. Is there any effort by the
Administration to try to come up with a compromise on it with
the Europeans who filed the initial action? Is there any effort
to perhaps take a look at some alternatives? I don't want to
concede a loss yet, but at least we need to have something in
place if in fact we are not successful.
Mr. Summers. On FSC, let me say that this is a very
important issue. I have asked Deputy Secretary Eizenstat to
take the lead in the Department and for the Administration on
this issue.
The case was appealed on January 19th and January 20th. Our
people felt that they received a fair hearing and a number of
aspects were explored. We don't yet know the decision.
Clearly what would be best, from our point of view, would
be a decision that upheld the U.S. position. We are working
very hard in an advocacy context for such a decision. In the
event that such a decision is not forthcoming, I think it will
be important to work as a matter of urgency to craft a solution
that preserves the incentive and does so in a way that is WTO-
legal. We will be pleased to work with members of this
committee and Senate Finance Committee to achieve that
objective in as expeditious and effective a way as possible.
I might just mention if I could, Congressman Matsui, with
respect to your very thoughtful question on compliance, that
this is something that Commissioner Rossotti and I have talked
a great deal about. I think it is our feeling that perhaps the
greatest threat in that area to the integrity of the system is
around the corporate tax shelter issue. And the essence of that
issue is, frankly, a tendency to play with what some refer to
as the audit lottery, carrying out these transactions and just
sort of hoping that nobody notices.
The commissioner has taken a number of administrative steps
to increase enforcement in this area, but it is our feeling
that containing the abuse problem--and again, this is a
separate issue from what everyone thinks about--containing the
abuse problem will require certain legislative remedies. It
would be our hope--regardless of what happens on the larger tax
picture but just in terms of maintaining the integrity of our
system--that is something that we all could discuss this year.
Mr. Matsui. Let me say this--I know my time has expired and
you do not need to respond to it--but I think it is important
to deal with obvious tax shelters. It is about $23 billion to
$30 billion over five years. But the larger issue in my comment
to you was the potential for people to say that they do not
have to comply any longer because it is a voluntary system. We
don't have to comply any longer because the Service isn't going
to check up on us and enforce the laws anyway.
If you recall, back in the early 1980s, we were talking
about a potential loss. In an underground economy, it went from
$100 billion to $200 billion a year. I am talking about a much
larger issue that I think deals with the whole process of the
Service and what it stands for.
Mr. Summers. You are raising a very crucial issue. I see
Congressman Portman sitting who has been enormously thoughtful
as a member of the Commission on these issues.
The judgment that we have come to--and it is really heavily
Commissioner Rossotti's judgment--is that just as business has
moved past the idea that there is a trade-off between quality
and cost, and have come to recognize that pursuing the highest
quality is often the way of pursuing the way of the lowest
cost.
And thinking of this in terms of a pendulum that swings
between customer service and enforcement is not the right way.
We are working very hard. I think it would be a serious mistake
for anyone to rely on the IRS' lack of enforcement capacity in
the years ahead. I think we are going to be providing better
service to the vast majority of honest taxpayers--more
appropriate service for the small minority of dishonest
taxpayers.
But this is an absolutely critical priority for us. If you
look to Commissioner Rossotti's exemplary report on his first
two years and his strategy for the IRS going forward, I think
you will find that it is responsive to the kinds of concerns
you are addressing, which are enormously important.
Chairman Archer. Well stated, Mr. Secretary.
The gentleman's time has expired.
Mr. Shaw?
Mr. Shaw. Thank you, Mr. Chairman.
Mr. Secretary, a few minutes ago you described yourself as
an optimist. I have been an optimist, particularly on Social
Security. The other day I saw a report that said that optimists
live longer, which made me more optimistic. But I will say that
I am losing my optimism when it comes to the question as to
whether this President or this Congress is going to be able to
work together to solve the problem of Social Security.
I also have to express profound disappointment that in a
12-page statement that you have provided us here in the Ways
and Means Committee, only a half-page is devoted to Social
Security, which consumes a very large percentage of the budget
over which you preside. And this hearing is about the national
budget.
But my optimism is further diminished into pessimism when I
read what is contained in that actually less than a half-page,
that the Administration is suggesting two things with regard to
Social Security reform. One is accumulating more Federal debt
within the trust fund--which you and I both know, as we have
discussed in the past, will be a call upon our kids and
grandkids to pay off. This is not a real economic asset.
Chairman Greenspan has testified to that. As a doctor in
economics, you are well aware of that. So this really does
nothing to help our the further generations, even though we may
not run out of Treasury bills until 2050 something under the
President's plan.
As those Treasury bills are paid off, that is going to call
upon the taxpayers, and we get closer to a situation where we
are going to have two workers supporting each retiree when
Social Security originally had 40 some workers supporting each
retiree. What an awful thing to leave to our kids and our
grandkids, that for them to pay for their parents' pensions,
there will only be two of them paying into the system to take
care of them. This is a terrible legacy.
And I am also very, very disappointed by the fact that the
President has proposed in his budget that we use the Social
Security trust fund to buy into the corporate sector of this
country. That is classic privatization of the Social Security
trust fund. The American people don't want it. Poll after poll
say that they don't want it. I don't think there is anyone on
either side of the aisle supporting privatization of Social
Security. I don't think the President has any takers with this.
So you have not only given us something that is dead on
arrival, this thing died months ago. This thing died years ago
when the President first brought it up and pulled back from it.
Now it has gone nowhere.
I would also like to say to my good friend Charlie Rangel--
he is talking about reaching across the aisle on January 5th in
a letter--I asked him to comment on the Archer-Shaw plan. We
have been reaching out. We reached out to the leadership on the
Democrat side in the Congress--Mr. Gephardt and the other
Democrat leadership--and we have been met with nothing but a
wall of silence.
In order to solve the problem of Social Security in this
country, it has to be done in a bipartisan fashion. And you
can't do it in a bipartisan fashion unless we are willing to
reach out across the aisle and work with each other. There is
no question in my mind but that we are being stonewalled as a
political motivation.
I am not talking about people necessarily on this
committee, but I am very concerned that we are getting
absolutely no leadership from the White House on this and we
are getting no leadership from the Democratic leadership with
regard to saving Social Security. It is time that we move
together.
The President has put out as part of his budget and plan--
he has had it sitting out there for several years there--the
question of USA accounts. Those are private accounts that are
set up for American workers. Why can't we bring that into the
Social Security system so that it leaves the Social Security
system totally alone, as Mr. Archer and I do in our plan? We
don't touch it. It stays exactly as it is, but we take funds
and set up individual retirement accounts.
Don't take it out of Social Security. It is totally
separate and apart that is out there for the retirement of
tomorrow's seniors that will be used to save the system so that
they won't get absolutely lambasted by a system that our
generation refused to fix.
Would you care to comment on that?
Mr. Summers. You have raised a number of very important
issues in your comments, Congressman Shaw. Let me just first
say that I did have an opportunity to testify before the
committee in early November on Social Security, as you know. At
that time I had a rather lengthy and detailed statement
defending the Administration's perspective and presenting the
Administration's perspective. I also provided rather extensive
comments on the individual accounts approach. So we certainly
have done our part in reaching out and seeking to consult to
find a common solution.
Mr. Shaw. I have to interrupt here.
I delivered to you a letter personally to be delivered to
the President just asking him to meet with Mr. Archer and me or
someone on this side in order to try to map out this private
ground.
This was done months ago. This letter was sent to you and
you assured me that you were going to deliver it to the
President's desk, and I am sure you did. I have heard nothing.
Mr. Archer and I have sent letters to the President. We
have heard nothing. The President told us over a year ago at
the White House Summit on Social Security that he was going to
be sending us a plan that would save Social Security for all
time. We are still waiting.
What is wrong?
Mr. Summers. Congressman Shaw, from my perspective, looking
at this as an economist, we have a defined benefit pension plan
that works well for beneficiaries, that is at this point under-
funded. That is the actuarial deficit.
It seems to me that the responsible course for the trustees
of a defined benefit pension plan that is under-funded in the
private sector context would be to look and see if it was an
extremely profitable year so that larger contributions could be
made and--
Mr. Shaw. Mr. Archer and I have introduced a plan that also
continues it as a defined benefit pension plan with the
possibility of increases in the amounts people are relying on
in retirement.
Mr. Summers. And I think we have recognized that the
proposal you have put forward is a valuable contribution to the
debate. We have expressed concerns about the magnitude of
future budgetary commitments that are implicit in a proposal of
the kind that you and Mr. Archer have put forward. There are
concerns about what it could mean over the longer term for the
ultimate coalition and progressivity that Social Security
depends on. There are certain concerns about administrative
costs and the fraction that would be used up in administrative
costs within a proposal of that kind.
But we are very much prepared to discuss--if there is
formal legislation embodying it--we in the Administration and
the Treasury Department would certainly be prepared to provide
commentary with respect to that formal legislation and our
concerns regarding it.
But I would urge you, Congressman Shaw, to take seriously
the plan that the President has put forward as something that
we can feasibly accomplish this year. I think it is not
accurate to suggest that it is simply placing I.O.U.s in the
trust fund because every penny that is contributed to the
Social Security trust fund in the President's plan represents a
direct allocation of interest saving that has resulted from
debt pay-down. Therefore, we are taking resources and
transferring them from one use--a sterile payment of interest--
to another use--the meeting of an existing obligation for
Social Security. I think that is fiscally responsible.
I think it is responsible, as the trustee of a large
pension plan, to look at the way its assets are managed, and to
be very reluctant to see those assets managed in a way that
earns a lower return than almost any other defined benefit plan
in the country.
That is why we introduced the discussion of equities. If
others prepared to rule that opportunity out, I think that is
an unfortunate reduction in the scope for us to compromise and
find common solutions. We very much would like to see this get
done, but it does depend on a willingness to take each other's
proposals seriously. I think the Administration has put forth a
very constructive foundation for anything that is going to
happen in the Social Security area by extending the life span
of the Social Security trust fund out past the life span of the
baby boom generation, and doing so in a fully paid-for way
based on debt reduction.
I think it should also be supplemented by investment policy
changes, but that is an issue that can be separated in either
direction from the issue of debt pay-down.
Mr. Shaw. I know my time is long past, but I would like to
say that the American people do not want us to privatize the
Social Security trust fund, and Republicans are not going to
privatize the Social Security trust fund. But we are very
anxious to talk to the President or talk to you to try to
hammer out a program. You know our telephone numbers, the
President has our telephone numbers, and we are waiting for the
phone to ring.
Mr. Summers. Congressman Shaw, you have used the phrase
``privatize the Social Security trust fund''--I would certainly
agree that it would be a very poor idea to privatize Social
Security.
Mr. Shaw. But that is what you do by buying corporate
equities out of the trust fund. That is what your statement
said. I did not make that up. You can read it back into the
record, if you want to, but that is what it says.
Mr. Summers. Let me say that I don't think of the Federal
Employee Retirement Fund as being privatized. I don't think of
the Pension Benefit Guarantee Corporation as being privatized.
I don't think of the California Public Employees Retirement
System being privatized, even though each of those entities do,
as is the best practice for defined benefit pension plans,
invest in equities.
Chairman Archer. The gentleman's time has expired, but
since my name has been mentioned a couple of times, I feel
compelled to very briefly make a couple of comments.
The American people do not view the Social Security trust
fund in the same way they do the other pension plans you
mentioned, Mr. Secretary. It is a very sacred fund to the
American people.
And the American people do not trust the Federal Government
to invest that sacred money in private corporations for two
reasons: number one is risk, and number two is their view that
the Federal Government should not have the potential to control
any private corporations in this country and thereby be in a
position to set policy. Those are the concerns Mr. Greenspan
has and those are the concerns of 80 percent of the American
people.
Very quickly, the President's so-called plan in your budget
is not really a plan, Mr. Secretary. It is simply a
placeholder. It simply makes a promise that in the years ahead,
when there is a shortfall in the fund, that the Treasury will
write a check to the trust fund from general revenues. That has
never happened in the history of the trust fund. That sacred
trust fund has been set apart from the general treasury.
I am surprised that AARP has just not gone up the wall
about this because year after year after year it has opposed
infusion of general treasury funds into the Social Security
trust fund. There is no immediate reform in the President's so-
called plan--no restructuring, no reform--other than the small
part of the fund that would be invested in the private sector
to gain added earnings. You might call that a reform, but that
is a reform that is dead on arrival with the American people.
So there really is no reform. It is a placeholder.
Finally let me say, as you know, Congress has never been
able to handle a significant reform of Social Security. It has
happened either from presidential leadership, as it did with
President Carter in the late 1970s, or it has happened through
the creation of a bipartisan commission as in the early 1980's.
No other major reform of Social Security has ever occurred
simply from within the Congress.
I have tried as hard as I know how. I have tried to get Mr.
Rangel to come over and say, What can we do to join together on
a plan? I have talked to minority leader Gephardt. Nothing has
happened because Congress cannot develop this within its
structure. It just has never been able to do so.
But the White House opposed the Social Security Reform
commission that we created in this committee, which had strong
bipartisan support and was passed by the House of
Representatives because the President said that he had his own
plan. He called for a national dialogue culminating in a White
House conference which would launch a bipartisan effort. I had
high hopes after that conference, as I walked across the street
from the Blair House to the White House with the President.
I don't believe that I am at liberty now to repeat the
private commitments that he made to me, but they are very
different from what has come out publicly. And I am not trying
to create controversy between me and the Congress and the White
House, but I will simply say that this will not happen without
aggressive, direct Presidential leadership.
As a result of the Administration's flip-flop on this issue
we will not find the solution to Social Security this year. I
am terribly, terribly saddened about that. And I apologize to
the committee for resuming on the time of the committee.
Mrs. Johnson?
Mrs. Johnson. Thank you, Mr. Chairman.
Mr. Summers, I have a rather specific question, but I
certainly do want to put on the record a couple of other
things.
First of all, at the beginning of this hearing it looked
like this committee had been acting in a very partisan fashion.
I want the record to note that the subcommittees are for the
most part running in a totally bipartisan fashion, and it is
because of the response--when the chairman of the Ways and
Means Committee calls the President and doesn't even get a call
back, there really is a problem. And I'm proud to say that most
of the legislation that actually comes out of this committee
comes out as a result of bipartisan action.
There is a lot of ground for bipartisan tax action in this
Congress. If you look at the package we proposed to go with the
minimum wage bill, much of those details are already in your
budget. And unless you are just going to on principle oppose a
tax package being coupled with a minimum wage bill, there is
plenty of ground for agreement--the low income housing tax
credit, the pensions reforms, the expensing for small business,
lots of things. And if philosophically we believe that those
provisions should help offset the cost to small businesses of
increasing the minimum wage so people don't have to get fired
and jobs can be protected, I really don't think that is such a
bad rationale. I hope it won't be a rationale that will mean
that you will a priori decide not to support tax changes as
part of the minimum wage bill.
If you look at the health access bill, I have heard the
President many times support our proposal to let people deduct
the cost of their health insurance premiums. Everybody else
gets to deduct the cost of their health insurance premiums
except individuals who pay their own health insurance. So in
fairness, just plain fairness, there are things we need to do
this session. And I will end up with the fairness issue on the
marriage penalty bill.
But before I do, I do want to mention that I am very
disappointed that your Medicare proposal does not propose any
new money back into Medicare. We all know that particularly in
the area of hospitals we only deferred certain problems for one
year. I have never seen the hospital system, from our
sophisticated medical centers on which the quality of American
health care depends and the world depends right down to our
little rural facilities, under such crushing distress.
I urge you to give specific directives to HCFA that they
can make proposals to increase spending in that area, that they
are not in the budget but you are going to support them. I
don't want to go through what we went through last time with
your people sitting over there knowing how serious the problems
were, saying we must address the problems, but not being able
to make specific proposals because you had cut Medicare in your
budget, you cut it again when you brought the tax package up to
try to avoid the 1 percent across the board, and so their hands
are tied. Untie their hands. We have got to do something again
this year for hospitals. So on Medicare, this is not enough.
On retirement security, I hear you about that and I am
pleased there are some pension proposals in here. But your big
money is for matching. At least those people already have a
pension plan. Fifty percent of working people in America work
for employers who provide no pension plan. You have some
proposals that will help that. But let's get our money out
there so that everyone can have an income stream that will
compliment Social Security. And that is why I do not understand
why you would take $8 billion more out of the insurance
industry that will increase the cost of the kinds of retirement
products that are the only option people have to really create
a retirement economic security; that is, Social Security and a
complimentary privately saved income stream.
So on retirement security, I think there is common ground
but I think there are some backhanded hits in your budget. And
the irony is that those provisions have already been rejected
by this committee and House on many occasions, by Democrats as
well as Republicans.
Lastly, let me get to the marriage penalty bill that we are
going to vote on tomorrow. I am very pleased that in your bill
you do provide for stay at home moms. Now those can be
described as people already benefitting from the marriage
bonus. That's true. But they are also the little families in
America making the greatest sacrifice to live on a single
income.
You provide a total of $1,000 new deductibility. Can you
tell me how does that compare to the new deductibility we
provide for stay at home moms? Because if we care about
families and children, we have got to do something about the
bias in the system against those who are making the really
tough choice of staying home and taking care of their children.
And in addition to the provisions specifically for
deductibility, then I want to ask a question about
refundability.
Mr. Summers. Let me respond if I could to five points in
what you raised. First, with respect to stay at home moms, our
proposal does, as you say, directly benefit them. We believe it
does so in a more targeted, progressive, and less costly way
than the alternative that the committee is considering.
Mrs. Johnson. But why is it less costly? Because it
provides $1,000 and we provide how much?
Mr. Summers. Because it is more targeted to be progressive.
Mrs. Johnson. No, no, it is not more targeted to be
progressive. I am talking specifically about the stay at home
provision which would be the same for every stay at home, as my
understanding of your proposal from your write-up in the
summary pages. In other words, you are not going to provide a
stay at home deduction for a mom whose husband makes more than
a certain income.
Mr. Summers. Excuse me, Congressman Johnson, I thought you
were speaking about the marriage penalty. I think I now
understand that you are speaking about the child and dependent
care.
Mrs. Johnson. They have the effect that we get from a very
simple mechanism in our marriage penalty of helping stay at
home moms or stay at home dads, whatever the case may be. You
do it through other programs but the impact is the same. Do you
limit that to very low income families?
Mr. Summers. We have certain limits, I don't remember what
the limit is, but you receive the full benefit up to an income
of $59,000 in our proposal and after that it phases down. My
impression is that the limits are somewhat higher in your
proposal.
Mrs. Johnson. But you take no consideration for the number
of children, because $59,000, if you have three or four
children, is really still pretty tough sledding.
Mr. Summers. This is something we are happy to work with
the Congress on. I think that is a crucial point. In our EITC
proposals the question of multiple child families is something
we very explicitly pick up on because there is a real problem
with the way our tax system and our AMT proposal treats
families with multiple children.
Mrs. Johnson. Now in the EITC area, have you been able to
lower the fraud rate below 20 percent which are most recent
figures? Do you have any more recent figures on error and fraud
in the EITC?
Mr. Summers. We do not have more recent figures. But we
have taken a number of steps, including the allocation of a
specific enforcement budget for the EITC, including
simplification measures to conform the earned income
definitions which we expect will significantly reduce the rate
of error, including an outreach effort to tax preparers in this
area, and including a requirement that the EITC beneficiaries
give their Social Security numbers.
Mrs. Johnson. I would just say that having chaired the
committee that oversaw that for a number of years, we worked
hard to eliminate the amount of fraud there is. If there were
an appropriated program that had a 20 percent fraud rate around
here, it would not be there long. And for us to expand a tax
program that has a 20 percent fraud rate when there are very
direct and simple ways to help people, stay at home moms and
make families stronger seems to me questionable. But I am very
pleased that you do recognize the need to provide better
support to stay at home moms. I hope your colleagues on this
committee will work with us on that provision in our marriage
penalty bill.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Houghton?
Mr. Houghton. Thank you, Mr. Chairman.
Mr. Secretary, good to see you.
Mr. Summers. Good to see you.
Mr. Houghton. I have two questions. One has to do with
complexity, the other has to do with the Customs issue in terms
of ACE.
On complexity, we have had, and I happen to be on the
oversight committee, we have had Val Oveson, who is sort of the
taxpayer advocate from the IRS, come up here and he says the
number one issue really with taxpayers is tax complexity. I
totally agree with him. You take a look at the Treasury
introductions to the budget, I have a report here from 1995 and
it is that thick, and the one this year is that thick.
Proposals of just geometrically increased. This is not just the
fault of the Administration. As a matter of fact, it is the
fault of Congress also. We complexify this whole thing. It is
bothersome.
Now you have attended this in a certain way in terms of
your report. In terms of tax simplification, you say you
propose to redress a particular problem with the AMT by
allowing taxpayers to deduct all their exemptions for
dependents against the AMT. You know, that is a good idea but
it really does not get at the complexity because I am making
out my tax form and I have to still go through all the
arithmetic before I come to the point to where maybe I will
have an exemption here.
It is a very important issue. I think, frankly, from a
personal standpoint, it is even more important than tax
reduction, the tax complexity issue. I do not see really either
of us getting at this. And I would appreciate any comments you
have.
The second issue is in terms of the customs. We have had
the head of the Customs Service up here quite a few times. He
has talked about this automated commercial system, ACE, and you
know about this. It is really important. The problem is one of
money and where does it come from and where does it go. It is
going to cost another $200 million and you feel that is a good
idea, but at the same time, it should be paid for by user fees.
The business community sort of feels that they have given
at the office. In other words, they pay in user fees almost $1
billion and a whole bunch to the Customs Service, about $900
million. And so then to sort of lay on another $200 million
doesn't really seem to me to make an awful lot of sense.
So those are two issues, the tax complexity, which is
really a huge megaissue, and the other thing specifically in
terms of helping our Customs Service.
Mr. Summers. Let me say, Congressman, I agree with what you
said about the seriousness of the tax complexity issue and it
is something that we are very focused on. I think we have done
some things that are constructive; the AMT is constructive,
raising the standard deduction and reducing the number of
itemizers is constructive, expensing for small business is
constructive. But I think there is a lot more that can be done.
I would say that I think this is a largest problem for a
small minority of relatively fortunate taxpayers. Some 30
million Americans are able to file their taxes by pushing
buttons on a telephone in less than seven minutes. The
increased emphasis on the use of software to do this is making
many of things that used to be very computationally burdensome
much less burdensome. So you are getting a kind of
simplification in that way.
But I think this is a crucial issue and it is one that we
need to be in a position to work together on. I would be sorry
though if that were to be seen as a reason not to extend
existing mechanisms. We have tried to work in our budget by
achieving some of the social objectives by working with
existing mechanisms--expanding EITC, expanding the child and
dependent care credit. It seems to me those things provide
important benefits to families without creating increased
complexity. But I think it is a fair concern.
With respect to--
Mr. Houghton. Can I just interrupt a minute. I really think
that we are probably equally to blame with the Administration.
But in something like this you need leadership and it really
ought to come from the White House. So last year, you know,
there were 28 different tax credits, this year there were 18 or
20. It just seems to roll on and roll on and roll on. So the
only thing I ask you is if you could really think in terms of
what does the White House do to lead all of us, because that is
where the direction must come from on this.
Mr. Summers. We will carefully consider it. I would also
say that I think if you probe what people don't like about
complexity, some of it is the hassle of filling out their own
returns, and some of it is the sense that out of all that
complexity somebody else is getting an unfair break. The reason
I have put such emphasis in my remarks today on the corporate
shelters is that, I think, is an important thing that is
stimulating anger or even outrage with respect to the code and
that if we do not address it will do so even more in the
future.
With respect to ACE, I think we all have a common position
that this is very important to get done if we are going to have
the efficient flow of goods across our borders. I should say
that we in the Department have learned a lot from the painful
TSM experience at the IRS, the computer program at the IRS. I
think we have this under control so that those kinds of
mistakes will not be repeated.
Budget realities being what they are, this program is not
it seems to me likely to be fully funded without a contribution
of the business community. We have reconfigured the proposal
that is in this year's budget relative to the proposal that was
in last year's budget so as to make very tangible that the
contribution the business community is making is going right to
the things that will benefit them. But as important as this
issue is, I do not think I could responsibly propose measures
that would reduce the number of people who were monitoring
narcotics on incoming flights or agents who were doing that
kind of work protecting our borders against drug incursions in
order to invest more heavily in this computer system.
So my hope would be that we could work with the affected
people in the private sector to find a solution. We were very
mindful in the design of this year's proposal, frankly, that,
as you put it, the private sector had given at the office and
we had to find a proposal in which what they were being asked
to do was commensurate with some benefit they were going to
receive. That is what we tried to do. We are obviously happy to
work with members of this committee and the affected trade
associations to try to find a solution to this problem.
Mr. Houghton. I think that is really important because the
Customs Service clearly is important. This is very, very
important for the Customs Service. And you want to have people
working with it rather than bucking it all the time. And I
think the private sector has really made an enormous
contribution already for that.
Thanks very much, Mr. Chairman.
Chairman Archer. Mr. Coyne?
Mr. Coyne. Thank you, Mr. Chairman.
Welcome, Mr. Secretary. As a result of last year, the
Administration came around to signing legislation relative to
rectifying the 1997 Balanced Budget Act inequities relative to
hospitals. I wonder if you or Ms. Mathews could explain in the
proposal this year are we doing more to try and rectify the
problem that was created as a result of the 1997 Balanced
Budget Act relative to reimbursement for hospitals.
Ms. Mathews. We do not have a specific extension or
additional proposal to the BBRA that we passed last year. What
we did, in trying to do our efficiency proposals, is ensure
that we take steps that are consistent with what we did last
year in terms of increasing competition, as we discussed
earlier. For example, in some of our proposals there are
distinctions made for rural hospitals that build upon some of
the concepts that were discussed as part of what passed and was
signed last year.
Mr. Coyne. Well, can hospitals look with any encouragement
to additional help in this proposed budget, help from what
occurred in the 1997 situation?
Ms. Mathews. We do not currently have a proposal, as I
said, that extends in the same way that the BBRA did last year.
There are proposals such as GME hospitals where we have doubled
the funding on the discretionary side from $40 to $80 million.
There are specific proposals like that. But I think you are
referring in a particular area, and we do not have those.
Mr. Coyne. On another subject, I wonder if the Secretary or
yourself could tell us a little bit about who is going to
benefit from the proposal in the proposed budget about the
Earned Income Tax Credit and extending the benefits. What grade
of income level in the country is going to benefit from
expansion of the EITC?
Mr. Summers. I think most of the benefits will go to those
with incomes between, say, $10,000 and $30,000, and the groups
will principally be those with more than two children, married
couples who will avoid the marriage penalty, and those who are
making special efforts to save who will benefit from the
conformity of the earnings definition.
Let me say that the EITC has probably been more successful
than any other social program we have had in moving people from
poverty to work. I would also say, at this point, when more
than at any time in the last 35 years, our economy's issue is
jobs looking for people as well as people looking for jobs.
Doing everything we can to stimulate work incentives and
improve the supply of labor is crucial if we are going to be
able to keep growing at these rates without running into a
bottleneck.
Mr. Coyne. We have a responsibility in Congress to do
everything we can to ensure the solvency of the Social Security
program and the Medicare program. But in a time like this when
the economy is so strong, it seems that it is time to invest in
public infrastructure, to have a growth in the future of
workmanship for workers to become more productive in the
economy. And along those lines, what is this budget going to do
to invest in trying to make workers more productive and also to
help the public infrastructure of the country?
Mr. Summers. Let me comment on some components of that and
then I will turn to Ms. Mathews if I could. I think probably
among the most important infrastructure investments we can make
as a country are in satisfactory schools. It is wrong that with
all the prosperity that we have children in America beginning
the school day at 4:00 because their schools work in three
shifts. Other children in America are going to school in
closets. Other children in America have the lunch period begin
at 9:45 in the morning because the school facility is so
constricted. The restroom facilities in some of our schools are
an embarrassment.
If we want kids to take learning seriously, it seems to me
we ought to take seriously the kind of facilities that we
provide them. That's why one of our priorities in the tax area
is the school construction proposal. That is why we are also
proposing measures for repair and modernization of schools in
the discretionary budget.
More generally, it stands to reason, and statistics confirm
what common sense suggests, that when there are fewer kids per
teacher the kids learn more. When there is more emphasis on
quality, more learning takes place. So we are focused very much
on improvement in education. This year's budget includes the
most robust improvements in education budget that we have had
in a number of years. I think that is an important step.
Ms. Mathews could probably add something on the worker
training side.
Ms. Mathews. On the worker training side, we are continuing
our youth formula grants which include the Summer Jobs
programs. There are a number of specific programs, such as the
Head Start increase of $1 billion which is starting at the very
beginning of the educational process. Additionally, our After
School monies which we have put in before are proposed again.
There is a smaller schools initiative with regard to
infrastructure issues that relates to our building of schools
and our modernizing of schools. Another part of that is
addressing the digital divide. As part of our school
modernization plan on the tax side, we want to modernize and
create an ability for those schools to wire and get the
computers in. Some of the schools don't have the ability to do
that. So those are some infrastructure as well as some
programmatic things we do in the area of education.
Mr. Coyne. Thank you.
Chairman Archer. Mr. Herger?
Mr. Herger. Thank you, Mr. Chairman.
Mr. Secretary, it is good to have you with us. I would like
to ask you a question concerning a provision that I understand
was recommended by the Treasury, was put in the President's
budget at the end of the budget cycle this last year and which
the Congress passed. I think it was done inadvertently. It had
to do with the installment sales method for the accrual method
of selling small businesses. The way it used to be, people with
small businesses maybe worth $100,000 who would be retiring and
would be selling these small businesses. If they sold it over
ten years there would be $10,000 per year that maybe they would
receive in payments and the capital gains then would be on that
$10,000 say per year. What this has done is that now these
small businesses have to pay all of the taxes up front, which
on $100,000 the 20 percent capital gain would be $20,000.
What is happening is that these businesses are not able to
sell for as much. The buyers of these small businesses who many
times are unable to obtain credit from the banks, their only
way of getting into small businesses is through this method,
are unable to buy. Again, I feel that we are hearing as Members
of Congress from literally hundreds of small business people
throughout our districts, and it is not just my district, I'm
sure every congressional district in the Nation is hearing
this.
My question is, were the end results of this anticipated by
Treasury and by the Administration at the time that it was
proposed? And if it was not, I understand that Chairman Archer
did send a letter to the President requesting that this
correction be made in the President's budget. My question would
be, was it anticipated? And if it was, why was this not
included in the President's budget?
Mr. Summers. Thank you for raising that issue, Mr. Herger,
which touches on what is a very real concern for us as well. My
colleagues in the tax policy area at the Treasury and in the
IRS have had a series of meetings with the NFIB and other
representatives of the affected parties. I think it is clear
that these provisions have impacted in a way that was much more
broad than was originally intended. We expect in the very near
future to provide regulatory guidance that I think will, at
least in a large part and perhaps completely, clear up what
have been very legitimate concerns. We are working in tandem
with the groups that represent many of the small businesses
because this is a serious problem. I would be happy to ask my
colleagues to provide you or your staff with a more detailed
briefing on what is involved.
Mr. Herger. Very good. I appreciate that, and that will
help us very much because these businesses that are selling
right now are being very dramatically affected. I am authoring
legislation along with Mr. Tanner from this committee and Mr.
Matsui. It is bipartisan legislation. We have some 21 members
just of Ways and Means who are on legislation to correct this.
Of course, this will take some time. But if you could work on
this in the meantime to help these businesses that are being
affected right now, that would be very helpful.
I would gather by what you are saying--well, let me just
state. We would really appreciate your support as well, not
only in correcting it now but in changing the legislation,
repealing what I believe was inadvertent certainly by the
Congress and I believe, by what you are saying, by the
Administration.
Mr. Summers. Let me suggest that those who are more
knowledgeable than I about the technical details take this up.
You have my commitment to address in a regulatory way the
overly broadness of the past legislation. Whether we are in
precise agreement on any specific proposal or not is something
that I can say until I have had a chance to review it. But I
think we will be able to act and act very quickly, frankly, on
a shorter timeframe than would be possible legislatively to
address this concern in large part. And I very much appreciate
your having raised it.
Mr. Herger. Mr. Summers, thank you very much.
[An additional statement by Mr. Herger was subsequently
received.]
Statement of Mr. Herger to Secretary Summers
Rep. Herger: ``Mr. Secretary, since 1992 no taxpayer has
ever been able to claim one penny of tax credits under section
45 for biomass power production because the code section was
drafted too narrowly.
Biomass power provides important waste removal and rural
employment benefits to rural communities such as my district in
Northern California and around the country. Unfortunately, many
of the plants are shutting down or running at reduced capacity.
I have introduced legislation to fix section 45, and I am
pleased to know that the President is aware of this problem and
has adopted my solution of providing a tax credit for existing
facilities.
I applaud the Administration for stepping up to bat on this
issue and look forward to working with you to fix section 45
this year.''
Chairman Archer. Mr. Secretary, obviously, it is going to
take some significant additional time to let all members have
an opportunity to inquire. My guess is that you may need a wee
bit of relief at this point.
So the Chair is going to recess the committee. Hopefully,
everybody can grab a bite of lunch and return at a quarter to
one.
Mr. Shaw. Mr. Chairman, could I read something into the
record very quickly because there was a question as to the
definition of ``privatize`` or ``privatization`` a moment ago.
Chairman Archer. Without objection, so ordered.
Mr. Shaw. In the American Heritage Dictionary, ``privatize/
privatizing'' is described as ``To change in industry or
business, for example, from government or public ownership or
control to private enterprise.'' And the American Academy of
Actuaries describes ``privatization'' as ``The broad concept of
investing funds in the private sector which, in turn, implies
accumulating substantial advanced funding is known as
privatization.''
Thank you, Mr. Chairman.
Chairman Archer. Mr. Secretary, if you can accommodate
another five minutes, Mr. Levin is going to have to go to
another meeting and would like to get his five minutes of
questioning. I will leave it up to you. If you can handle
another five minutes--
Mr. Summers. I would be delighted to.
Chairman Archer. The Chair will recognize Mr. Levin.
Mr. Summers. I will remain with Mr. Levin as long as Mr.
Levin wishes.
Mr. Levin. I will take my five minutes. I think the
Chairman will grant another five minutes on the other side.
Thank you, Mr. Chairman.
Mr. Secretary, Mr. Crane raised the trade issue, and I am
glad he did. And in response, reflecting your own views and
that of the President as he articulated at Davos so well, you
talked about the need for expanded trade and also for an
expanded perspective of trade in this new era. And in terms of
a new perspective to incorporate considerations of the
environment and labor, you referred to child labor. But I trust
that when you refer to labor you are talking about, as the
President did, issues of core labor standards, not universal
minimum wages, but core labor standards as articulated by the
ILO.
Let me also say a word about the reference to waiting for a
call from the President on Social Security. I just hope the
Republican majority would look back at how they handled the
marriage penalty. As I understand it, when there was the
meeting of the leadership with the President there wasn't even
a reference to this first step in their tax program. I think
that if we are going to get off on the right foot in terms of
bipartisanship, there needs to be a willingness on the part of
the majority to raise issues like the marriage penalty and try
to work them out before they are simply sprung on the minority.
One other quick comment, and this relates to Mr. Shaw's
reference to privatization. However one thinks about investment
of equities by the Government, a small portion, I do not think
it is fair to refer to that as privatization, and you mentioned
that.
Let me now close by just talking about the share of income
that people today pay in Federal income tax. You discussed this
earlier but I think the record should be clear. I have from the
Treasury Department a chart that talks about the Federal income
and FICA tax rates and it uses the median income for a four-
person family. As I read the chart, it shows that average
combined tax rate--we are now talking about for the median
income--is less today than it was in 1979. Is that correct? Do
I read that chart correctly?
Mr. Summers. Yes.
Mr. Levin. The projected rate for 1999 is 15.11 percent
compared to 16.97 percent twenty years ago. That is reflected
in the CBO chart that compares the effective tax rate, this is
the Federal tax rate, projected 1999 compared to 1981. I just
want to read the figures. For the lowest quintile, 4.6 percent
compared to 8 percent in 1981; the second quintile, 13.7
percent compared to 15 percent; the middle quintile, 18.9
percent versus 19.5 percent; the fourth quintile, 22.2 percent
compared to 22.9 percent. The only increase is for the highest
quintile. The retort is, of course, that takes money out of
private investment.
So if you would comment quickly on what really has happened
in terms of the Federal tax rate and the fact that the highest
income category is paying a higher tax rate but whether that
has had a negative impact in terms of growth in this country.
Mr. Summers. Let me make these comments if I could,
Congressman Levin. First, from the mid-1990s on we have had
what some would call the greatest, and it is certainly one of
two or three greatest, economic expansions in the history of
our country, driven by productivity growth, driven by capital
formation and investment. We have had record levels of
investment as a share of GNP, record levels of investment in
absolute terms, and record levels of growth in investment
during this period.
And so it seems to me difficult to argue that we have seen
new or serious impediments to the capital formation process
from anything we have done with tax policy. Indeed, I would
argue that the budget surpluses have been major sources of
strength for investment.
The tax rates for the same family, configured in the same
way for something like 90 percent of American families have
come down and are lower now than they were at any time in the
last twenty years. As I indicated earlier, the statistic is
frequently cited that a ratio of taxes to GNP has gone up. That
is a reflection of two things. It is a reflection of the fact
that income relative to GDP has gone up because there is more
foreign income, because there is more capital gains than there
once was. And so, in some sense, GDP is not really the right
denominator for looking at taxes. And the other factor that it
represents is that a larger share of income represents
corporate profits which are taxed at the corporate level and
represents income to higher income people that is taxed at a
higher rate.
So, and this is the crucial point, the changes in the taxes
to GNP ratio do not reflect tax increase policies. They reflect
instead changes in the pattern of who is receiving the income.
A universally agreed technique for measuring the impact of
policies is to look at taxpayers configured in a given
situation and seeing what happens to their tax burden. And by
that standard, for the vast, vast majority of Americans taxes
have declined since the late 1970s, taxes have declined since
the early and mid-1990s.
Mr. Levin. Federal taxes.
Mr. Summers. Federal taxes.
Mr. Levin. Thank you. And thank you, Mr. Chairman, for your
indulgence.
Chairman Archer. Your welcome, Mr. Levin.
I must say I can't just let that stand because, as usual,
when you deal with statistics there are any numbers of ways to
receive them, present them, analyze them, and ultimately reach
conclusions.
Mr. Secretary, what you did not mention is that as we sit
here today America has the lowest private savings rate in all
of its history--in all of its history. It is negative. What you
did not allude to is that a great part of the investment on
which we are presently building our economy is foreign
investment, the savings of foreigners who save far in excess of
what we do in this country. And the great danger to the stock
market, the cloud that hangs over the stock market is that if
these foreigners begin to have more confidence in their own
domestic economies than in ours, there could be an outflow of
this investment capital and we would be in very big trouble. So
we do need to be concerned about that, and I think you probably
share that concern. I am not saying it is imminent but it is a
cloud hanging over the economy.
Now, if we are not to care about what percent of GDP the
Federal Government is taking, that all that we care about is
what median families are paying in taxes, then we can increase
taxes on everything that does not relate to median families and
it would not affect anybody. Now, as an economist, you know
that is not true. The embedded cost of the income tax
represents roughly 20 percent in the price of the products on
average in this country, according to the very, very
comprehensive study done at Harvard by one of your colleagues.
And so if you keep taxing everything else and you say, ``Oh,
but the median family's taxes have not gone up,'' you are
ignoring this reduction from the economy that must be paid for
by the median families in the price of their products which is
hidden from them.
And so on the thesis that Mr. Levin and you are exchanging,
we could take 50 percent of the GDP provided that the median
family did not show any increase in taxes. That clearly would
not be wise. And so the percent that we are taking out of the
economy, particularly at a time when this goes in the other
direction, which it will at some point sometime, I don't know
when, it may be ten, fifteen, twenty years from now, will leave
us at this bigger demand at the Federal level. You and I may
disagree, but I think this is something to be concerned about.
Mr. Summers. Mr. Chairman, let me clarify very explicitly
my position. You are, of course, correct that if you raised
taxes on some people but not the median person and you looked
only at the median person, that would be a misleading
statistic. That is why I was careful to cite those with half
the median income, those with the median income, those with
twice the median income.
But I suspect you could agree that if the stock market goes
up and more individuals realize capital gains and nothing else
changes, it would be quite misleading to describe that
situation as a tax increase on the American people. And yet the
statistic that is frequently cited comparing taxes to GNP
suggests a tax increase when that has taken place.
If the distribution of income changes and no tax law is
changed so that more income is received by those in the 28
percent bracket relative to those in the 15 percent bracket,
then more taxes will be collected and compared to GNP. But
again, it would be hard to see that as having been a
legislative tax increase. We would be happy to do more
comprehensive analysis, but what I can assure you that analysis
will show is that the increase in the tax ratio to GNP that is
of concern to you, and is something we do need to investigate,
we will find that it is not a consequence of tax law policy
changes but is instead a consequence of the two factors that I
have been citing--an increase in income that is not reflected
in GDP, such as capital gains, and a change in the composition
of income towards those who have higher tax rates. And it would
surprise me if one took the view that a stock market increase
constituted a tax increase, and yet that is the logic of the
comparison of taxes to GNP.
With respect to savings, I can only agree with you. I think
we can take common satisfaction that whereas our country's
national savings rate had reached its historic low ever in
1992, as a consequence of the progress we have made in
increasing public savings, that national savings rate has more
than doubled over the last seven years. I think we have made
great progress in the public area and I think we can all agree
on the importance of working to increase private savings.
I was particularly encouraged by Congresswoman Johnson's
suggestion that we stress the needs of the 70 to 75 million
Americans who do not have any kind of pension plan. I think if
we can agree on that as a primary objective rather than raising
the limits for those who are already most fortunate, I think if
we can agree on the 70 million, as Mrs. Johnson suggested, then
I think we would be in a very strong position to work out an
approach that I believe would be the most effective approach
and provide the greatest incremental benefit in encouraging
personal and private savings.
Chairman Archer. Mr. Secretary, we will continue this
comprehensive economic discussion at a seminar somewhere. For
the time being, the committee will be recessed now until 1:00.
[Whereupon, the committee recessed, to reconvene at 1:01
p.m., the same day.]
Chairman Archer. The committee will come to order.
Mr. Secretary, I know that you have a lot of demands upon
your time. I inquire as to how long you can comfortably stay
with us?
Mr. Summers. The discomfort level would start rising
geometrically after 2:00.
Chairman Archer. Well, we will see if we can expedite the
inquiry so that we can release you, as it were, at 2:00.
Mr. Summers. Thank you.
Chairman Archer. Next on the list is Mr. Nussle.
Mr. Nussle. Pass.
Chairman Archer. He passes.
Is Ms. Dunn here?
[No response.]
Chairman Archer. Mr. Collins?
[No response.]
Chairman Archer. Mr. Portman?
Mr. Portman. Thank you, Mr. Chairman.
Thanks to you, Mr. Secretary, for being willing to be
patient and stay for the second round. I have lots of questions
and what I would like to start with, if I could, is picking up
where we left off a moment ago on the pension issue.
You mentioned in your dialogue with the Chairman the
importance of increasing the private savings rate in this
country. In my view, nothing would be more important with
regard to the tax code and what we could do this year than
encouraging people to save more for their own retirement. We
have a crisis I believe among baby-boomers not saving enough.
We also have a Social Security crisis which we have talked a
lot about today. And the solvency of Social Security and the
backstop that private retirement savings can offer is another
reason to move forward. And finally, we have half the
workforce, about 75 million Americans who have no pension
coverage today, which I think is something this Congress and
the Administration ought to focus on because it is
unacceptable.
We have a proposal, as you know, to allow all Americans to
save more for their own retirement. In this budget, you have
again picked up some of the so-called Portman-Cardin
provisions. I know Mr. Cardin, who is here with us now, is also
interested in talking about some of the differences between
your proposals and ours. But I want to start by focusing on the
fact that there are a lot of similarities, and we appreciate
the movement that you have made toward the Portman-Cardin
proposal in the area now called the Retirement Savings Account,
which was the USA Account. I think the RSA proposal that you
have is an improvement from the USA Account. It, frankly, takes
away some of what I viewed to be a counterproductive proposal
that could compete with the private side.
I do have some questions about how RSAs would work. If I
could just quickly go through some of those questions and, to
the extent you have answers today, it would be very helpful I
think for our further understanding. If you don't, we are happy
to have you follow up in writing through the appropriate
person.
First, how would they work in terms of the employee and the
employer? One of the concerns that I have is if it is based on
a matching basis from the Government, does the employer have to
know what the employee's adjustable gross income is to make
that calculation, and how would that work?
Second, and I think this is in relation to that in terms of
the practicality, if there is a tax credit provided as the
match, what is the timing of that? Is it practical for an
employer or a financial institution, because, as you know,
financial institutions can also be involved in this, to provide
that match before the tax credit is available? I see a timing
issue there.
If you could briefly address those practical issues, and
then let me just go ahead and put on the table one other issue
because it is really of question of how it would work. When
there is no tax liability, for instance, a governmental entity,
a nonprofit, a hospital where you don't have the ability to
take advantage of that tax credit, how would this work?
Mr. Summers. Let me first say that our objective is to find
common ground with you and Congressman Cardin and the others
who are working in this area. And towards that end, the
President's budget contains a number of new proposals, new for
us, that incorporate many of the elements that you have been
working on. My hope would be that we could forge a common
approach that would meld all our priorities. My understanding
is that my staff has already begun meeting with your staff and
Congressman Cardin's towards that objective.
With respect to the questions that you raised, we would
envision a procedure that benchmarked the size of the accounts
towards last year's AGI. So there would be no recordkeeping
burden on employers but a relatively simple certification by
the individual.
The time value of money issues with respect to the credit
is something that I think we would have to work on. Once the
program was started and there was a regular flow of new
accounts at the financial institution or new pensions and a
regular flow of estimated tax payments, I would expect that
they could be dovetailed very closely. But there are some
start-up issues and those are things that we would be happy to
work with you to find the best way to address.
With respect to nonprofits, this is something that is of
concern to us. Our expectation would be that nonprofits would
contract with some kind of financial institution that was for
profit who was involved in the benefits who would be able to
make use of the credits and would pass on the benefits to the
employees of the nonprofit.
But those are very important issues. I have given you what
our preliminary thoughts are but these would be things we would
be very happy to work with you and other Members of Congress
on.
Mr. Portman. I appreciate that. I do think there is an
opportunity to make progress here. I have been disappointed, as
you know, with Treasury's inability to accept some of our very
modest increases in limits. You mentioned earlier in your
dialogue with the Chairman you were concerned about raising
limits. All we do in our legislation is take the limits that
somebody can put into a 401(k), for instance, back to where
they were in the early 1980s. In the aggregate, it is not even
keeping up with inflation, as you know.
It is not just about allowing people who are bumping up
against the limits now to be able to save more for their own
retirement, which I think is a good idea. It is about allowing
small businesses, most of whom offer no pension at all today,
to offer pensions to workers who are low or middle income
workers. We have to understand how those decisions are made.
They are made by business owners, they are made by managers who
will have an incentive to set up a plan if they can see some
benefit to it.
I would hope that we can take the blinders off, talk about
the crisis that is at hand, which is half of America's workers
not having a pension, get the politics aside, get out of the
rich-poor debate, and really begin to help all Americans save
more for their own retirement.
Mr. Summers. I would agree with that general orientation.
And to the extent that raising limits can be constructive in
raising the number of employers who are covered by pensions, we
will be particularly enthusiastic.
I think we all agree that 75 million people without
pensions represents a major problem in our country. There will
undoubtedly be a combination of approaches that will be most
effective. We obviously feel that we have suggested some
constructive ideas, we have incorporated some of your ideas
which we think are particularly constructive, and we are
certainly prepared to work in a spirit of compromise to try to
find the best way forward in this.
Mr. Portman. Thank you, Chairman. I have lots of other
questions but I will be following up later.
Mr. McCrery [presiding]. Thank you.
Mr. Hulshof?
Mr. Hulshof. Thanks, Mr. Chairman.
Mr. Secretary, thank you for bearing with us. I have some
technical questions regarding qualified zone academy bonds and
the new proposal on qualified school modernization bonds that I
will probably need to follow up in writing because my time will
not permit, and I would appreciate Treasury, as it has done in
the past, responding to those questions.
What I do want to do, Mr. Secretary, is to make some
comments, and maybe there will be some time at conclusion that
you can respond to any of these points or none of these points
as you so deem. What I would like to highlight are what I
believe are some inconsistencies from what I have been hearing
through the questions that you have sat through this morning.
Earlier, you said that we are ``in a remarkable moment in
our Nation's economic history.'' And I don't disagree with
that. What I find troubling, however, is an insistence, as we
look at the President's budget, on raising taxes and user fees
especially in an era of surplus. That to me seems to be
somewhat inconsistent.
You were quick to point out that the amount of Government
spending as a percentage of GDP has gone down. And yet when the
Chairman pointed out that the tax take on the American worker
in this country continues to be at the highest percentage of
GDP, you were quick to explain that away. I find that somewhat
inconsistent. I find that troubling.
Talking about waste, fraud, and abuse, Ms. Mathews made an
excellent point to Mr. Thomas' question about Medicare. We
always invoke the mantra, we want to eliminate waste, fraud,
and abuse. And yet, Mr. Secretary, you mentioned as far as
expanding the Earned Income Tax Credit, and I think we all
share your opinion that this has been a useful program as far
as the income supplement to working Americans, we have got an
over 20 percent error and fraud rate with the Earned Income
Tax. So, in other words, for every five dollars that are being
paid out in income supplements one of those dollars is not
deserved under the law. And yet we are continuing to talk about
this very wasteful program. We have had hearings on that and
representatives of your office have talked about that. I find
that extremely troubling.
I want to focus just another comment on something that I
think in principle we agree on, and something you talked about,
corporate tax shelters. I notice my colleague from Texas was
nodding very vigorously in the affirmative. I know this is an
issue he finds very important. You talked about closing
corporate transactions that are void of substance. We agree
with you.
But what I find inconsistent, Treasury came to us in 1997,
and maybe even before but I got here in 1997, but I remember we
had hearings on the President's budget proposals back in 1997
and Treasury asked us for some additional authority to crack
down on corporate shelters. Specifically, we passed a provision
that would require registration of corporate tax shelters. Two
and a half years later we still are waiting for regulations and
rules to come from Treasury on something we passed two and a
half years ago. And I find that inconsistent.
When we talk about tax cuts or tax fairness, we have heard
every excuse imaginable, not from you, Mr. Secretary, but from
those who oppose tax cuts. We have heard back in 1997 with the
Taxpayer Relief that it was inconsistent to give tax cuts at a
time when we had deficit spending. When we had the 1999 tax
bill that we debated we heard from some on the other side that
this is not the time, it would overheat the economy, as the
Minority Leader said on the floor. And then there were the
others who said we can't cut taxes because the economy is too
fragile. When we had the extenders package, and I certainly
appreciate the fact the President signed that RND credit and
these extenders, but the thought was we can't do that because
it is not paid for. Now we are hearing from the other side that
we don't have this budget document in place.
And I follow along with what Ms. Johnson said in her
comments, Mr. Secretary, and that is there are so many areas of
agreement, whether it is the Portman-Cardin pension plan,
whether it is the marriage penalty, whether it is the long-term
dependent care, you have a credit, we had a deduction. The
point is that I find that our substance doesn't match our
rhetoric. And even here today in this hearing, there are so
many things that I think there is agreement on, and yet when
the rubber meets the road we aren't actually putting into
practice what we profess regarding those changes.
My time is running short, but one quick point. I know that
there are some school bond proposal, going to the technical
question, school bond proposals that would invoke Davis-Bacon
prevailing wage requirements on school districts that utilize
these tax credit bonds. If you can give me a yes or no answer
on this, in the Treasury's ``green book'' it is silent on this
issue. Where is the Administration on Davis-Bacon. And if that
is something where you need to respond in writing, that would
be fine. I have got some other questions I will submit in
writing regarding the school construction bond proposal.
With that, if you have any comments, my time has expired
and so I would yield.
Mr. Summers. I will respond in writing on the school
construction question.
I would stress in response to a number of your points,
Congressman Hulshof, that we believe that debt reduction, which
removes the obligation to pay principal and pay interest, takes
pressure off interest rates and holds down their costs is
probably the most effective form of tax relief that we can
provide. And we believe that we need to not do anything that
puts that at risk in terms of unrealistic budgeting.
Mr. Hulshof. If the Chairman would indulge me on that
point. Just as you say we are trying to put pressure on
interest rates, the Fed does not agree. Mr. Greenspan and the
Federal Reserve are doing just the opposite as far as pushing
interest rates up to try to curtail so-called inflation. Not to
put you at odds with the Chairman.
Mr. Summers. Congressman Hulshof, I of course cannot
comment on Federal Reserve policy. What I can say is that
every, and I use that word every advisedly, serious
professional economist who has looked at these issues would
agree that an environment of paying down debt will be an
environment of lower interest rates, whatever else happens,
than an environment without paying down debt. That is the
operative principle and the reason why debt reduction is such
an important and effective form of tax cut.
The President's budget contains $350 billion in tax cuts
for American families. We are prepared to legislate those any
time we are sure that they are in the context of a program that
is paying down debt and assuring our ability to strengthen
Social Security and Medicare.
With respect to tax shelters, the regulations you described
I expect will be announced within the next month. But, frankly,
as we have drafted them, we have realized that the legislative
authorities were in some ways insufficient and would permit tax
shelters to still be marketed in stealth to those who play the
audit lottery. That is why we will be coming back and asking
for new legislation.
With respect to the EITC, there are real compliance
problems. We have addressed them in the ways I mentioned--more
budgeting, Social Security numbers, conforming definitions, tax
preparer's initiative. But I think it is quite a misleading
suggestion about the compliance statistics to suggest that one
dollar out of every five dollars is somehow fraudulently
wasted. The 20 percent figure refers to returns in which there
is some kind of error. The error is often not of large
magnitude. The error is in most cases not fraudulent. In many
cases the error comes from anomalies that the President's
proposing to simplify this year, such as the distinction
between earned income for EITC purposes and earned income for
other purposes.
With respect to the taxes over GDP figure, we will just
have to agree to disagree. I don't see how it can be said that
more capital gains from a stronger economy constitutes a tax
increase even though it does raise tax revenues. And every
evaluation of the situation of the typical working family, or
the working family that is at half the typical income, or
family at twice the typical income does say that they are
paying less taxes today than at any point in the last twenty
years.
Finally, with respect to the question of the revenue offset
measures that you raised, it seems to me that just as you take
the position that even in a time of surplus we need to
eliminate any wasteful spending, it is also appropriate to take
the position that if there are tax measures that constitute
distortionary subsidies or inappropriate measurement of income,
that is something we should also be looking at for fairness and
integrity of the tax system regardless of what the overall
budget surplus is. And it is from that perspective that the
President has put forward his offset proposals.
Chairman Archer. The gentleman's time has expired.
The Chair observes that there are nine members who have not
yet inquired. The Chair will attempt to conclude the hearing at
2:00, so the Chair will be constrained to strictly invoke the
five minute rule so that every member will have their full five
minutes.
Mr. Cardin?
Mr. Cardin. Thank you, Mr. Chairman, for calling on me,
even under the new interpretation of our five minute rule.
Let me thank Mr. Summers for his testimony and for laying
out I think a very comprehensive budget that we can follow.
Just in response to some of my colleagues' points about why we
are so concerned about voting tomorrow on a tax bill without
having a budget is that the Administration has laid out a very
clear agenda; five objectives that you spelled out, Mr.
Secretary, at the beginning of your comments--reducing the
debt, dealing with Social Security and Medicare to protect
those programs, targeted tax cuts, and our international
commitments, and some of our new spending priorities. Most of
that is within the jurisdiction of this committee.
It was interesting to hear comments about Social Security.
Well, your budget provides that we can preserve Social
Security. I question the Republicans and their tax proposals,
that will exceed $1 trillion dollars over ten years, whether
they can do that and still pay down the debt and deal with
Social Security. You have given us a blueprint that we can deal
with Social Security. I question whether the Republican budget
allows us to really modernize Medicare to include prescription
drugs for our seniors, which we need to do.
I was interested in Mr. Thomas' comments about competition.
I can tell you what the Medicare Plus choice has done in my
State, a rather urban State, where now 14 of our 24
jurisdictions do not have any Medicare Plus choice. No option
but the fee-for-service as a result of changes we made. So I am
not so sure there is the interest in the private sector that
some of my colleagues believe in ensuring our seniors.
I do want to emphasize though a point that was made by Mr.
Levin on trade because I do hope that we can develop a broader
consensus in this Congress on expanding international
opportunities. Mr. Secretary, our concern about labor and
environment is not for protectionist policies to protect
American markets, but that we should be a leader in
establishing international core standards in these areas. Where
it is right for us to be a leader in the world, as we were on
financial services, as we were on intellectual property rights,
we should be with labor and environment. I think if you do
that, you are going to find a broader consensus in this
Congress on both sides of the aisle on the trade agenda.
But let me in the few minutes I have just underscore the
point that Mr. Portman made on the private retirement and
savings and the Chairman made right before our break. The
economic figures are very encouraging for this Nation but we
still need to save more. You understand that, we understand
that. And what the Portman-Cardin bill attempts to do is make
it easier for Americans to be able to save for their retirement
by eliminating some of the complexity and making it easier.
I really do appreciate your comment about finding common
ground. I applaud the President's RSA proposal because you put
some money on the table. We weren't quite that bold. We didn't
spend quite as much on most of our proposals as you are putting
on the table. That is good because we should be willing to have
targeted tax relief for people who are willing to put money
away for their retirement, particularly lower wage workers. We
agree with you, we want to get to that 70 million who do not
have private retirement. We also want to get the low wage
workers, small businesses, and the decisionmakers to have
pension plans so those 70 million can get pension plans.
Just one last point on this, and then I invite your
response. We are not suggesting increasing the caps. We are
suggesting that we go back and bring the caps where they used
to be. We have had such a regression in the ability of
Americans to put money away for private retirement because we
are so concerned that some people might put more away than
others that we find that people aren't putting anything away.
So, our objectives are to deal with the 70 million, but it
is also to deal with the low savings rates, to put more money
into private retirement plans so we can have less pressure in
the future on Social Security. Social Security is supposed to
be just one leg of a three-legged stool. So I really do
appreciate your comments, and your proposal, on common ground
on the pension issues. But I invite you to work with us so that
we can bring out legislation in this Congress to deal with that
issue. And I invite your comments.
Mr. Summers. I think I agree with everything you said,
Congressman Cardin, and I look forward very much to working
with you and Congressman Portman and other members of this
committee to address what I think is a macro economic problem
for our country in terms of too low a personal savings rate,
and what is a personal problem for a large number of
individuals in terms of their preparation for retirement. I
think this is an issue which ought to, and I think does, reach
across party lines, reach across generational lines, and it is
one that I would hope that as we pay down the debt and
strengthen Social Security and Medicare this year we could also
work on.
Mr. Cardin. Thank you, Mr. Secretary.
Chairman Archer. The gentleman's time has expired.
Mr. McInnis?
Mr. McInnis. Thank you, Mr. Chairman.
Mr. Secretary, I will have a number of questions here I
would like your response to in writing since I am limited to
five minutes.
Let me kind of put it in context because I think you and I
come from opposing ends in regard to the estate tax. I always
think of your quote when you were talking about estate tax,
that the advocation of the repeal of the estate tax is ``about
as bad as it gets.'' That is when you were the Deputy
Secretary. And then you went on to say that, ``When it comes to
the estate tax there is no other case other selfishness.'' As
you know, my district is geographically larger than the State
of Florida, comprised primarily of farms and ranches. Needless
to say, we take strong issue with that position. Further on, I
would like you to confirm in writing so I am sure of the
accuracy of the quote, but the Washington Post on April 22,
1997, says, ``You have to raise revenue somewhere and the
ability to pay seems like a good way to do it.''
So I expected that the Administration was going to continue
in its opposition to relief on the estate tax. Although I would
be curious as to the upper income level of members of the
cabinet or in the Administration. My guess is that most of them
have taken steps to hire tax accountants to be sure that they
are not hit with this estate taxation, unlike the middle class
for whom they are advocating no repeal of the estate tax. But
what I did not expect from the Administration in the budget,
and what I would like confirmation on in the letter, is in fact
an estate tax increase.
I knew you weren't going to give us any kind of relief out
there with the estate tax. I didn't expect an increase. I would
like just to confirm that my numbers or the proposals are
correct. They restore the phase-out of the unifying credit for
large estates. The Administration proposes a $1.1 billion
increase in that element of the estate state. They propose a
$214 million increase in required consistent valuation for
estate and income tax purposes; $55 million increase in the
estate tax for basis allocation for part sale/part gift
transactions; a $1.054 billion increase in conformed treatment
of surviving spouses in community property States; $18 million
include the QTIP trust assets and surviving spouses estates; $6
billion in eliminate nonbusiness valuation discounts in the
estate tax; eliminate gift taxation exemption for personal
residents trusts, $408 million; limit use of the CRUMY powers,
$208 million.
So the proposal in this new budget on an increase in the
estate taxation is $9 billion. I would like some comment in
writing on that.
The second issue is last year we had 28 members of this
committee, Democrat and Republican, sign a letter that I had
drafted opposing what we call tracking stock. The
Administration appeared to somewhat backtrack but, kind of like
the estate tax, they didn't give it up. And lo and behold, as I
look at the new budget, you are back again but this time with a
different mask. Now I understand that under the tracking stock,
instead of taxing the issuing corporation, you are now going to
tax the stockholder. So you are still back on the tracking
stock. Apparently the Administration is still taking the
position, and I stand to be corrected I would hope when you
answer these questions, but you are still at the position
apparently that the tracking stock is an income and should be
taxed.
Both of those issues are issues that I think are important.
The other thing, and I will conclude with these comments, I
believe early in your remarks you said the drop in the interest
rate of mortgages is an administrative way of a tax cut for
families. Now I kind of think the Administration in this
economy takes credit for rain. I want to tell you, this is the
market's benefit to the families. This is not a tax cut to the
families out there of America that the Administration and the
Congress have decided to cut your mortgage rates. That is a
result of market functions, not a result of a tax cut.
I think it is somewhat of a misappropriation of the term
tax cut when you talk about interest factors, interest rates
being lowered out there and you all of a sudden now put that in
the classification of a tax cut. When I talk to middle America
out there, when I talk to the average person and I say ``If the
interest rate on your car, the financing of your car drops from
10 percent to 9 percent, is it a tax cut?'' They don't see it
as a tax cut. I think there is confusion with the words.
Thank you, Mr. Chairman.
Chairman Archer. Unfortunately, Mr. Secretary, your answers
will have to be submitted in writing because the gentleman's
time has expired.
Ms. Thurman. Mr. Chairman, I think some of the rest of us
members would like to have those answers as well. So if we
could have--
Chairman Archer. Perhaps the gentlelady will provide time
within her five minutes. I have got to be able to release the
Secretary and still let everybody have their five minutes.
Mr. Summers. Mr. Chairman, I would be prepared to stay till
2:03 in order to take three minutes to respond to the
gentleman's thoughtful question.
Chairman Archer. Mr. Secretary, whatever you want.
Mr. Summers. Let me just say with respect to interest
rates, I think the words I used were tantamount to a tax cut to
take the pressure off credit markets and allow interest rates
to fall. I don't believe for a moment that we would have
anything like the interest rate environment we do if we had not
made progress in creating budget surpluses.
With respect to tracking stock, I would simply say to you
that I think it is appropriate for us to conform tax rules for
corporations to all forms of corporate distributions in some
level playing field way. That is the thrust of our corporate
tracking stock regulation.
With respect to the estate tax, I have made clear both in
writing and in public comments immediately after the remarks
you quoted that I had what might be referred to as a learning
experience with respect to those observations and that they
were not a fair statement with respect to the motives of those
who advocated estate tax repeal and have worked very hard in
connection with the 1997 legislation to provide tax relief to
farmers and to small businesses and to be part of a program to
generally raise the limits on the estate tax.
With respect to the set of provisions that you identified,
to say that estate tax burdens are a legitimate concern for
many small businesses and farmers is not to say that we
shouldn't be responsive to loop holes that arise in estate tax
that in many cases were not intended. The references to QTIP
trusts, to the CRUMY powers, to certain valuation discounts, to
residential trusts, these are responses to various systems that
have been designed over time to avoid the intent of the estate
tax as it was legislated. I think it is much better for us to
debate what the appropriate level of that tax is and make
decisions explicitly rather than to allow loop holes to be
expanded. The legislation is not directed at increasing the tax
but only at responding loop hole concerns that have arisen.
Chairman Archer. Now Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman.
Mr. Secretary, thank you very much for being here and for
being so patient with your time. Let me also compliment you and
certainly the President and Vice President on the proposal that
you have put before us in your budget to try to address Social
Security, Medicare, and certainly of course to pay down the
debt. I would also congratulate you on what you did with the
EITC. I think it is great that we are looking at more ways to
make work pay for working families that otherwise would fall in
the poverty limits of what we have defined as poverty. And by
the way, I think we should acknowledge Chairman Archer as well
because he also had a similar proposal on EITC.
You mentioned a number of things, you answered a number of
questions on a number of subjects. Let me just touch on a
couple. First, FSC. I hope that Treasury will take with as much
seriousness the issue of FSC and what happens with the WTO on
that issue as the USTR is taking it. I think if we don't treat
that as a very high priority, we could find ourselves at a
great disadvantage, competitively speaking, with our European
counterparts. I think the last thing we want to see is a loss
of jobs in this country because we are not able to export on
competitive terms with our European colleagues.
The digital divide. I am glad you spoke a little bit about
that. I am very pleased to see the President's proposal to help
households acquire computers and help young people and adults
get connected. I am fortunate to work with Mr. Portman on a
bill that we call the New Millennium Classroom Act which does
something very similar. It tries to provide a tax deduction for
companies or individuals that contribute computers to
classrooms and to senior citizen centers to help child and
seniors get connected. So I hope you will take a close look at
that bill that we have.
I am not sure if it was mentioned, but because so much of
your budget talks about working families, I hope that we can
count on you to work with us on an issue that is affecting a
number of States more and more dramatically every year, and
that is the whole issue of runaway productions in the
entertainment industry. We are seeing more and more countries
offer tax credits to companies that would leave the United
States to do their productions abroad, places like Canada,
Australia, England. And as a result, they are getting tax
credits of up to 40 percent on the production costs,
principally in labor. It has become very difficult for a number
of companies in the U.S. to stay here and for us to compete to
keep those companies here.
I hope that you will take a close look at the opportunities
to try to help those industries. And by the way, we are not
talking about helping the movie star who makes $5 million to
$20 million with a movie, or the producer, or the writer, or
the director who is making megabucks. We are talking for the
most part about the folks behind the camera, the stagehands in
productions, the boom individuals who operate all of the
equipment, we are talking about the caterers who provide the
lunch to those who are actors who make working man's wage. So
if you could do us a favor and take a close look at that. That
is becoming more and more an important issue.
And finally, if I can focus the remainder of my time on an
issue that I hope you will take a close look at dealing with
Customs. Customs right now has an automation problem. It has a
computer system that works to track product that is imported
into this country that uses 1980s technology. As a result, we
have already experienced on occasions brown-outs, delays in the
ability to move a lot of this product. And with our in and out
system of production these days where it is time sensitive to
be able to bring in what you need to produce your product, a
lot of companies in this country would suffer greatly if we
found not just a brown-out but a black-out where products that
are supposed to be coming in to help manufacturing here in
America would not reach their location.
I have a letter that I will leave with you rather than
getting into detail since we are constrained on time. But you
are probably familiar with the new system that Customs is
trying to implement, the ACE system that would replace the ACS
system that is in place right now. The problem becomes that at
this stage the Administration has proposed only to fund the
modernization through a new fee. I think most of us have seen
that hasn't worked. I would hope that you all would think
seriously about other options to try to do that. I know that at
some point there was an exploration of the possibility of
earmarking some of the merchandise fee that is used right now
and collected from importers to offset the cost of that
modernization or perhaps using a straight appropriation to do
that.
Somehow or another we have to get this resolved because if
we don't get that new computer system in place I think we are
going to find that we are all going to be hurt. Certainly,
American business will suffer, consumers will suffer, and our
competitiveness will suffer. I don't know if you have any
comment on the whole issue with Customs and automation, but I
would welcome an answer.
Mr. Summers. I will take one minute to respond to your four
points, if I could. I've got a clock in front of me.
On FSC, I agree. We are absolutely committed. Deputy
Secretary Eizenstat is leading the effort.
On computer donations, we share the objective with respect
to the digital divide but we have some concerns about the form
of your proposal in terms of encouraging overly old computer
donations rather than ours which is focused on newer equipment.
But I am sure we could work something out.
Mr. Becerra. We could work on that.
Mr. Summers. On runaway production in the entertainment
area, this points up the generally important issue of tax
competition which we are pursuing very actively through the
OECD because this is an issue that arises in a number of
contexts.
On ACE, we agree with you on its importance. We have
reconfigured the proposal in this year's budget to much more
clearly link the benefits to the business community to their
contribution. And I hope we can move forward with it because
you are absolutely right that it is essential.
Mr. Becerra. Thank you very much.
Chairman, thank you very much.
Chairman Archer. Mr. Lewis?
Mr. Lewis. Thank you, Mr. Chairman.
Mr. Secretary, over the next ten years, the Federal
Government is going to be taking in about $24 trillion in money
from the taxpayers' pockets in this country, with a sizeable
projected surplus. Do you think that the American people are
not paying enough to take care of the needs of the Federal
Government?
Mr. Summers. I think there is room to meet the needs of the
Federal Government and to provide for appropriate tax relief.
Although I think we have had a real accomplishment in the last
seven years in reducing the number of Federal employees by a
sixth and bringing Government, by a wide variety of measures,
down to its smallest size since the 1960s, and that we have
enjoyed the first decade in which we have been significantly
cutting discretionary spending, which I think represents a real
achievement for our country, we have got to be very
disciplined.
Mr. Lewis. Do you think $170 billion in net tax relief over
ten years is a significant amount of tax relief? That is
basically seven-tenths of 1 percent. That is not a lot of tax
relief. And let me say this, you have increased taxes by $181
billion, $69 billion of which comes out of families in
Kentucky, tobacco farmers that are struggling. They just had a
45 percent cut in their quota, last year 30 percent. They are
dying out there on those family farms. Their income has been
cut in half.
Is it the President's desire to totally tax legal tobacco
out of existence and the family farmer?
Mr. Summers. With respect to the tax cuts, $170 billion is
a lot of money where I come from.
Mr. Lewis. Out of $24 trillion?
Mr. Summers. But $350 billion in gross tax cuts is even
more.
With respect to tobacco, the core of the President's
proposal is a youth penalty that would fall on companies whose
products are sold to young people below the age of consent. I'm
sure that if there were proposals to ensure that those
penalties were borne by the companies rather than passed on to
consumers, if there were an approach along those lines, I am
sure that is something we would be prepared to join in working
on.
Mr. Lewis. Let me ask you this. One of the major causes of
death with teenagers today is automobile accidents. Are we
going to make automobile manufacturers responsible for
decisions made in the family home? One of the biggest causes of
cancer today is exposure, over exposure to the sun. Are we
going to make those manufacturers of swimwear responsible for
kids getting out on the beach and being over-exposed to the
sun? Are we going to have lookback provisions for every company
in this country for decisions that should be made in the home
and the responsibility should be there? Where will this all
end? Are we going to always have lookback provisions? Where is
the responsibility here?
Mr. Summers. I think that is a fair and important question.
Let me just emphasize that whatever we do, it is very important
that we protect the interests of tobacco farmers who are not
the people who are responsible for all of this.
That said, we have had effective public health policies
around automobile accidents that have reduced the number of
fatalities per mile by 50 percent over the last 35 years. We
have had effective policies in the other areas that you cited
that have reduced fatalities very substantially. We, frankly,
have not had similar effectiveness with respect to tobacco even
though tobacco is a far, far greater cause of death than either
of the examples you cited.
This is the best strategy as judged by all the public
health authorities to rely on price to achieve the same kinds
of benefits the Government has achieved with respect to most of
the other sources of--
Mr. Lewis. Let me interrupt just for a second. My time is
short here. When I said legal tobacco, there is a law of
diminishing returns here. The reason that the tobacco farmers
have been cut by 45 percent is because they can't afford to
stay in business any longer. Underground tobacco products are
already being sold. Our kids are going to be exposed to illegal
tobacco where they are going to be buying it at cheaper prices
because you are going to force the legal people out of
business.
Mr. Summers. Congressman Lewis, that is something we would
be happy to discuss with you. I think the Bureau of Alcohol,
Tobacco, and Firearms and others who have looked at this issue
can make a compelling case that youth penalties in the range
that we are considering can quite comfortably be administered.
But the concern you are raising, if it did lead to smuggling or
illegal use, obviously is a very serious one but it is one that
we have given a lot of thought to and that I believe can be
controlled.
Chairman Archer. The gentleman's time has expired.
Ms. Dunn?
Ms. Dunn. Thank you very much, Mr. Chairman.
Welcome, Secretary Summers. I enjoyed your presentation. It
did clarify where the Administration stands from different
points of view and it will be useful as we compare your
proposals to those that we intend to propose as we put together
our budget document.
I did want to move back to asking you some questions about
the death tax. In some areas that I do a lot of work, the
minority community and women business owners, where we see
women starting businesses at twice the rate of men, and they
are small businesses but they are businesses that are being
built and that these women would like to provide as a legacy to
their children when they finish their life.
The 1993 budget agreement increased the rates of
inheritance tax up to 53 and 55 percent. That puts us at the
second highest inheritance tax rate of the whole world. Japan
is the only country that is ahead of us. That concerned me when
it happened then. But now as I have done work in the
entrepreneurial community, I have learned that many minority
groups, particularly black enterprises, see that it takes about
three generations to create a business that provides a legacy,
that provides them standing in the community so that they can
continue to do well in their lives. And for them the death tax
becomes a true enemy.
I know that you agree with me that we need to encourage
entrepreneurial women and minority women to get into the
business market to become more independent. I wanted to ask
you, when Congressman Tanner's bill, my bill, the death tax
repeal that phases out death tax in ten years, when it is
supported by groups like the National Association of Women
Business Owners, the Black Chamber of Commerce, the National
Indian Business Council, the National Congress of American
Indians, the United States Hispanic Chamber of Commerce, the
Hispanic Business Round Table, the United States-Pan-Asian
American Chamber of Commerce, and the Texas Conference of Black
Mayors, why doesn't the Administration want to help by
repealing the death tax? In fact, why do they stand in the way
of that repeal even to the extent of increasing it as they do
in this budget? And I would like to know from you the answer to
that question. I think it would be very useful to those of us
who believe that this onerous tax should go away. I know that
the Administration's position is in opposition to positions you
took, for example, when you were teaching at Harvard
University.
So I ask your comments.
Mr. Summers. Let me say first, just with respect to your
last comment, the Administration's position is consistent with
positions that I took as an academic. I did write something
that summarized the conclusions of another researcher, who took
a position favoring the estate tax.
I think you have very powerfully stated what is a very
important concern, which is the proper treatment of small
businesses, and it should not be the way things work, that the
estate tax is a force for liquidation of small businesses.
We have proposed--and supported in 1997, and at other
points--a variety of proposals that are designed to provide
relief from what can be a liquidity problem, an enormous
problem, for small businesses at the most threatening moment in
the business' experience, when the founder or the owner passes
away. That is a very real and large concern to us.
With respect to the full-scale elimination of the estate
taxes that some have proposed, we would share the view of many
tax experts that the estate tax provides a very important
backstop to the income tax. If the estate tax were completely
removed, you would see a very substantial erosion not just of
the estate tax revenue, but also of the income tax revenue, as
income was put into various forms where it accumulated tax-free
and there was never any taxation with respect to the income
that had been earned.
So we think it would be dangerous to our fiscal integrity
to, full-scale, repeal the estate tax.
We would also have a concern about the very large volume of
philanthropic contributions to the Nation's universities, to
the Nation's religious institutions, to the nongovernmental
organizations and social organizations that do so much of the
Nation's work, that would not be there but for the
deductibility that takes place under the estate tax.
So we would be pleased to work on proposals to address the
specific inequities with respect to small businesses to the
extent that they can be identified, but we do not believe that
it would be prudent to eliminate a tax that does, after all, as
real as the issues are, only impact about seven-tenths of a
percent of all American estates.
Chairman Archer. The gentlelady's time has expired.
Ms. Thurman?
Ms. Thurman. Thank you very much, Mr. Chairman.
Mr. Secretary, thank you very much for being here today and
spending all of this time with us.
First I would like to say something to our colleagues that
I think is important because we have talked about this abuse
and fraud issues. You know, that is really some part of our
responsibility as well. We have governmental operations to
overlook, these kinds of issues. I served on that committee; we
had some 300 reports on Defense spending that we should have
been looking at, but we did a lot of other investigations
instead. And I think we have to take some responsibility; and
then, in those findings, how we're putting them into
legislative proposals.
We, in fact, should take some credit for that because we
did that under the EITC. We did that in 1995. We did it again
in 1997 under the leadership here. So I think we should be
careful of how we address some of these issues.
Mr. Secretary, I would suggest, though, for some of us in
the idea of this Medicare issue and the idea that some things
are just cutting across the board on hospitals, I just met with
my hospitals this last week and one of the things that they
told me was because of the uninsured rate going up, of people
not having insurance, has created a real problem for them
because of indigent health care.
So in your proposals--I mean, you may want to reiterate all
of the new steps that you are taking to bring people into
insurance, because I think this is very important in the fact
that we really are helping the health care system. So if you
could just give us kind of a little run-down, a little bit
more, on that.
Another issue, though, in all due respect to my colleagues,
if I remember correctly under the Social Security proposal that
was given--in fact, for many of us--I can't speak for the
President not returning the phone call, but many of us sat for
almost an entire day with the Chairman and others, trying to
learn the intricacies of Social Security. You all weren't
invited; some outside folks came in and gave us that. But in
that proposal, if I remember correctly, it was done so that 60
percent of the surpluses were going to be put into equities as
well, or some sort of investment. And I understand the
difference between the private account and the 15 percent, but
I don't think you can just say out there, ``Oh, you guys are
doing this, but you're not doing this.'' That's just wrong.
Thirdly, I would like to ask--and I am particularly
interested in this proposal, which is on the sustainable or
renewable energies issue; I am co-chair of that--and in looking
at the issues that we've been talking about over the last
couple of months, how this economy has grown with technological
innovations--what in this budget, because your comment at the
beginning was, ``You know, we have to make some choices here.''
In this budget, where do you see and what do you see as choices
that we've made that will sustain this economy?
Mr. Summers. I think the most important--
Ms. Thurman. Wait, one last thing. Prescription drugs, as
well. If we have a prescription benefit, which you've proposed,
or which has been proposed, let me tell you the dollars that
we're going to save in Medicare by not hospitalizing people,
because they can have their medicines and stay on their
medicines and not cut them in half to choose between food and
medicine. They will stay on them and we will save money there.
Mr. Summers. I share your last point. I think there is a
general issue in all of the scoring exercises that we do that I
think that, probably appropriately, we're very conservative
about taking account of the various feedback effects. Just as
the Chairman has expressed concern at some points that we don't
take account of all the behavioral effects of tax policies, and
that raises certain questions, I think similar kinds of
questions can be raised with respect to the economies that come
from prescription drugs.
All things considered, I think in the formal scoring
processes it's best to be conservative, but there certainly is
the effect that you described.
With respect to promoting the recovery in a broad sense,
the most important thing we're going to do to promote the
recovery is have a large-scale pay-down of debt.
In the sense of sustainable development, in the
environmental sense, the most important provisions are the
increases in research and development at the Department of
Energy. And of particular importance to me, the tax credits for
more miles to the gallon automobiles, greater use of biomass,
and other kinds of carbon-conserving policies. We've had a
great achievement in that while we've had this remarkable
growth in the economy, we've actually had record low growth in
carbon emissions in recent years. That's a tribute to the move
to the information technology type economy, and that's
something that I think that we need to build on.
I think Ms. Mathews can say something about the question
you raised with respect to Medicare.
Ms. Mathews. I think it's absolutely true in that we will
be helping our hospitals by ensuring that their indigent care
numbers go down.
I would just point to a couple things quickly. One is
family care, which is the expansion of something that was
passed in 1997 on a bipartisan basis, which was the CHIP
proposal. We've proposed expanding it to cover the parents of
those children. In addition, also getting more information so
that children that are not yet covered, are. That's two
examples.
Chairman Archer. The gentlelady's time has expired.
Mr. McCrery?
Mr. McCrery. Thank you, Mr. Chairman.
Mr. Secretary, welcome, and thank you for staying so long.
You made the point earlier that spending by the Federal
Government is at, probably, a 40-year low, or close to it. I
think if you go back to find a year in which spending as a
proportion of our national income was lower, you would have to
go back to 1966, if I'm not mistaken. And I think that is good,
I agree with you that it's good that we have restrained
spending to the extent that we have. We have made progress in
shrinking Government at the Federal level.
But I would want to make a point that we could have done
better had the Clinton Administration not fought the Republican
Congress every year since we've been in control, for more
spending. And here you are, back again this year, asking for
more spending.
I think President Clinton deserves some of the credit for
restraining spending, but I am reminded of Secretary Shalala
coming and sitting right where you are, back in 1995, promoting
welfare reform, which was great; we were all for welfare
reform, but her welfare reform program--that is, the Clinton
Administration's welfare reform program--actually would have
spent more money than we were then currently spending on
welfare; whereas, as you know, the welfare reform program that
was ultimately adopted by the Congress and finally signed by
the President, after two vetoes, actually reduced spending on
welfare by some $60 billion over five years.
Here we go again. At a time when we have surpluses, when
the Federal Government is taking in more money than we need to
finance Government, as pointed out by Chairman Archer, tax
revenues, unlike spending, are at an all-time high for
peacetime. Over 20 percent of our gross domestic product is
coming into the Federal Government in the form of revenues, and
instead of coming in and saying, ``Let's have a tax cut, let's
let the people who have created this strong economy to keep
doing the good things they're doing,'' you all are coming in
asking us to increase taxes.
Your budget proposal, as it is designed, would continue the
surpluses, you're right. But if the tax increases and the fee
increases that you have asked for don't materialize, then
you've got a problem with your budget; it doesn't work, the
numbers don't work. And I think it's safe to say this Congress
is not in a mood to raise taxes.
I would like for you to explain to us any contingency plans
that you have for scaling back the spending increases that you
all have proposed, just in case we don't adopt the tax
increases that you've proposed.
Mr. Summers. Let me respond, if I could, in three ways to
what you've said.
First, with respect to the question of credit allocation, I
think the news is good enough that we can all take credit for
what's happened, although I would note that spending has
increased and Federal employment has increased, but far less
than it did in either the legislation between 1981 and 1993, or
in the Executive Branch's proposals between 1981 and 1993.
With respect to the level of taxes, I would just
respectfully have to disagree. I honestly don't see how it's
possible to argue that higher stock prices and more capital
gains taxes, coupled with more of the income going to those in
high brackets, constitutes a tax increase. And if one looks at
standardized families, one does, once again, see that taxes are
lower than they've been in 20 years.
Mr. McCrery. Well, Mr. Secretary, though, if you compare--I
like your figure on spending, and I congratulate the
Administration and the Congress for working together to get
spending down to 18.7 percent of GDP this year. But if you're
going to compare apples to apples, you have to say that the
Federal Government is taking in over 20 percent of GDP in the
form of revenues, and that's an all-time high for peacetime.
So as an economist, don't you have any concerns that we are
taking an ever-higher proportion of our national income into
Washington to redistribute?
Mr. Summers. As an economist I have analyzed that figure
very, very closely, and the increase does not derive from any
legislative change. It derives from higher stock prices and
more capital gains, with a constant tax law, and it derives
from a change in the income distribution towards those who are
more highly taxed.
When one looks at the tax law as a measure, one finds that
it is taking less relative to income than at any time in the
last 20 years.
With respect to the question of tax cuts, the
Administration's budget, of course, does propose net tax cuts
over the next 10 years, and quite significant gross tax cuts.
You spoke of new spending, but those calculations are done
relative to one of the first two CBO baselines, which would
require either a scaling-back of the defense buildup, or cuts
on the order of 20 to 25 percent in a number of key areas of
Government expenditure. I'm not sure just what is envisioned by
those who invoke that baseline.
Our judgment is that it's better to use a current services
baseline, because just as we learned in the 1980s that it was
important to avoid overly-optimistic economic forecasts, we
believe that unrealistically-optimistic forecasts about future
spending could put us in a situation where we were back in
deficit. These forecasts are volatile and we can't always rely
on the kind of good news that is reflected in this year's
forecast.
Chairman Archer. The gentleman's time has expired.
Mr. Secretary, unfortunately, if we're going to get to the
other three members who have not enquired, assuming we stay
strictly within the five-minute rule, we're looking at another
15 minutes. Can you handle that?
Mr. Summers. Yes.
Chairman Archer. Without objection, I would insert in the
record at this point a compilation of the figures in your
budget, based on your estimates, which show that there is a $14
billion net tax and user fee increase, over and above what you
give in the way of tax relief.
[The material follows:]
Administration's FY01 Budget
Tax and User Fee Increase of $14,730 Million Over Five Years
Fiscal Years 2001-
2005 (Millions of
Tax Relief Dollars)
Claimed gross tax relief including refundable -101,749
credits (AP, p. 88)
Less three tax increases
(1) Accelerated vesting for qualified plans -550
(AP, p. 87...................................
(2) Electricity restructuring (AP, p. 88)..... -105
(3) Levy tariff on certain textiles (AP, p. -676
88)..........................................
Less other provisions affecting receipts
(1) Replace harbor maintenance tax (AP, p. 90) -3,197
(2) Roll back Federal retirement contributions -1,206
(AP, p. 90)..................................
-36
(3) Provide Government-wide buyout (AP, p. 90) +5,999
Plus refundable credits (actually increased -101,520
spending) (AP, p. 88)
-------------------
Actual gross tax relief:
Tax and User Fee Increases +47,151
Claimed tax increases (p. 90) +550
Plus three tax increases +105
(1) Accelerated vesting for qualified plans +676
(AP, p. 87)..................................
(2) Electricity restructuring (AP, p. 88).....
(3) Levy tariff on certain textiles (AP, p. +2,466
88)..........................................
Plus other provision affecting receipts (AP, p. +3,823
90)
(1) Environmental tax (AP, p. 90)............. +6,667
(2) Superfund excise taxes (AP, p. 90)........ +31,194
(3) Airport user taxes (AP, p. 90)............ +431
(4) Tobacco taxes (AP, p. 90)................. +3,752
(5) Recover state bank supervision (AP, p. 90) +49
(6) Maintain federal reserve surplus (AP, p. +218
90)..........................................
(7) Premiums for United Mine Workers (AP, p. +25
90)..........................................
(8) Abandoned mine reclamation fees (AP, p. +19,143
90)..........................................
(9) Corp of Army Engineer fees (AP, p. 90)....
Plus other user fees not included above (AP, pp. +116,250
98-99)
-------------------
Actual gross tax and user fee increase: +14,73
===================
Actual net tax and user fee increase:
Chairman Archer. These are your figures, Mr. Secretary, and
they are right here in black and white.
Mr. Summers. I would hope that you would permit me to
insert a response to that analysis in the record.
Chairman Archer. Absolutely.
Chairman Archer. Mr. Ramstad?
Mr. Ramstad. Thank you, Mr. Chairman.
Mr. Secretary, thank you for your indulgence. It's good to
see you again.
I have a question concerning one of the items in the
revenue-raising portion of the Administration's budget, and I
refer to the proposal affecting employee stock ownership plans,
the so-called ``ESOPs,'' that are for S-corporation employees.
First, I must say that I am relieved that this year's
proposal doesn't go as far as last year's proposal, which would
have effectively killed this effective retirement savings
program for thousands of S-corp employees. As you know, a
strong bipartisan majority--in fact, 23 members of this
committee; I see Ms. Thurman shaking her head affirmatively--a
strong bipartisan majority of this committee went on record as
opposed to that approach.
So this year's proposal certainly moves in a better
direction, and we're happy to see that, Mr. Secretary. It seems
that it's an attempt to preserve broad-based employee
ownership, but I think there's a problem--and we certainly
differ on what constitutes ``broad-based.'' Quite candidly, we
believe that the ``highly-compensated employee test,'' so-
called in the Administration's proposal, is unworkable.
The legislation that 23 of us, Democrats and Republicans
alike, on this committee have introduced, H.R. 3082, uses a
control test to determine whether an ESOP is truly benefitting
rank and file employees.
The important question here, I think, Mr. Secretary, can I
interpret the Administration's new proposal as an offer to work
with us, to work with Congress, on preventing possible misuses
of the 1997 law, which everyone agrees we should do? But at the
same time, preserving employee ownership opportunities for rank
and file workers of S-corporations?
Mr. Summers. If I understood you right, Congressman, you're
asking for my agreement on the dual principles, that we want to
preserve the ESOP as an important tool, and at the same time we
want to avoid any shelter opportunities created by the 1997
legislation, and we want to do those two things in the most
effective and reasonable way possible.
We are absolutely prepared to work with you and members of
this committee toward those two objectives, and that is
precisely the motivation behind our proposals.
Mr. Ramstad. Well, I certainly appreciate that movement and
that willingness to work together in a collaborative way,
because the last thing we want to do is kill ESOPs for S-
corporation employees. I mean, that makes absolutely no sense
at all when we're trying to improve and increase savings
programs and retirement programs. They're doing it right, and
for us--for the Administration, for anybody--to try to put a
damper on this sort of employee stock ownership plan is, I
think, counterproductive to any good public policy.
Mr. Summers. I agree.
Mr. Ramstad. I am glad to hear that you do agree.
Let me also just ask you parenthetically, could you provide
us with a definition of the term ``highly-compensated
employee'' that you are using in this year's proposal?
Mr. Summers. Not off the top of my head, but wait just one
second.
I have just been provided with an answer that you may or
may not find helpful.
We define ``highly-compensated employee'' for this purpose
in a way that parallels the definition of ``highly-compensated
employee'' in other areas of the pension law. [Laughter.]
It may be better for us to pursue some parts of this in
writing because it would be difficult to underestimate my
degree of knowledge of these details. [Laughter.]
Mr. Ramstad. Let me use the remaining minute. I want to
focus on the President's prescription drug proposal.
We all agree that for many low-income seniors, prescription
drugs are a crisis, the lack of accessibility, for the 35
percent that aren't covered under Medicare. Why not, instead of
spending $76 billion, as the President's budget does, why not
target prescription drug coverage to low-income seniors? Why
displace the coverage that a majority of enrollees have? Why
not target the 35 percent of low-income seniors? And I ask that
in good faith; I'm not trying to politicize this issue. In my
judgment, this is the last issue that we should politicize. I
really don't understand why we don't simply target the 35
percent of those Medicare beneficiaries without prescription
drug coverage.
Mr. Summers. That's something we've--
Chairman Archer. Mr. Secretary, you have one minute. It
just expired. [Laughter.]
Chairman Archer. Go ahead.
Mr. Summers. Thank you, Mr. Chairman.
Three reasons. First, more than half of those without
prescription drugs have incomes above 150 percent of the
poverty line.
Second, many of those with some coverage have completely
inadequate coverage that is important to build on, and our
proposal contains incentives for the preservation of that
coverage, and wraps a better form of coverage around that base
coverage.
Third, the strength of Medicare has traditionally been its
universality. Everybody pays in and everyone receives the
benefits. To carve out certain portions of Medicare benefits
and make them only available to some individuals, it seems to
us, would weaken the program.
For those three reasons, we favored a universal approach.
A fourth reason is to avoid various kinds of adverse
selection effects.
Mr. Ramstad. Thank you.
Thank you, Mr. Chairman.
Chairman Archer. The gentleman's time has expired.
Mr. Ramstad. Let me just say I hope we can work together,
and I hope the Administration doesn't persist with an all-or-
nothing approach to this, because it's too--
Chairman Archer. The gentleman's time has expired.
Mr. Doggett?
Mr. Doggett. Thank you, Mr. Secretary, for your leadership
on so many issues.
Let me say first that I really applaud the initiative that
you've taken on tax havens, these international tax havens that
have been used to provide tax shelters, and I'm already working
on some legislation in this area and I look forward to
cooperating with you.
Second, with reference to tobacco, do I understand that
your recommendation basically is to use the tax code to address
the problem of youth smoking and the leading cause of
preventable death in America today in much the same way we used
the tax code to encourage research and development, or
accomplish some other reasonable social objective?
Mr. Summers. It could be put that way, Congressman Doggett.
I think I would prefer to think of it as not using the tax
code, but simply working to create a youth penalty in an
overall tobacco program that would reduce youth smoking, and
some of which would be administered through the tax system.
I think we've made much greater progress, frankly, with
respect to most other forms of public health problems than we
have with respect to tobacco, and I think the price sensitivity
is very clear. And that's why we're going with this approach.
Mr. Doggett. We certainly have in some other areas, as you
have noted. There is a smuggling problem, and I do have some
legislation on that, that I think we need to work together on.
But it just seems to me that your tobacco area that you're
working on here deserves the title ``death tax'' much more than
the misapplication of that term to the alleged inheritance tax
plight of the Steve Forbes family.
Let me say as a third area that I am concerned about that
you have addressed, and I am pleased to see you do it, is
something similar to the approach that I have advocated through
H.R. 2255 on addressing corporate tax shelters.
During last year, when this Congress largely ignored the
problem of abusive corporate tax shelters and never got around
to even having a hearing on it until Members were packing in
the middle of November to leave town, I noted recently that
period was described by a top official at the Internal Revenue
Service in the Wall Street Journal as one in which there was
``almost a product of the week, or a product of the day, that
these tax hustlers were promoting.''
Let me just ask you if you would characterize the problem
of abusive shelter tax evasion as having grown much worse
during 1999.
Mr. Summers. You know, it's the nature of this problem that
it is very difficult to track, because it takes multiple years
until one can fully analyze corporate returns, and those who
engage in these transactions don't take out advertisements
indicating that they have engaged in these transactions. So any
evidence has to be inherently circumstantial.
But from the conversations that we've had with a range of
practitioners, I think both Commissioner Rossotti and I have
come away with a sense that there is more and more pressure to
engage in these transactions, and in part it takes the form of
a kind of competitive pressure, where Chief Tax Officers of
corporations are told by their CFOs, you know, ``The other CFOs
are engaging in that transaction; why won't you?'' And then
increasingly, law firms are giving opinions in support of
transactions that they would have been unwilling to give
several years before, because of the competitive pressure.
So it is our sense that this is a problem that is of
growing significance.
Mr. Doggett. I believe you refer to that as a ``race to the
bottom'' in your written testimony.
You know, at our last and only hearing on this in November,
Mr. Kies, who has been a real head cheerleader for these
abusive tax shelters, indicated he had no familiarity with the
BOSS transaction marketed by his company. I was so pleased to
see Treasury move forward to deal with the BOSS problem. My
question to you would be, why is it that legislation is
necessary? Why can't you just go and solve these problems
administratively?
Mr. Summers. Let me say we have had, I think, a number of
successes in dealing with these problems administratively, and
I am proud of the work which my colleagues have done which I
think has saved the Treasury over the last three years
literally tens of billions of dollars as a consequence of their
alertness.
But I don't think we can rely for the integrity of our tax
system on an approach based on Treasury staff picking up
rumors, going and investigating, finding out about
transactions, and closing them. It seems to me that the people
and the companies that engage in these transactions know that
these are transactions of a somewhat questionable nature, and
it seems to me appropriate that they be expected to flag these
transactions so that they can be clearly considered. And if
they are within the law, no one should pay more taxes than the
law requires them to pay, but they should flag these
transactions rather than being encouraged to carry them out by
stealth.
It seems to me that where we have situations--not where
people make an honest error, or a controversial judgment is
ruled against them--but where there are transactions that are
devoid of economic substance, if we want to deter those types
of transactions, some increases in penalties seem to us to be
appropriate in those cases.
It also seems to me appropriate that as part of a
simplification that a number of people have espoused here, that
rather than encouraging reliance on a common law approach where
everybody reads a lot of different court cases to seek to
understand what the definition of ``economic substance'' is, it
seems to me appropriate to codify what is meant by ``economic
substance'' and for this to be an area in which policy is set
by the Congress rather than by the Judiciary.
And so for all of these reasons, it seems to me appropriate
to legislate in this area, although you have my assurance that
the Department and the IRS will do what we can within our
authorities, but we want to be very careful not to overstep our
authorities. That's why we're looking to Congress for what we
regard as very much necessary legislation.
Chairman Archer. The gentleman's time has expired.
The last member to enquire, you will be happy to hear, Mr.
Secretary, is Mr. English.
Mr. English. And thank you, Mr. Chairman. Hopefully, as in
the Bible, the last shall be first.
I thank you for the opportunity to enquire, Mr. Secretary.
There are some things in your budget that I really don't care
for. Probably at the head of that list is the $70 billion in
unitemized Medicare cuts, and I understand why they're in
there.
I do think you deserve credit for having included a number
of tax changes that could be positive. I would specifically
reference the end of the Section 415 restrictions on
multiemployer defined benefit plans, which unnecessarily
restricts the pension rights of many workers in this country.
You have proposed the elimination of the 60-month limit on
student loan interest deduction; that makes a great deal of
sense. You have proposed to extend the exclusion for employer-
provided education assistance to graduate education, and I've
come to recognize how important that is.
Mr. Secretary, I am interested in your comments on earned
income tax credit, because I think the modest proposal you put
forward probably does not increase fraud and is probably worth
doing for the working poor, but that's something that I want an
opportunity to examine.
If I might, because my time is limited, I would appreciate
your written response on a number of points.
One, you proposed modifying the Section 179 expensing
provision for small business, which is a very important
provision, all out of proportion to its size. You propose
putting the additional limit on it, liberalizing it elsewhere,
applying it only to firms with $10 million in gross receipts.
If you would, I am interested in that proposal and I would
like your further justification of it.
[The information was not available at the time of
printing.]
Mr. English. I would like for you to outline for me in
writing, in proposing your exemption of severance pay from
income tax, which seems to be a solid proposal going in the
direction of income stabilization. Why do you apply it only to
the first $2,000, if it's for some reason other than simply
limiting the revenue loss?
[The information was not available at the time of
printing.]
Mr. English. I would look forward to your justification of
your proposal to tax the gains from the sale of a principal
residence if it is a residence that has been obtained through a
``like kind'' exchange within the prior five years. I don't
understand the abuse you're trying to address here, if there is
one. In my view, I don't want to see us move back in the
direction of taxing the capital gains on residences for
taxpayers; that exclusion is one of the best things we've been
able to do in recent years, and I would like you to justify, if
you would, why you have again proposed to moving to monthly
payments of UC taxes for small employers. I don't see that does
anything positive in terms of regulation or recordkeeping
except impose an enormous paperwork burden on many small
employers.
[The information was not available at the time of
printing.]
Mr. English. If you could get back to me in writing on
those, I would like you to comment now--while, as I have noted,
I support some of the things the Administration has proposed in
the area of education tax policy, I am disappointed that you
have not proposed any additional tax break for college savings.
That seems to me to be something that we ought to be
encouraging. We ought to be taking college savings out from aid
calculations.
I wonder if you can comment on why the Administration
didn't pursue this area, and how your proposed college
opportunity tax cut would interact with the Hope Scholarship,
with a phase-out starting at $50,000 in some cases. That, to
me, seems to be an extremely low threshold. I look forward to
your comments.
[The information was not available at the time of
printing.]
Mr. Summers. We will get back to you in writing on the
multiple concerns you raised.
With respect to education, the so-called RSAs, Retirement
Savings Accounts, despite their name, would be available for
college education and would involve withdrawals for college
education. We've had some concerns about how some of the
Education Savings Account proposals could be turned into an
estate planning technique, frankly, and that's why we prefer
our Retirement Savings Account approach.
With respect to the college opportunity deduction, my
understanding is that it would have a substantially higher
income limit than you suggested, somewhat closer to $100,000--
Mr. English. That's for joint filers, though. I think for
single income filings it starts at $50,000 to $60,000, is that
not correct?
Mr. Summers. It is, as you suggest, lower for single
filers.
We also have the existing IRAs and the existing approach to
qualified State tuition plans. Those provide additional
incentives for saving.
With respect to your question about college financial aid
formulas, speaking personally I have very considerable sympathy
for your view, although in the reauthorization legislation a
year or two ago it wasn't possible to make that change in the
higher education area.
My sense is that we now have, particularly if we have the
RSAs, the IRAs, the qualified State tuition plans, very
substantial inducements to save for tuition, but that it is
important also to provide direct assistance as college
educations become economically more important, particularly for
the third and fourth years. Only about a third of Americans who
begin college actually graduate, and that points up the
importance of support in the third and fourth years.
Mr. English. Thank you, Mr. Chairman.
Chairman Archer. The gentleman's time has expired.
Ms. Mathews, thank you for your patience and for appearing
with the Secretary today.
Mr. Secretary, thank you very much. We appreciate your
responses. We appreciate the succinctness with which you
deliver them, and we appreciate your patience for spending so
much time with us today.
There being no further business before the committee, the
committee will stand adjourned.
[The following questions submitted by Chairman Archer, and
Secretary Summer's reponses, are as follow:]
Debt Buyback Plan
1.) How has Treasury's announcement to buy back up to $30
billion of outstanding debt affected the bond market?
The Treasury's announcement that it expects to purchase up
to $30 billion in debt this year has had a positive effect on
the bond market. In a period of budget surplus such as we now
enjoy, debt buybacks allow us to maintain larger, more liquid
issuance of securities while simultaneously preventing an
unjustified increase in the average maturity of the national
debt. In conjunction with Treasury's announced policy of re-
openings for 5, 10 and 30-year notes and bonds, buybacks will
help to preserve the liquidity that is the hallmark of the US
Government securities market.
2.) What is the estimated cost of the debt buyback plan in FY
2001?
Debt buybacks allow us to enhance the liquidity of
Treasury's benchmark securities, which promotes overall market
liquidity and should reduce the government's interest costs
over time. The budget treatment (in accordance with CBO and
OMB) for any price premium is as a ``means of financing.'' This
is the section of the budget that includes funds used for debt
reduction (or borrowed to finance deficits), seigniorage on
coins, changes in Treasury cash balances, and other items that,
like debt buybacks, do not represent a true cost to the Federal
government.
3.) Other countries that implemented debt buyback plans have
abandoned the policy because it created unintended effects.
Have you taken the experience of other countries into account
in announcing this policy, and how do you plan to avoid the
unintended effects that other countries experienced?
The Treasury Department is aware that other countries have
conducted, and still conduct, debt buyback operations somewhat
similar to our own. Canada, for instance, conducts regular debt
buybacks and Sweden recently announced its own buyback program.
However, those countries that have stopped buybacks appear to
have done so for budgetary reasons as opposed to any adverse
effects related to the buyback programs themselves.
Social Security
1.) The President's legislative proposal submitted last fall
dropped the idea of government investing in the stock market,
which he had proposed in two prior versions of his plan. Why
was government investing dropped from the President's bill,
which was introduced by Mr. Gephardt and Mr. Rangel, among
others? Why was the provision revived in the most recent plan?
The President believes that part of the new Social Security
solvency transfers should be invested for higher returns, and
he has held this belief consistently ever since he put forward
his first framework for Social Security reform in the 1999
State of the Union address. The President omitted this proposal
from the legislation he submitted in October because it was
late in the Congressional session and he was looking for
agreement on a starting point for Social Security reform. The
President recognized that implementing a plan that included
investing the solvency transfers in equities is a complex
process that requires substantial discussion. So, in the
interest of a bipartisan agreement, he put forward a plan he
thought could attract support from a wide spectrum of opinion
in the Congress in a very short amount of time. This year, with
the benefit of a full Congressional year before him, the
President returned to a full specification of the package he
believes should be put in place to shore up Social Security for
the long term.
2.) Why does the President's plan wait until 2011 to transfer
``interest savings'' to the Social Security Trust Funds? Why
aren't the interest savings transferred this year to gain
compounded returns immediately?
First, the policy begins in Fiscal Year 2001, with the
reduction in publicly held debt from the Social Security
surpluses and the associated interest savings. It is these
interest savings that are credited to the Social Security Trust
Fund, starting in 2011.
Second, the problems facing Medicare are more immediate
than those facing Social Security. At the time the President
put forward his budget the Hospital Insurance (Medicare Part A)
Trust Fund was projected to be exhausted in 2015, compared with
2034 for the Social Security Trust Fund. Even now, it is still
projected to be insolvent 12 years earlier, in 2025, compared
to 2037 for Social Security. Therefore, the President has
proposed using $299 billion of the on-budget surpluses over the
next ten years to strengthen Medicare.
Third, on-budget resources are limited. Within these
limits, the President put forward a framework that keeps the
on-budget account in balance or surplus; preserves core
government functions at realistic levels; extends Social
Security solvency and Medicare solvency; provides a long-
overdue Medicare prescription drug benefit and extends health
insurance to millions of currently uninsured Americans; pays
down the national debt by 2013; and provides tax cuts that are
affordable, targeted, and progressive.
3.) How does the President's plan seek to protect the Trust
Fund investments from political interference? What firewalls
are in place?
The President has emphasized that the Administration and
Congress must work together to put mechanisms in place that
ensure that any investments are made independently and without
political interference.
The President has proposed that equity investment be
implemented in a manner that:
Is independent and non-political;
Uses the most effective private sector management
services;
Invests with a broad-based, neutral approach; and
Minimizes administrative costs.
One approach that would satisfy these principles would be
to establish an independent Social Security investment board.
This board would, in turn, engage private money managers in a
competitive process for the right to manage a portion of the
Trust Fund's equity investment. These managers would each be
instructed to invest their pool of money ``passively''--that
is, according to a broad-based index of equity prices that
reflects the movement of all or a very substantial portion of
the equity market. Overall investment of the Trust Fund in
equities would be strictly limited--to no more than 15 percent
of the total value of the Trust Fund. We anticipate that total
Trust Fund holdings would average about 3 percent of the
overall market over the next 30 years.
We are confident that these protections will result in an
investment structure that is maximally effective in
strengthening the financial standing of the system. The Federal
government's Thrift Savings Plan is a good example of how we
expect the equity investment to be managed.
4.) Why hasn't the President submitted a plan that saves Social
Security for 75 years--his stated goal in the State of the
Union address in 1998?
The President has consistently stated that achieving full
75-year solvency would require a bipartisan effort. He has also
consistently believed that he could best move that effort
forward by working with the Congress to jointly develop a
bipartisan plan, rather than by unilaterally putting forward a
plan of his own. That said, the President clearly has taken the
first step. He submitted a budget that, under the assumptions
underlying last year's Trustees' Report, would extend the
solvency of the Social Security Trust Fund from 2034 to 2054.
With the President's reforms, the 75-year actuarial deficit
would have been reduced by more than half, from 2.07 percent of
taxable payroll to 0.80 percent. (Under the assumptions of the
2000 Trustees' Report, the President's proposal would extend
solvency from 2037 to 2058, and reduce the 75-year actuarial
deficit from 1.89 percent of taxable payroll to 0.67 percent.)
The President encourages Congress to work with him in a
bipartisan fashion to close the rest of the 75-year solvency
gap through sensible reforms to the Social Security system.
5.) The latest plan has a ``safeguard'' mechanism to ensure
that the general revenue transfers do not exceed the size of
the on-budget surplus in any given year. Since the plan relies
on annual transfers from 2011 through 2050, is OMB projecting
that we will have sizeable on-budget surpluses every year for
the next 50 years to make this plan work? If the surpluses do
not materialize, what will happen to Social Security's
solvency? Do you have an alternate plan for Social Security in
case these surpluses do not materialize over the next 50 years?
OMB is indeed currently projecting that, under current
policy, the on-budget account would remain in balance past
2050. This projection was developed under conservative economic
assumptions--in fact, slightly more conservative than either
CBO's or the Blue Chip consensus. Many respected private
forecasters have more optimistic projections. For seven years
in a row, throughout the Clinton Administration, both economic
and budget results have been better than predicted.
Our policy of paying down the debt and securing the future
of Social Security and Medicare is the best insurance against
adverse developments in the future. Eliminating the publicly
held debt by 2013 frees up the 13 percent of Federal spending
now going to interest payments. And we believe the benefits of
debt reduction should be earmarked to meeting our existing
commitments to Social Security and Medicare, not to create new
obligations.
The ``safeguard'' referred to in the FY 2001 Budget places
annual dollar-specified limits on the maximum amount of the
general revenue transfers to the Social Security Trust Fund.
The general revenue transfers in the President's budget are
based on the amount of interest savings from using the Social
Security surpluses to reduce publicly held debt, up to these
limits. If the actual on-budget surpluses turn out to be
smaller than projected, the transfers to the Trust Fund would
still occur. Even in that event, we would still be better off
having used the resources to improve the net financial position
of the government than to have paid for new spending or new tax
cuts. Even with adoption of the President's proposal, the Trust
Fund would be exhausted in 2058, and the 75-year actuarial
deficit would be 0.67 percent of taxable payroll, under the
assumption underlying the 2000 Trustees' Report. A bipartisan
effort will still be needed to close the remainder of the 75-
year gap.
6.) The President's plan extends Social Security's solvency
through 2054, according to Social Security's actuaries. Does
this mean that the President's plan ensures that taxes will not
need to be raised and benefits will not be reduced before 2054?
First, the 2054 figure is a projection, based on economic
and demographic assumptions. Actual performance of the Social
Security Trust Fund could be better or worse than projected,
which could result in the need for additional measures to
secure Social Security's solvency even to 2054.
Second, the fact that OMB is projecting on-budget surpluses
past 2050 means that it will be possible to implement the
President's Social Security plan while paying full benefit and
not increasing taxes. In fact, OMB's projections are based on
the President's policy, which cuts taxes below the baseline
with targeted tax cuts totaling $256 billion from 2001-10.
[Whereupon, at 2:27 p.m., the hearing was adjourned, to
reconvene at the call of the Chair.]
[Submissions for the record follow:]
Statement of the Air Courier Conference of America International, Falls
Church, VA
This statement is submitted by the Air Courier Conference
of America (``ACCA'') in conjunction with the House Ways and
Means Committee's February 9 hearing on President Clinton's
proposed budget for fiscal year 2001. ACCA is the trade
association representing the air express industry. Its members
include large firms with global delivery networks, such as DHL
Worldwide Express, Federal Express, TNT U.S.A. and United
Parcel Service, as well as smaller businesses with strong
regional delivery networks, such as Global Mail, Midnite
Express and World Distribution Services. Together, our members
employ approximately 510,000 American workers. Worldwide, ACCA
members have operations in over 200 countries; move more than
25 million packages each day; employ more than 800,000 people;
operate 1,200 aircraft; and earn revenues in excess of $50
billion.
ACCA would like to comment on one aspect of the President's
proposed budget as it relates to the U.S. Customs Service. This
is a critical area of interest to our industry because Customs
administrations play a vital role in ensuring expeditious
movement of goods across borders and consequently are critical
to our industry's ability to deliver express international
service. To give a sense of the size of our industry in U.S.
trade--and as a customer of U.S. Customs--the express industry
accounts for roughly 25 percent of all Customs formal and
informal entries. In addition, express operators enter more
than 10 million other manifest entries on low-value shipments,
plus millions of clearances on letters and documents. In short,
the flow of international commerce carried by express operators
has become a significant portion of the total entering the
United States, and American business has incorporated express
service as an integral part of regular business operations.
Express operators and these American businesses are highly
dependent upon an efficient and effective Customs Service.
For the U.S. Customs Service to be efficient and effective,
it must have modern, fully functional automation systems.
Unfortunately, as the Ways and Means Committee knows, the
current Customs automation system--the Automated Commercial
System, or ACS--is antiquated and in desperate need of
replacement. ACCA is extremely concerned about the pending
obsolescence of ACS because the express industry operates in a
virtual seven-day, 24-hour mode and thus relies on automation
more than any other mode of transportation. We have invested
tens of millions of dollars in automated systems designed to
expedite shipment and delivery of goods within an express
timeframe. An interruption in Customs' automation programs
would devastate our ability to meet our express delivery
deadlines and would harm a significant portion of the U.S.
economy.
ACCA is extremely concerned that the Clinton Administration
budget for FY2001 once again fails to acknowledge the critical
importance to the U.S. economy of maintaining and improving an
automated Customs environment. The budget proposes a new user
fee to pay for Customs' automation programs, with the
expectation that this would generate $210 million in the next
fiscal year. First, this proposal fails to acknowledge the true
cost for Customs to maintain its existing system, ACS, and
develop a next-generation automation regime. The actual cost of
this effort is probably close to $400 million annually. Second,
the Clinton budget proposal fails to acknowledge the fact that
the trading community has been and continues to pay an enormous
annual stipend in the form of the merchandise processing fee
(MPF) that should be directed to U.S. Customs' operations,
including automation programs. MPF revenues total about $900
million annually and would be more than enough to pay for
Customs automation programs. However, the MPF revenues have not
been channeled to U.S. Customs; instead, they have gone to the
general revenue fund of the U.S. Treasury.
With respect to user fees for Customs services, the express
industry has a unique perspective because we pay for dedicated
Customs resources at our facilities; this is a revenue source
distinct from the MPF paid on entry. In order to obtain
inspectional services whenever needed at our hub and express
consignment facilities, the express industry agreed about 12
years ago to pay ``reimbursables'' to Customs. These fees are
supposed to cover the costs to Customs of providing inspectors
when needed. However, in recent years the cost of reimbursables
has escalated well beyond the understood intent of the law and
regulations, to the extent that reimbursables have become a
serious burden on the express industry. Reimbursable charges
cost the industry more than $20 million last year--and the
bills are mounting rapidly. On top of that, the express
industry generated in excess of $75 million in MPF revenues in
1999. Since the MPF collected already exceeds the cost of
services provided by Customs for express operations, the
reimbursables system represents a hidden tax that is borne by
the express industry and that is ultimately paid by U.S.
importers. Yet, notwithstanding the significant user fees we
already pay to U.S. Customs, we are facing a situation where we
may not be able to provide express international service
because of possible breakdowns in Customs' automation systems.
ACCA commends the Ways and Means Committee for opposing
past Clinton Administration proposals to impose user fees on
the trading community to pay for Customs automation, and we
urge Congress to deny once again the Clinton Administration's
request for a user fee for FY2001. However, we also urge
Congress to recognize the critical need for new Customs
automation systems and to acknowledge the fact that the trading
community has already been paying for such a service without
receiving any return on its investment. If Customs automation
programs are allowed to founder for an additional year without
any appropriated monies, the consequences could be dire for the
entire U.S. economy. Therefore, ACCA urges Congress, as part of
its FY2001 budgetary process, to appropriate MPF monies
specifically for the development of a next-generation Customs
automation program.
Statement of the Alliance of Tracking Stock Stakeholders
I. Position Statement
The Administration's proposal to impose a tax on certain
distributions or exchanges of tracking stock (Tracking Stock)
is unsound tax policy which, if enacted, will harm
shareholders. It will also restrain new business and technology
investment and development, cost jobs, cause severe harm to
companies with Tracking Stock presently outstanding, and reduce
business expansion.
In 1999, a substantial majority of the members of the House
Ways and Means Committee (28 of 39 members) opposed a proposal
by the Administration to impose a tax on corporations that
issue tracking stock. The Committee should reject the current
Administration proposal because it is even more onerous than
last year's proposal for a number of reasons:
It imposes a tax on shareholders upon the receipt
of Tracking Stock in a distribution or recapitalization, even
though the shareholder's overall investment in the corporation
remains the same before and after the receipt of the Tracking
Stock.
The shareholder does not receive any cash with
which to pay the taxes imposed and could be forced to liquidate
part of his/her investment.
The proposal gives the Treasury Department the
authority to treat Tracking Stock as non-stock or as stock of
another entity ``as appropriate for other purposes,'' thus
granting the Treasury unlimited authority to impose a tax on
corporations that issue Tracking Stock.
The new Treasury Department authority could
preclude companies with Tracking Stock from being able to
engage in ordinary nontaxable corporate recapitalizations
(e.g., stock for stock exchanges) and distributions, thus
limiting their ability to compete with companies with
traditional equity structures.
Therefore, this proposal should be rejected.
The issuance of Tracking Stock is motivated by
compelling business needs. It provides a market-efficient
source of capital, particularly to corporations attempting to
grow lines of business that would not be valued appropriately
by the equity markets without Tracking Stock.
The proposal, if enacted, would eliminate a
valuable source of capital to new businesses, deter the use of
Tracking Stock, and possibly also force companies with over
$500 billion of equity securities outstanding or pending to
recapitalize at a considerable cost to them and to their
shareholders.
If Treasury becomes aware of inappropriate uses of
Tracking Stock, it should resolve the issues administratively
(through Treasury regulations and pronouncements) in a targeted
way that avoids adverse consequences to business-driven
Tracking Stock issuers. In abusive situations, Treasury has
authority under current law to do this.
The revenue estimates are unrealistic. The
proposal would economically eliminate the use of Tracking Stock
and provide little if any revenue to the Treasury.
II. Definition of Tracking Stock
Tracking Stock is a type of equity security issued by some
companies to track the performance or value of one or more
separate businesses of the issuing corporation. The holder of
Tracking Stock has the right to share in the earnings or value
of less than all of the corporate issuer's earnings or assets
while retaining voting rights, liquidation rights and other
risks of the issuing corporation as a whole. The Tracking Stock
instrument has developed largely in response to the dual
economies arising from the equity market's preference for
``pure-play'' securities (i.e., pure, single line of business
companies) and the debt market's preference for diversified
corporate balance sheets.
III. Business Considerations
Since General Motors first used it as an acquisition
currency in September 1984, to acquire Electronic Data Systems
Corporation (EDS), Tracking Stock has found wide receptivity by
shareholders in North America.
To date, a total of 23 public companies have issued 33
separate Tracking Stocks for a variety of business reasons
including:
Acquisitions
Growth of start-up businesses
Source of equity capital
Creation of stock-based employee incentive
programs
Continuation of economies of scale for
administrative costs
Retention of operating synergies
Maintenance of consolidated credit and existing
borrowing arrangements
Valuation enhancement
Increasing shareholder knowledge, and
Broadening of the investor base
Numerous real-life examples demonstrate the beneficial
impact the issuance of Tracking Stock has had on the U.S.
economy:
USX Corporation raised sufficient capital, through
its U.S. Steel Tracking Stock, to modernize its steel
operations and transform U.S. Steel from a company that
generated billions of dollars in losses throughout most of the
80's into a more efficient steel company. It is the largest
employer in the domestic steel industry, with high paying jobs,
generating taxable income rather than losses and paying
substantial income and payroll taxes to federal, state and
local governments.
Genzyme Corporation, a biotechnology company
founded in 1981, develops innovative products and services to
prevent, diagnose, and treat serious and life-threatening
diseases. It initiated its use of Tracking Stock in 1994 when
it founded a new program to develop tissue repair technologies.
More recently, it adopted a new Tracking Stock to fund
molecular oncology research, including cancer vaccine clinical
trials in breast, ovarian and skin cancer.
Perkin-Elmer (now PE Corporation), a high
technology company, chose Tracking Stock for several business
reasons including: facilitating new business and technology
development; recruiting and retaining key employees; exposing
and facilitating appropriate valuation for new technology
opportunities; and providing flexibility for raising future
capital and optimizing further development and expansion of
each of its businesses.
The economic benefits of Tracking Stock to these and other
companies will be substantially eliminated if a tax is imposed
on shareholders or issuers.
IV. Financial Market Impact of the Administration's Budget
Proposal to Tax Tracking Stock
Should the Tracking Stock proposal be enacted,
many future uses of Tracking Stock would be deterred and
companies currently capitalized with Tracking Stock--and their
shareholders--would be severely impacted. The imposition of tax
upon the issuance or exchange of equity to shareholders would
effectively shut down a Tracking Stock company's ability to
access the equity capital markets.
The new Treasury Department authority could
preclude companies with Tracking Stock from being able to
engage in ordinary non-taxable corporate recapitalizations
(e.g., stock for stock exchanges) or distributions, thus
limiting their ability to compete with companies with
traditional stock structures.
The proposal would seriously reduce the ability of
Tracking Stock companies to raise capital through the debt
markets. It would undermine their credit worthiness in the
marketplace by hampering their ability to continue to use
Tracking Stock to raise equity to strengthen their balance
sheets and build their businesses in a cost efficient manner.
High-technology companies in particular would lose
a medium used to attract and retain key personnel.
As a result of these consequences, investors would
see Tracking Stock as an inefficient capital structure and
equity valuations would suffer.
Ultimately, as a result of this Tracking Stock
proposal, over $500 billion of equity securities currently
outstanding or pending could need to be restructured at great
cost and under intense market pressure, causing a loss of
shareholder investment and competitive vulnerability.
V. Tax Policy Considerations
Treasury states that the use of Tracking Stock is outside
the contemplation of subchapter C and other sections of the
Internal Revenue Code. Treasury also states that receipt of
Tracking Stock by a shareholder in a distribution or exchange
for other stock of the issuing corporation is a recognition
event, as the shareholder has altered its interest in the
issuing corporation. Both of these statements are wrong.
Tracking Stock is consistent with subchapter C of
the Internal Revenue Code because the tracked business remains
in the same corporation and the Tracking Stock represents
equity in that same corporation.
Tracking Stock does not reduce a corporation's tax
liability compared to its tax liability prior to the issuance
of Tracking Stock. Thus, revenues to the U.S. Treasury are the
same before and after the initial transaction. If the tracked
business is successful, however, it will generate taxable
income, create jobs, and pay additional taxes to federal, state
and local governments. Likewise, increased equity valuations
generate additional capital gains for individuals.
Tracking Stock is not used to circumvent the
requirements of section 355 of the Internal Revenue Code,
including the Morris Trust provisions in section 355(e).
Unlike Morris Trust transactions, corporations do
not use Tracking Stock to dispose of businesses tax-free.
Tracking Stock is a vehicle used for building and maintaining
business assets within a single corporation.
Tracking Stock does not result in a sale of the
tracked business. Subsequent to adopting Tracking Stock, a
corporation will recognize gain on any future disposition of
the tracked assets, unless all of the provisions of Section 355
are satisfied.
A shareholder receiving Tracking Stock has not
altered his/her overall investment in the issuing corporation.
The shareholder continues to own an equity
interest in the same corporation, continues to have voting
rights in the same corporation, and continues to participate in
the growth of the same corporation.
Although dividends paid to the shareholder on
Tracking Stock may be based on the performance of a division or
subsidiary, and not on the entire issuing corporation, the
dividends are still subject to limitations at the corporate
level.
It is inappropriate to tax a shareholder at the
time he/she receives Tracking Stock in a distribution or
exchange for other stock of the issuing corporation, as the
shareholder has received no cash to use to pay the tax. The
shareholder may be required to liquidate a portion of his/her
holdings to pay the tax. The proper time for taxation is when
the shareholder disposes of the Tracking Stock.
Corporations do not issue Tracking Stock for tax
reasons. The fiduciary responsibilities incumbent on the
directors of a corporation with Tracking Stock (i.e., to
multiple shareholder interests) far outweigh any conceivable
tax motivation.
Legislation is unnecessary. In abusive situations,
Treasury has authority to address transactions it perceives as
inappropriate under current law, through regulations and
pronouncements, in a way that avoids adverse consequences to
business-motivated Tracking Stock issuers.
A statutory attack is unnecessary and
inappropriate because:
It harms shareholders by reducing the market value
of their shares and by imposing a tax upon a distribution or
exchange of Tracking Stock.
It harms employees and customers. Unless a
replacement source of capital is found, businesses will scale
back operations, adversely impacting employees, customers, and
the communities in which the companies operate.
It harms corporations, impairing their equity and
adversely impacting their ability to raise capital.
It adds more complexity to the Internal Revenue
Code.
Tracking Stock transactions undertaken to-date
have been driven by business considerations. The complexities
associated with the issuance of Tracking Stock should prevent
it from becoming a tax motivated vehicle. Tracking Stock is
only appropriate for those companies for which the business
advantages outweigh the complexities. These complexities
include:
The fiduciary responsibilities of the Board of
Directors to shareholders of all classes of common stock, which
may create conflicts.
Each Tracking Stock business has continued
exposure to the liabilities of the consolidated entity.
The Administration's published revenue estimates
for the proposal are unrealistic. Taxing Tracking Stock at
issuance or upon receipt by shareholders would make it non-
competitive relative to other sources of capital. Thus, the
legislation would generate little or no revenue.
VI. Conclusion
Last year, the Administration proposed to tax corporations
when they issued Tracking Stock to their shareholders. This
year, the Administration proposes instead to tax shareholders
when corporations issue Tracking Stock to them. The same tax
considerations that mandated rejection of last year's proposal
also require rejection of this year's proposal. Indeed, this
new proposal is even more onerous as it attempts to impose tax
on shareholders who have sold nothing and have received no cash
with which to pay the tax.
Issuance of Tracking Stock is motivated by compelling
business needs. Treasury's Tracking Stock proposal will disrupt
financial markets and cause severe harm to companies with
Tracking Stock since it will not only restrict access to
capital in the future, but also require massive financial re-
engineering for some companies. Individual investors, and
possibly entire communities in which Tracking Stock companies
operate, will be adversely affected as a result of the
competitive pressures this tax would impose.
Alliance of Tracking Stock Stakeholders
The Alliance is an informal group of companies that
currently utilize or are considering using Tracking Stock.
Members of the Alliance include companies such as Cendant
Corporation, Circuit City, Comdisco Inc., General Motors,
Genzyme Corporation, PE Corporation, Quantum Corporation,
Staples Inc., The Walt Disney Company, USX Corporation, and
others. These companies share a common concern for the value of
shareholder investment in tracking stocks, as well as their
continued ability to meet various business objectives through
the issuance of tracking stock. For further information,
contact Scott Salmon, Manager, Governmental Affairs, USX
Corporation, 202-783-6797.
Statement of American Association for Homecare, Alexandria, VA
The American Association for Homecare is pleased to submit
the following statement to the House Ways and Means Committee.
The American Association for Homecare is a new national
association resulting from the merger of the Home Care Section
of the Health Industry Distributors Association, the Home
Health Services and Staffing Association and the National
Association for Medical Equipment Services. The American
Association for Homecare is the only association representing
home care providers of all types: home health agencies and home
medical equipment providers, be they not-for-profit,
proprietary, facility-based, freestanding or governmentally
owned.
What is a Home Health Agency?
Home Health Agencies provide skilled nursing care, therapy
and home health aide services to individuals recovering from
acute illnesses and living with chronic health care conditions.
Health care services in the home setting provide a continuum of
care for individuals who no longer require hospital or nursing
home care, or seek to avoid hospital or nursing home admission.
The range of home care services includes skilled nursing;
respiratory, occupational, speech, and physical therapy;
intravenous drug therapy; enteral feedings; hospice care;
emotional, physical, and medical care; assistance in the
activities of daily living; skilled assessments; and
educational services.
What is an HME Provider?
Home medical equipment (HME) providers supply medically
necessary equipment and allied services that help beneficiaries
meet their therapeutic goals. Pursuant to the physician's
prescription, HME providers deliver medical equipment and
supplies to a consumer's home, set it up, maintain it, educate
and train the consumer and caregiver in its use, provide access
to trained therapists, monitor patient compliance with a
treatment regimen, and assemble and submit the considerable
paperwork needed for third party reimbursement. HME providers
also coordinate with physicians and other home care providers
(e.g., home health agencies and family caregivers) as an
integral piece of the home care delivery team. Specialized home
infusion providers manage complex intravenous services in the
home.
Home Care is Just Beginning
Over the last two decades, advances in medical technologies
and changes in Medicare's payment structure have spurred a
considerable growth in the use of home care. As in every other
aspect of modern medicine, home health care has benefited from
an explosion of new and emerging technologies. From the use of
space-age materials to make wheelchairs and mobility aids
lighter, to the application of micro-chip computer technology
in implantable devices used to dispense critical medication,
technology makes it possible for the care received in the home
to equal or exceed that received in a hospital, at a fraction
of the cost. Today, it is common for a Medicare beneficiary to
undergo chemotherapy in the comfortable surroundings of his or
her own home, a fete that was inconceivable just a few years
ago. In the future, advances in tele-medicine and similar
technologies will make it possible to further reduce health
care costs and improve the quality of health care provided in
the home. None of these advances could have been envisioned at
Medicare's inception in 1965.
Recent changes to Medicare's payment system have also
spurred a growth in home health utilization. In the late
1980's, the Health Care Financing Administration's (HCFA's)
rigid definition of the coverage criteria for home health
services was struck down by a United States District court,
making it possible for more beneficiaries to access home health
services. At roughly the same time, Medicare instituted a
prospective payment system for hospital inpatient care, which
reimbursed hospitals according to the patient's diagnosis
regardless of the number of days spent in the institution.
Together, these changes have resulted in a situation where
more Medicare-eligible beneficiaries are arriving home
``quicker and sicker'' than ever before. In turn, these
beneficiaries require increasingly complex health services. All
indicators show that as the 'baby-boomers' continue to age,
this trend will continue. The American Association for Homecare
believes that the increased utilization of home health care
prompted by these changes should be seen as a rational response
to the changing needs of Medicare beneficiaries and the
increased ability of home health providers to meet these needs.
Home Care is Economical
Importantly, home care is not only patient-preferred, it is
also cost effective. Numerous studies \1\ have shown that home
care providers are a cost-efficient component of the healthcare
delivery system, as they help keep beneficiaries out of costly
inpatient programs. One study, conducted by an independent
research organization, particularly demonstrates these savings.
This study, The Cost Effectiveness of Home Health Care,
examines the highly successful In-Home/CHOICE program
instituted by the State of Indiana in 1985. Indiana provides
100% of the funding for this program, which covers the costs of
home health care for qualified residents in need of long term
care in order to prevent institutionalizations.
---------------------------------------------------------------------------
\1\ For recent studies, please see:
Styring, William & Duesterberg, Thomas, The Cost
Effectiveness of Home Health Care: A Case Study on Indiana's In-Home/
CHOICE Program, (Vol. 1, No. 11), November 1997, (Hudson Institute,
Indianapolis, IN).
Mann, Williams C. et al, ``Effectiveness of Assistive
Technology and Environmental Interventions in Maintaining Independence
and Reducing Home Care Costs for the Frail Elderly,'' Archives of
Family Medicine, May/June 1999 (Vol. 8, pp. 210-217).
---------------------------------------------------------------------------
The authors of the Study note that the coming crisis in
health care funding for America's rapidly growing elderly
population could be alleviated by home health care programs
such as Indiana's. By avoiding institutionalized care, Indiana
was able to reduce inpatient caseload costs by 50% or more,
while allowing patients to receive care in the comfort of their
own homes. The cost savings associated with this increased
reliance on home care were considerable. The study states that
home care for the elderly in Indiana can be provided for one
half the cost of skilled nursing facility care. Similar care
for the disabled costs 1.5 times more in a skilled facility
than in the home. In addition, the quality control and
screening procedures used in the Indiana program have
successfully avoided problems with fraud and abuse. The Hudson
Institute Study concludes that ``Properly crafted and
administered, home health care can play a critical role in
helping society meet the looming health care needs of the 'Baby
Boom' generation.''
Resist the Rush to Competitive Bidding
The President's budget proposal includes a provision that
would expand and strengthen Medicare's competitive bidding
authority. The American Association for Homecare urges the
Committee to withhold support for competitive bidding for
Medicare Part B durable medical equipment, prosthetics,
orthotics and supplies (DMEPOS) until the results of the
current demonstration project can be fully evaluated.
As the Committee is aware, the first demonstration project
testing competitive bidding for DMEPOS services has just begun
in Polk County, Florida. This project is a necessary first step
to determine whether Medicare can effectively administer a
competitive bidding program, whether it will achieve savings,
and whether it will maintain access to quality HME services.
Currently, very little is known about the administration or
long-term impacts of such a complicated change to the DMEPOS
benefit. The demonstration project will not be completed until
the end of 2002.
Our concerns about the undue rush to implement national
competitive bidding are bolstered by the fact that competitive
bidding for HME services has been tried and rejected in the
Ohio, Montana, and South Dakota state Medicaid programs. These
states cited increased administrative costs and serious
management problems as reasons for dropping competitive
bidding. Each state also experienced an actual reduction in
competition among providers (and, consequently, higher bid
prices) and reduced access to provider support services.
The Polk County Demonstration
The American Association for Homecare is particularly
concerned that HCFA's current competitive bidding plan
threatens access to important health services. Home medical
equipment (HME) such as oxygen equipment cannot be drop-shipped
to patients; the therapeutic support services offered by HME
providers are as crucial to positive health outcomes as the
equipment itself. We are concerned that the 'winning' bidders
in Polk County will face budget pressures that lead them to
eliminate these important therapeutic services, which are not
separately reimbursed by Medicare (e.g., preventative
maintenance, patient education, 24-hour on call service, the
professional care of respiratory therapists, and the furnishing
of supplies). If these services are eliminated, beneficiaries
will be much more likely to experience negative health
outcomes.
Importantly, beneficiaries in the demonstration area have
lost their ability to choose their own HME provider. These
beneficiaries are not granted the option to ``opt out'' of the
demonstration; they are forced to use the ``winning'' bidders
if they want Medicare to continue to cover their HME needs. A
beneficiary who is dissatisfied with the quality of products or
the level of the services provided to him/her through the
bidding program will have very limited alternatives. Medicare's
winning bidders, therefore, are not being subject to the market
forces of consumerism.
Although the demonstration is only months old, a number of
problems have already emerged. In fact, the parent company of
one winning bidder has filed for Chapter 11 protection and some
beneficiaries have expressed confusion about the availability
of providers. HCFA has not yet examined the impact of the
demonstration on beneficiary satisfaction or health outcomes.
The American Association for Homecare urges the Committee to
examine carefully the results of this demonstration and the
suitability of the demonstration design before expanding the
demonstration to other areas.
Eliminate Additional Cuts to the Home Health Benefit
The American Association for Homecare urges the Committee
to maintain Medicare beneficiaries' access to home health
agency services by eliminating the additional 15% payment cut
scheduled to be implemented on October 1, 2001. Home health
reimbursements have already been reduced by much larger amounts
than originally forecasted, and the most frail elderly are
experiencing problems with access to home health care. The
addition 15% reduction will only exacerbate these problems.
The Balanced Budget Act of 1997 (BBA, P.L. 105-33) was
originally scored to reduce the home health benefit by
approximately $16.1 billion over five years. However, the
actual impact of the BBA was much more dramatic. In March 1999,
the Congressional Budget Office (CBO) revised their estimate to
a reduction of more than $48 billion over five years, more than
twice the intended amount. In January 2000, HCFA announced that
home health services had a rate of growth of -4%, less than any
other health care sector. Unfortunately, reductions such as
this have an inevitable impact on the availability of the home
health benefit. The most significant concern has been lack of
access for eligible Medicare beneficiaries to the home health
benefit.
The George Washington University's Center for Health
Services Research & Policy has released two studies reviewing
the impact of BBA 97 on home health patients and providers. The
studies provide the following points:
1. The number of Medicare home health patients has declined
by 50% from 1994 levels and by 21% as a percentage of all
patients in 1998 alone.
2. Patients who were most likely to lose access to covered
services under the interim payment system included those
suffering from complex diabetes, congestive heart failure,
chronic obstructive pulmonary disease, multiple sclerosis, skin
ulcers, arthritis, and mental illness.
3. 68 percent of hospital discharge planners surveyed
report increased difficulty in initially obtaining home health
services for Medicare beneficiaries.
4. 56 percent of respondents report increases in the number
of beneficiaries requiring substitute placements, primarily in
skilled nursing facilities, in lieu of home health services.
The American Association for Homecare urges this Committee
to avoid further disruptions in access to home health care by
permanently eliminating the scheduled additional 15% reduction.
Home Health Prospective Payment System
The American Association for Homecare strongly supports the
implementation of the prospective payment system for home
health agencies. The BBA mandated HCFA develop a PPS to be
implemented in October 1999. HCFA requested a further delay
until October 2000 and Congress granted that request.
During the development of PPS, the home health industry is
being reimbursed under an interim payment system (IPS). The
interim payment system was implemented for cost reporting
periods beginning on October 1997. IPS changed the way home
health agencies were reimbursed by setting new limits and
removing the old cost-based incentives. As stated above, the
IPS imposed significant losses on home health agencies and
resulted in reductions more than double the 1997 baseline
developed by the CBO.
Home health agencies were unable to receive from HCFA
definitive information on what their reimbursement would be
under IPS until a year or more into the new system. The home
health agencies were then required to reimburse HCFA for
overpayments made during the first year. The inability of home
health agencies to access the accurate reimbursement
information needed to plan appropriately for the care of
beneficiaries negatively impacted home health patients and
providers alike.
It is crucial for HCFA and Congress to work with home
health providers as the new reimbursement system is implemented
to ensure access to care for beneficiaries while providing
needed information to home health providers and fiscal
intermediaries.
Conclusion
Home health care continues to evolve and expand to meet the
increasingly complex needs of today's Medicare beneficiaries.
By capitalizing on technical innovation, home care providers
can conduct increasingly complex medical and therapeutic
regimens in the comfort of beneficiary's own homes. In
addition, recent studies have shown that an expanded home care
benefit would reduce Medicare expenditures by avoiding costly
institutionalizations. We urge the Committee to recognize the
many benefits of home care by strengthening Medicare's
commitment to the home health benefit.
Statement of American Bankers Association
The American Bankers Association (ABA) is pleased to have
an opportunity to submit this statement for the record on
certain of the revenue provisions of the Administration's
fiscal year 2001 budget.
The American Bankers Association brings together all
categories of banking institutions to best represent the
interests of the rapidly changing industry. Its membership--
which includes community, regional and money center banks and
holding companies, as well as savings associations, trust
companies and savings banks--makes ABA the largest banking
trade association in the country.
The Administration's Fiscal Year 2001 budget proposal
contains a number of provisions of interest to banking
institutions. Although we would welcome certain of those
provisions, we are once again deeply concerned with a number of
the Administration's revenue raising measures. Many of the
subject revenue provisions are, in fact, thinly disguised tax
increases rather than ``loophole closers.'' As a package, they
would inhibit job creation and inequitably penalize business.
The package may also lead to the reduction of employee and
retiree benefits provided by employers.
Our views on the most troubling provisions are set out
below.
REVENUE INCREASE MEASURES
Modify the Corporate-Owned Life Insurance Rules
The ABA strongly opposes the Administration's proposal to
modify the corporate-owned life insurance rules (COLI). We urge
you not to enact any further restrictions on the availability
of corporate owned life insurance arrangements. We believe that
the Administration's proposal will have unintended consequences
that are inconsistent with other congressional policies, which
encourage businesses to act in a prudent manner in meeting
their liabilities to employees. Corporate-owned life insurance
as a funding source has a long history in tax law as a
respected tool. The Health Insurance Portability Act of 1996
eliminated deductions for interest paid on indebtedness with
respect to policies covering officers, employees, or
financially interested individuals. However, that legislation
allowed deductions with respect to indebtedness on COLI
covering up to 20 ``key persons'' (defined generally as an
officer or a 20-percent owner of the policy owner). The
Taxpayer Relief Act of 1997 applied a pro rata formula to
disallow the deduction of a portion of a taxpayer's total
interest expense with respect to COLI. That legislation
provided a broad exception for policies covering 20-percent
owners, officers, directors, or employees. Accordingly,
Congress has effectively ratified continued use of COLI,
pursuant to the requirements of those rules. In this
connection, taxpayers have, in good faith, made long term
business decisions based on existing tax law. They should be
protected from the retroactive effects of legislation that
would result in substantial tax and non-tax penalties.
Moreover, federal banking regulators recognize that
corporate-owned life insurance serves a necessary and useful
business purpose. Bank regulatory guidelines confirm that
purchasing life insurance for the purpose of recovering or
offsetting the costs of employee benefit plans is an
appropriate purpose that is incidental to banking.
The subject provision would effectively eliminate the use
of corporate-owned life insurance used to offset escalating
employee and retiree benefit liabilities (such as health
insurance, survivor benefits, etc.). It would also penalize
companies by imposing a retroactive tax on those that have
purchased such insurance. Cutbacks in such programs may lead to
the reduction of benefits provided by employers. We urge you
to, once again, reject this revenue proposal.
However, should any legislative change in this area be
contemplated, we would urge that the following principles
apply. Any proposal should:
Be prospective and should not put businesses that
made decisions based on existing law in a disadvantaged
position.
Only apply to contracts entered into after the
date of enactment. Any premiums paid after the date of
enactment with respect to contracts written prior to the date
of enactment should be grandfathered.
Continue to allow tax-free exchanges of insurance
contracts.
Create a ``safe harbor'' exception to general
interest disallowance for COLI to protect a certain level of
COLI.
Increased Information Reporting/Substantial Understatement
Penalties
The ABA strongly opposes the Administration's proposal to
increase penalties for failure to file information returns. The
Administration reasons that the current penalty provisions may
not be sufficient to encourage timely and accurate reporting.
We disagree. The banking industry prepares and files a
significant number of information returns annually in good
faith for the sole benefit of the Internal Revenue Service
(IRS). The suggestion that the Administration's proposal closes
``corporate loopholes'' presumes that corporations are
noncompliant, a conclusion for which there is no substantiating
evidence. Further, there is no evidence available to support
the assertion that the current penalty structure is inadequate.
Certainly, the proposed penalty increase is unnecessary and
would not represent sound tax policy. We urge you to, once
again, reject this revenue proposal.
The ABA also opposes the Administration's proposals to
modify the substantial understatement penalty. The proposed
increases would be overly broad and could penalize innocent
mistakes and inadvertent errors. The establishment of an
inflexible standard could effectively discourage legitimate
business tax planning. We urge you to reject this revenue
proposal.
Require Current Accrual of Market Discount
The ABA opposes the Administration's proposal to require
current accrual of market discount by accrual method taxpayers.
This proposal would not only increase administrative complexity
but would raise taxes on business unnecessarily. We urge you to
reject the Administration's proposal.
Subject Investment Income of Trade Associations to Tax
The ABA opposes the Administration's
proposal to tax the net investment income of trade
associations. The proposal would impose a tax on all passive
income such as interest, dividends, capital gains, rents and
royalties. It would not only impact national organizations but
smaller state and local associations as well. Dues payments
generally represent a relatively small portion of an
association's income. Associations maintain surpluses to
protect against financial crises and to provide quality service
to their members at an affordable cost. Indeed, investment
income is used to further the exempt purposes of the
organization.
The Administration's proposal would impose an overly broad,
and ill conceived tax on well managed trade associations that
would directly inhibit their ability to continue to provide
services vital to their exempt purposes. We urge you to reject
the Administration's proposal.
Environmental Taxes
The ABA opposes the proposal to reinstate the Superfund
environmental and excise taxes. We believe the burden of
payment of the taxes will fall on current owners of certain
properties (who may in many instances be financial
institutions) rather than the owners at the time the damage
occurred. It would, thus, impose a retroactive tax on innocent
third parties. In any event, such taxes would be better
considered as part of overall program reform legislation. We
urge you to reject the Administration's proposal.
Other Issues
The Administration's proposal contains a number of other
provisions to which we object as being harmful to banking
institutions, as listed below:
Prohibit deferral on swap fund contributions
Modify treatment of ESOPs as S corporation
shareholders
Modify the treatment of closely held REITs
Disallow interest on debt allocable to tax-exempt
obligations
Impose excise tax on purchase of structured
settlements
Penalty increases with respect to corporate tax
shelters
Treat certain foreign-source interest and
dividends equivalents as U.S.-effectively connected income
Recapture overall foreign losses when controlled
foreign corporation stock is disposed
Treat receipt of tracking stock as property
Recover state bank exam fees
TAX INCENTIVE PROPOSALS
Expand Exclusion for Employer Provided Educational Assistance
to Include Graduate Education
The ABA supports the expansion of the tax incentives for
employer provided education to include graduate education. The
banking and financial services industries are experiencing
dramatic technological changes. This provision will assist in
the training of employees to better face global competition.
Employer provided educational assistance is a central component
of the modern compensation package and is used to recruit and
retain vital employees.
Retirement Savings Accounts
The ABA fully supports efforts to expand the availability
of retirement savings. We are particularly pleased that the
concept of tax-advantaged retirement savings has garnered long-
standing bi-partisan support and that the Administration's plan
contains many significant proposals to encourage savings.
Low-income Housing Tax Credit
The ABA supports the proposal to raise the low-income
housing tax credit cap from $1.25 per capita to $1.75 per
capita. This dollar value has not been increased since it was
first set in the 1986 Act. Raising the cap would assist in the
development of much needed affordable rental housing in all
areas of the country.
Qualified Zone Academy Bonds
The ABA supports the proposal to authorize the issuance of
additional qualified zone academy bonds and school
modernization bonds and to modify the tax credit bond program.
The proposed changes would facilitate the usage of such bonds
by banking institutions in impacted areas.
Other Issues
The Administration's proposal contains a number of other
provisions that we support, as listed below:
Increase limit on charitable donations of
appreciated property
Make Brownfields remediation expensing permanent
Simplify the foreign tax credit limits for 10/50
company dividends
CONCLUSION
The ABA appreciates having this opportunity to present our
views on the revenue provisions contained in the President's
fiscal year 2001 budget proposal. We look forward to working
with you in the future on these most important matters.
Statement of American Petroleum Institute
Introduction
These comments are submitted by the American Petroleum
Institute (API) for inclusion in the written record of the
February 9, 2000 Ways and Means hearing on the tax provisions
in the Administration's FY 2001 budget proposal. API represents
approximately 400 companies involved in all aspects of the oil
and gas industry, including exploration, production,
transportation, refining, and marketing.
The U.S. oil and gas industry continues to be a leader in
exploring for and developing oil and gas reserves around the
world. However, this leadership position is being threatened
due to the diminishing advantages enjoyed by the domestic
industry in the areas of U.S. technology and investment
capital. At the same time, the continuing depletion of U.S.
petroleum reserves and federal and state government policies
restricting reserve replacement domestically have forced U.S.
petroleum companies to look increasingly overseas to replace
their petroleum reserves.
A recent API study demonstrates that despite the fact that
production outside the United States by U.S. companies
increased by 300,000 barrels per day over the period from 1987
to 1996, that was not enough to offset the decline in U.S.
production by those firms. Therefore, total global production
by U.S. oil and gas companies actually declined during that
period. As evidenced by recent events, ceding greater control
over petroleum product supplies to OPEC can have a profound
effect on the prices paid by U.S. oil and gas consumers.
A major factor behind the decline in the U.S. oil and gas
industry's global competitive position is U.S. international
tax policy. One of the provisions in President Clinton's budget
proposal is aimed directly at the foreign source income of U.S.
petroleum companies. The U.S. tax regime already imposes a
substantial economic burden on U.S. multinational companies by
exposing them to double taxation, that is, the payment of tax
on foreign source income to both the host country and the
United States. In addition, the complexity of the U.S. tax
rules imposes significant compliance costs. As a result, U.S.
companies are forced to forego foreign investment altogether
based on projected after-tax rates of return, or they are
preempted in bids for overseas investments by global
competition. Congress can help to stem further losses in the
global competitive position of the U.S. oil and gas industry by
rejecting the Administration's proposal to increase taxes on
their foreign source income, and the proposals to reinstate the
Superfund taxes and the Oil Spill tax.
Administration Proposals
Our testimony will address the following proposals:
modify rules relating to foreign oil and gas
extraction income;
reinstate excise taxes and the corporate
environmental tax deposited in the Hazardous Substance
Superfund Trust Fund;
reinstate the oil spill excise tax;
corporate tax shelters;
Harbor Maintenance Tax Converted to User Fee; and
tax investment income of trade associations
RULES RELATING TO FOREIGN OIL AND GAS EXTRACTION INCOME
President Clinton's budget proposal includes the following
provisions:
In situations where taxpayers are subject to a
foreign income tax and also receive an economic benefit from
the foreign country, taxpayers would be able to claim a credit
for such taxes under Code Section 901 only if the country has a
``generally applicable income tax'' that has ``substantial
application'' to all types of taxpayers, and then only up to
the level of taxation that would be imposed under the generally
applicable income tax.
Effective for taxable years beginning after
enactment, new rules would be provided for all foreign oil and
gas income (FOGI). FOGI would be trapped in a new separate FOGI
basket under Code Section 904(d). FOGI would be defined to
include both foreign oil and gas extraction income (FOGEI) and
foreign oil related income (FORI).
Despite these changes, U.S. treaty obligations
that allow a credit for taxes paid or accrued on FOGI would
continue to take precedence over this legislation (e.g., the
so-called ``per country'' limitation situations.)
This proposal, aimed directly at the foreign operations of
U.S. petroleum companies, seriously threatens the ability of
those companies to remain competitive on a global scale, and
API strongly opposes the proposal.
If U.S. oil and gas concerns are to stay in business, they
must look overseas to replace their diminishing reserves, since
the opportunity for domestic reserve replacement has been
restricted by both federal and state government policy. The
opening of Russia to foreign capital, the competition for
investment by the countries bordering the Caspian Sea, the
privatization of energy in portions of Latin America, Asia, and
Africa--all offer the potential for unprecedented opportunity
in meeting the challenges of supplying fuel to a rapidly
growing world economy. In each of these frontiers, U.S.
companies are poised to participate actively. However, if U.S.
companies can not economically compete, foreign resources will
instead be produced by foreign competitors, with little or no
benefit to the U.S. economy, U.S. companies, or American
workers.
With non-OPEC development being cut back, and OPEC market
share and influence once again rising, a key concern of federal
policy should be that of maintaining the global supply
diversity that has been the keystone of improved energy
security for the past two decades. The principal tool for
promotion of that diversity is active participation by U.S.
firms in the development of these new frontiers. Therefore,
federal policy should be geared to enhancing the
competitiveness of U.S. firms operating abroad, not reducing it
with new tax burdens.
The foreign tax credit (FTC) principle of avoiding double
taxation represents the foundation of U.S. taxation of foreign
source income. The Administration's budget proposal would
destroy this foundation on a selective basis for foreign oil
and gas income only, in direct conflict with long established
tax policy and with U.S. trade policy of global integration,
embraced by both Democratic and Republican Administrations.
The FTC Is Intended To Prevent Double Taxation
Since the beginning of Federal income taxation, the U.S.
has taxed the worldwide income of U.S. citizens and residents,
including U.S. corporations. To avoid double taxation, the FTC
was introduced in 1918. Although the U.S. cedes primary taxing
jurisdiction for foreign income to the source country, the FTC
is intended to prevent the same income from being taxed twice,
once by the U.S. and once by the source country. The FTC is
designed to allow a dollar for dollar offset against U.S.
income taxes for taxes paid to foreign taxing jurisdictions.
Under this regime, the foreign income of foreign subsidiaries
is not immediately subject to U.S. taxation. Instead, the
underlying earnings become subject to U.S. tax only when the
U.S. shareholder receives a dividend (except for certain
``passive'' or ``Subpart F'' income). Any foreign taxes paid by
the subsidiary on such earnings is deemed to have been paid by
any U.S. shareholders owning at least 10% of the subsidiary,
and can be claimed as FTCs against the U.S. tax on the foreign
dividend income (the so-called ``indirect foreign tax
credit'').
Basic Rules of the FTC
The FTC is intended to offset only U.S. tax on foreign
source income. Thus, an overall limitation on currently usable
FTCs is computed by multiplying the tentative U.S. tax on
worldwide income by the ratio of foreign source income to
worldwide taxable income. The excess FTCs can be carried back
two years and carried forward five years, to be claimed as
credits in those years within the same respective overall
limitations.
The overall limitation is computed separately for not less
than nine ``separate limitation categories.'' Under present
law, foreign oil and gas income falls into the general
limitation category. Thus, for purposes of computing the
overall limitation, FOGI is treated like any other foreign
active business income. Separate special limitations still
apply, however, for income: (1) whose foreign source can be
easily changed; (2) which typically bears little or no foreign
tax; or (3) which often bears a rate of foreign tax that is
abnormally high or in excess of rates of other types of income.
In these cases, a separate limitation is designed to prevent
the use of foreign taxes imposed on one category to reduce U.S.
tax on other categories of income.
FTC Limitations For Oil And Gas Income
Congress and the Treasury have already imposed significant
limitations on the use of foreign tax credits attributable to
foreign oil and gas operations. In response to the development
of high tax rate regimes by OPEC, taxes on foreign oil and gas
income have become the subject of special limitations. For
example, each year the amount of taxes on FOGEI may not exceed
35 percent (the U.S. corporate tax rate) of such income. Any
excess may be carried over like excess FTCs under the overall
limitation. FOGEI is income derived from the extraction of oil
and gas, or from the sale or exchange of assets used in
extraction activities.
In addition, the IRS has regulatory authority to determine
that a foreign tax on FORI is not ``creditable'' to the extent
that the foreign law imposing the tax is structured, or in fact
operates, so that the tax that is generally imposed is
materially greater than the amount of tax on income that is
neither FORI nor FOGEI. FORI is foreign source income from (1)
processing oil and gas into primary products, (2) transporting
oil and gas or their primary products, (3) distributing or
selling such, or (4) disposing of assets used in the foregoing
activities. Otherwise, the overall limitation (with its special
categories discussed above) applies to FOGEI and FORI. Thus, as
active business income, FOGEI and FORI would fall into the
general limitation category.
The Dual Capacity Taxpayer ``Safe Harbor'' Rule
As distinguished from the rule in the U.S. and some
Canadian provinces, mineral rights in other countries vest in
the foreign sovereign, which then grants exploitation rights in
various forms. This can be done either directly or through a
state owned enterprise (e.g., a license or a production sharing
contract). Because the taxing sovereign is also the grantor of
mineral rights, the high tax rates imposed on oil and gas
profits have often been questioned as representing, in part,
payment for the grant of ``a specific economic benefit'' from
mineral exploitation rights. Thus, the dual nature of these
payments to the sovereign has resulted in such taxpayers being
referred to as ``dual capacity taxpayers.''
To help resolve controversies surrounding the nature of tax
payments by dual capacity taxpayers, the Treasury Department in
1983 finalized the ``dual capacity taxpayer rules'' of the FTC
regulations. Under the facts and circumstances method of these
regulations, the taxpayer must establish the amount of the
intended tax payment that otherwise qualifies as an income tax
payment and is not paid in return for a specific economic
benefit. Any remainder is a deductible rather than creditable
payment (and in the case of oil and gas producers, is
considered a royalty). The regulations also include a safe
harbor election (see Treas. Reg. 1.901-2A(e)(1)), whereby a
formula is used to determine the tax portion of the payment to
the foreign sovereign, which is basically the amount that the
dual capacity taxpayer would pay under the foreign country's
general income tax. Where there is no generally applicable
income tax, the safe harbor rule of the regulation allows the
use of the U.S. tax rate in a ``splitting'' computation (i.e.,
the U.S. tax rate is considered the country's generally
applicable income tax rate).
The Proposal Disallows FTCs Of Dual Capacity Taxpayers Where
The Host Country Has No Generally Applicable Income Tax
If a host country had an income tax on FOGI (i.e., FOGEI or
FORI), but no generally applicable income tax, the proposal
would disallow any FTCs on FOGI. This would result in
inequitable and destructive double taxation of dual capacity
taxpayers, contrary to the global trade policy advocated by the
U.S.
The additional U.S. tax on foreign investment in the
petroleum industry would not only eliminate many new projects;
it could also change the economics of past investments. In some
cases, this would not only reduce the rate of return, but also
preclude a return of the investment itself, leaving the U.S.
business with an unexpected ``legislated'' loss. In addition,
because of the uncertainties of the provision, it would also
introduce more complexity and potential for litigation into the
already muddled world of the FTC.
The unfairness of the provision becomes even more apparent
if one considers the situation in which a U.S. based oil
company and a U.S. based company other than an oil company are
subject to an income tax in a country without a generally
applicable income tax. Under the proposal, only the U.S. oil
company would receive no foreign tax credit, while the other
taxpayer would be entitled to the full tax credit for the very
same tax.
The proposal's concerns with the tax versus royalty
distinction were resolved by Congress and the Treasury long ago
with the special tax credit limitation on FOGEI enacted in 1975
and the Splitting Regulations of 1983. These were then later
reinforced in the 1986 Act by the fragmentation of foreign
source income into a host of categories or baskets. The earlier
resolution of the tax versus royalty dilemma recognized that
(1) if payments to a foreign sovereign meet the criteria of an
income tax, they should not be denied complete creditability
against U.S. income tax on the underlying income; and (2)
creditability of the perceived excessive tax payment is better
controlled by reference to the U.S. tax burden, rather than
being dependent on the foreign sovereign's fiscal choices.
The Proposal Limits FTCs To The Amount That Would
Be Paid Under The Generally Applicable Income Tax
By elevating the regulatory safe harbor to the exclusive
statutory rule, the proposal eliminates a dual capacity
taxpayer's right to show, based on facts and circumstances,
which portion of its income tax payment to the foreign
government was not made in exchange for the conferral of
specific economic benefits and, therefore, qualifies as a
creditable tax. Moreover, by eliminating the ``fall back'' to
the U.S. tax rate in the safe harbor computation where the host
country has no generally applicable income tax, the proposal
denies the creditability of true income taxes paid by dual
capacity taxpayers under a ``scheduler'' type of business
income tax regime (i.e., regimes that tax only certain
categories of income, according to particular ``schedules''),
merely because the foreign sovereign's fiscal policy does not
include all types of business income.
For emerging economies in lesser developed countries that
may not be ready for an income tax, as well as for post-
industrial nations that may turn to a transaction tax, it is
not realistic to always demand the existence of a generally
applicable income tax. Even if the political willingness exists
to have a generally applicable income tax, such may not be
possible because the ability to design and administer a
generally applicable income tax depends on the structure of the
host country's economy. The available tax regimes are defined
by the country's economic maturity, business structure and
accounting sophistication. The most difficult problems arise in
the field of business taxation. Oftentimes, the absence of
reliable accounting books will only allow a primitive
presumptive measure of profits. Under such circumstances the
effective administration of a general income tax is impossible.
All this is exacerbated by phenomena typical of less developed
economies: a high degree of self-employment, the small size of
establishments, and low taxpayer compliance and enforcement. In
such situations, the income tax will have to be limited to
mature businesses, along with the oil and gas extraction
business.
The Proposal Increases The Risk Of Double Taxation
Adoption of the Administration's proposals would further
tilt the playing field against overseas oil and gas operations
by U.S. business, and increase the risk of double taxation of
FOGI. This will severely hinder U.S. oil companies in their
competition with foreign oil and gas concerns in the global oil
and gas exploration, production, refining, and marketing arena,
where the home countries of their foreign competition do not
tax FOGI. This occurs where these countries either exempt
foreign source income or have a foreign tax credit regime that
truly prevents double taxation.
To illustrate, assume foreign country X offers licenses for
oil and gas exploitation and also has an 85 percent tax on oil
and gas extraction income. In competitive bidding, the license
will be granted to the bidder that assumes exploration and
development obligations most favorable to country X. Country X
has no generally applicable income tax. Unless a U.S. company
is assured that it will not be taxed again on its after-tax
profit from country X, it very likely will not be able to
compete with another foreign oil company for such a license
because of the different after-tax returns.
Because of the 35 percent additional U.S. tax, the U.S.
company's after-tax return will be more than one-third less
than its foreign competitor's. Stated differently, if the
foreign competitor is able to match the U.S. company's
proficiency and effectiveness, the foreign company's return
will be more than 50 percent greater than the U.S. company's
return. This would surely harm the U.S. company in any
competitive bidding. Only the continuing existence of the FTC,
despite its many existing limitations, assures that there will
be no further tilting of the playing field against U.S.
companies' efforts in the global petroleum business.
Separate Limitation Category For FOGI
To install a separate FTC limitation category for FOGI
would single out the active business income of oil companies
and separate it from the general limitation category or basket.
There is no legitimate reason to carve out FOGI from the
general limitation category or basket. The source of FOGEI and
FORI is difficult to manipulate. The source of FOGI was
determined by nature millions of years ago. FORI is generally
derived from the country where the processing or marketing of
oil occurs which presupposes substantial investment in
nonmovable assets. Moreover, Treasury has issued detailed
regulations addressing this sourcing issue. Finally, unless any
FORI is earned in the extraction or consumption country, it is
very likely taxed currently, before distribution, as Subpart F
income even though it is definitely not passive income.
The FTC Proposals Are Bad Tax Policy
Reduction of U.S. participation in foreign oil and gas
development because of misguided tax provisions will adversely
affect U.S. employment, and any additional tax burden may
hinder U.S. companies in competition with foreign concerns.
Although the host country resource will be developed, it will
be done by foreign competition, with the adverse ripple effect
of U.S. job losses and the loss of continuing evolution of U.S.
technology. By contrast, foreign oil and gas development by
U.S. companies increases utilization of U.S. supplies of
hardware and technology. The loss of any major foreign project
by a U.S. company will mean less employment in the U.S. by
suppliers, and by the U.S. parent, in addition to fewer U.S.
expatriates at foreign locations. Many of the jobs that support
overseas operations of U.S. companies are located here in the
United States--an estimated 350,000 according to a 1998
analysis by Charles River Associates, a Cambridge,
Massachusetts-based consulting firm. That figure consists of:
60,000 in jobs directly dependent on international operations
of U.S. oil and gas companies; over 140,000 employed by U.S.
suppliers to the oil and gas industry's foreign operations;
and, an additional 150,000 employed in the United States
supporting the 200,000 individuals who work directly for the
oil companies and their suppliers.
Thus, the questions to be answered are: (1) Does the United
States--for energy security and international trade reasons
among others--want a U.S.-based petroleum industry that is
competitive in the global quest for oil and gas reserves? (2)
If the answer is ``yes,'' why would the U.S. government adopt a
tax policy that is punitive in nature and lessens the
competitiveness of the U.S. petroleum industry? The U.S. tax
system already makes it extremely difficult for U.S.
multinationals to compete against foreign-based entities. This
is in direct contrast to the tax systems of our foreign-based
competitors, which actually encourage those companies to be
more competitive in winning foreign projects. What we need from
Congress are improvements in our system that allow U.S.
companies to compete more effectively, not further impediments
that make it even more difficult and in some cases impossible
to succeed in today's global oil and gas business environment.
These improvements should include, among others, the repeal of
the plethora of separate FTC baskets, the extension of the
carryback/carryover period for foreign tax credits, and the
repeal of section 907.
The Administration's FY 1999 and FY 2000 budgets included
these same proposals which would have reduced the efficacy of
the FTC for U.S. oil companies. Congress considered these
proposals at that time and rightfully rejected them. They
should be rejected this year as well.
REINSTATMENT OF EXPIRED SUPERFUND TAXES
The Administration's proposal would reinstate the Superfund
excise taxes on petroleum and certain chemicals through
September 30, 2010 and the Corporate Environmental Income Tax
through December 31, 2010. API strongly opposes this proposal.
It is generally agreed that the CERCLA program, otherwise
known as Superfund, has matured to the point that most of the
sites on the National Priorities List (NPL) are in some phase
of cleanup. Problems, however, remain in the structure of the
current program. The program should undergo comprehensive
legislative reform and should sunset at the completion of
cleanups of the CERCLA sites currently on the NPL. Issues that
the reform legislation should address include liability, remedy
selection, and natural resource damage assessments. A
restructured and improved Superfund program can and should be
funded through general revenues.
Superfund sites are a broad societal problem. Revenues
raised to remediate these sites should be broadly based rather
than unfairly burdening a few specific industries. EPA has
found wastes from all types of businesses and government
agencies at hazardous waste sites. The entire economy benefited
in the pre-1980 era from the lower cost of handling waste
attributable to standards that were acceptable at the time. To
place responsibility for the additional costs resulting from
retroactive Superfund cleanup standards on the shoulders of a
very few industries when previous economic benefits were widely
shared is patently unfair.
The petroleum industry is estimated to be responsible for
less than 10 percent of the contamination at Superfund sites
but has historically paid over 50 percent of the Superfund
taxes. This inequity should be rectified. Congress should
substantially reform the program and fund the program through
general revenues or other broad-based funding sources.
REINSTATMENT OF OIL SPILL EXCISE TAX
The Administration proposes reinstating the five cents per
barrel excise tax on domestic and imported crude oil dedicated
to the Oil Spill Liability Trust Fund through September 30,
2010, and increasing the trust fund limitation (the ``cap'')
from $1 billion to $5 billion. API strongly opposes the
proposal.
Collection of the Oil Spill Excise Tax was suspended for
several months during 1994 because the Fund had exceeded its
cap of $1 billion. It was subsequently allowed to expire
December 31, 1994, because Congress determined that there was
no need for additional taxes. Since that time, the balance in
the Fund has remained above $1 billion, despite the fact that
no additional taxes have been collected. Clearly, the
legislated purposes for the Fund are being accomplished without
any need for additional revenues. Congress should reject this
proposal.
CORPORATE TAX SHELTERS
In a sweeping attack on corporate tax planning, the
Administration has proposed fifteen provisions purported to
deal with corporate tax shelters. These proposals are overly
broad and would bring within their scope many corporate
transactions that are clearly permitted under existing law.
Moreover, their ambiguity would leave taxpayers uncertain as to
the tax consequences of their activities and would lead to
increased controversy and litigation. Business taxpayers must
be able to rely on the tax code and existing income tax
regulations in order to carry on their business activities.
Treasury's proposed rules could cost the economy more in lost
business activity than they would produce in taxing previously
``sheltered'' income.
HARBOR MAINTENANCE EXCISE TAX CONVERTED TO COST-BASED USER FEE
The Administration's budget contains a placeholder for
revenue from a new Harbor Services User Fee and Harbor Services
Fund. This fee would raise $1.7 billion in new taxes, more than
three times what is needed for harbor maintenance dredging.
Despite the intense and uniform opposition from ports,
shippers, carriers, labor and many Members of Congress, the
Administration has provided few details about how the new user
fee would be structured and has not sought stakeholder input
since September 1998.
API strongly supports the use of such funds for channel
maintenance and dredge disposal. We object to the
Administration's proposal to use these funds for port
construction and other services. The Administration should
earmark these funds to address the growing demand for harbor
maintenance and dredging. Furthermore, the Administration's
proposal would force commercial shipping interests to bear the
entire cost of the Army Corps of Engineers' harbor maintenance
and dredging program rather than spreading the costs among all
beneficiaries. We urge Congress to pass H.R. 3566 and create an
off-budget trust fund for the Harbor Services Fund. Finally,
API urges Congress to take the lead in seeking stakeholder
input and developing a fair and equitable means of generating
the needed revenue.
SUBJECT INVESTMENT INCOME OF TRADE ASSOCIATIONS TO TAX
The Administration's proposal would subject to tax the net
investment income in excess of $10,000 of trade associations
and other organizations described in section 501(c)(6). API
opposes this provision that is estimated to increase taxes on
trade associations and other similar not-for-profit
organizations by $1.5 billion. We agree with the Tax Council
and other groups that subjecting trade association investment
income to the unrelated business income tax (UBIT) conflicts
with the current-law purpose of imposing UBIT on associations
and other tax-exempt organizations to prevent such
organizations from competing unfairly against for-profit
businesses. The Administration's proposal mischaracterizes the
benefit that trade association members receive from such
earnings. Without such earnings, members of these associations
would have to pay larger tax-deductible dues. There is no tax
abuse. Congress should reject this proposal.
Statement of Michael S. Olson, American Society of Association
Executives
Mr. Chairman, my name is Michael S. Olson, CAE, President
and Chief Executive Officer of the American Society of
Association Executives (ASAE). ASAE is an individual membership
society made up of 25,200 association executives and suppliers.
Its members manage more than 11,000 leading trade associations,
individual membership societies, and other voluntary membership
organizations across the United States and in 48 countries
around the globe.
I am here to testify in strong opposition to the budget
proposal that has again been submitted to Congress by the
Clinton Administration that would tax the net investment income
of Section 501(c)(6) associations to the extent the income
exceeds $10,000 annually. Income that would be subject to
taxation, however, is not as narrow as would be expected from
the characterization in the proposal of ``investment income''
but includes all ``passive'' income such as rent, royalties,
interest, dividends, and capital gains. This provision, which
is estimated by the Treasury Department to raise approximately
$1.55 billion dollars over five years, would radically change
the way revenue of these tax-exempt organizations is treated
under federal tax law. In addition, if enacted this proposal
would jeopardize the very financial stability of many Section
501(c)(6) organizations.
This proposal is identical to the provision included last
year in the President's FY2000 budget. At that time, the
proposed change was meet by broad and unified opposition from
the professional society and trade association community that
it targeted. It also created serious concern among charities
and other Section 501(c) organizations who were alarmed with
the dangerous precedent the provision, if enacted, would set in
altering the fundamental tax treatment of tax-exempt
organizations that has existed for nearly a century.
Last year, this proposal was received by Congress with
broad, bipartisan opposition. In the House of Representatives,
twenty-eight members of the House Ways and Means Committee sent
a bipartisan letter to the chairman and ranking member of the
committee, voicing strong opposition to the proposed tax on
investment income. In the Senate, thirty-five Senators of both
political parties sent a similar letter to the chairman and
ranking member of the Senate Finance Committee. In addition,
the entire Senate passed a resolution in opposition to this
ill-conceived legislation. We are therefore troubled that the
Administration has chosen to resurrect this measure given the
broad-based opposition from Congress to the original proposal.
America's trade, professional and philanthropic
associations are an integral part of our society. They allocate
one of every four dollars they spend to member education and
training and public information activities, according to a new
study commissioned by the Foundation of the American Society of
Association Executives. ASAE member organizations devote more
than 173 million volunteer hours each year, time valued at more
than $2 billion, to charitable and community service projects.
95 percent of ASAE member organizations offer education
programs for members, making that service the single most
common association function. ASAE member associations are the
primary source of health insurance for more than eight million
Americans, while close to one million people participate in
retirement savings programs offered through associations.
Association members spend more than $1.1 billion annually
complying with association-set standards, which safeguard
consumers and provide other valuable benefits. Those same
associations fuel America's prosperity by pumping billions of
dollars into the economy and creating hundreds of thousands of
jobs. Were it not for associations, other institutions,
including the government, would face added burdens in the areas
of product performance and safety standards, continuing
education, public information, professional standards, ethics,
research and statistics, political education, and community
service. The work of associations is woven through the fabric
of American society, and the public has come to depend on the
social and economic benefits that associations afford.
The Administration has suggested that their proposal would
only affect a small percentage of associations, that it is
targeted to larger organizations, that the proposal targets
``lobbying organizations,'' and that it somehow provides
additional tax benefits to those who pay dues to associations.
All of these assertions are misleading, ill-informed and
incorrect.
Based on information from ASAE's 1997 Operating Ratio
Report, this proposal will tax most associations with annual
operating budgets as low as $200,000, hardly organizations of
considerable size. In fact, the bulk of the organizations
affected would include associations at the state and local
level, many of whom perform little if any lobbying functions.
Furthermore, existing law, as outlined below, already
eliminates any tax preference, benefit, or subsidy for the
lobbying activities of these organizations, and can even unduly
penalize their lobbying.
The primary argument the Administration has used to support
its proposal is that association members prepay their dues in
order to enjoy a tax-free return on investment. This flawed
argument fails to recognize (1) the existing outright ban on
associations paying dividends to their members; and (2) the
fact that association members do not tolerate any amount of
excessive dues.
In many ways, this proposal attacks the basic tax-exempt
status of associations, and runs counter to the demonstrated
commitment of Congress to furthering the purposes of tax-exempt
organizations. These exempt purposes, such as training,
standard-setting, and providing statistical data and community
services, are supported in large part by the income that the
Administration's proposal would tax and thereby diminish. If
Congress enacts this proposal, it will alter in a fundamental
way the tax policy that has governed the tax-exempt community
for nearly a century, and will set a dangerous precedent for
further changes in tax law for all tax-exempt organizations.
I would now like to review more completely the existing tax
law governing this area, and to specifically address some of
the arguments that have been made in support of the
Administration's proposal. I believe that a careful
consideration of the issues involved will make the Committee
conclude that this proposal is both ill-advised and ill-
conceived, and should be rejected.
I. Taxation of Section 501(c)(6) Organizations Under Current
Law.
Section 501(c)(6) organizations are referred to in the tax
law as ``business leagues'' and ``chambers of commerce.'' Today
they are typically known as trade associations, individual
membership societies, and other voluntary membership
organizations. These organizations are international, national,
state, and local groups that include not only major industry
trade associations but also small town merchants' associations
or the local Better Business Bureau. Currently, the tax law
provides that Section 501(c)(6) organizations are exempt from
federal taxation on income earned in the performance of their
exempt purposes. Associations engage primarily in education,
communications, self-regulation, research, and public and
governmental information and advocacy. Income received from
members in the form of dues, fees, and contributions is tax-
exempt, as are most other forms of organizational income such
as convention registrations and publication sales. However,
Section 501(c)(6) groups and many other kinds of exempt
organizations are subject to federal corporate income tax on
revenues from business activities unrelated to their exempt
purposes (``unrelated business income tax'' or ``UBIT''). UBIT
is applicable to income that is earned as a result of a
regularly-carried-on trade or business that is not
substantially related to the organizations' tax-exempt
purposes. Section 501(c)(6) organizations are also subject to
specific taxes on any income they spend on lobbying activities.
The UBIT rules were designed to prevent tax-exempt
organizations from gaining an unfair advantage over competing,
for-profit enterprises in business activities unrelated to
those for which tax-exempt status was granted. Congress
recognized, however, that Section 501(c)(6) tax-exempt
organizations were not competing with for-profit entities or
being unfairly advantaged by the receipt of tax-exempt income
from certain ``passive'' sources: rents, royalties, interest,
dividends, and capital gains. Tax-exempt organizations use this
``passive'' income to further their tax-exempt purposes and to
help maintain modest reserve funds--to save for necessary
capital expenditures and to even out economic swings. Indeed,
the legislative history regarding UBIT recognizes that
``passive'' income is a proper source of revenue for
charitable, educational, scientific, and religious
organizations [Section 501(c)(3) organizations], issue advocacy
organizations [Section 501(c)(4) organizations], and labor
unions and agricultural organizations [Section 501(c)(5)
organizations], as well as trade associations, individual
membership societies, and other voluntary membership
organizations [Section 501(c)(6) organizations].
Therefore, Congress drafted the tax code to expressly
provide that UBIT for most tax-exempt organizations does not
extend to ``passive'' income. As a result, exempt organizations
such as associations are not taxed on rents, royalties,
dividends, interest, or gains and losses from the sale of
property. The proposal to tax ``net investment income'' of
Section 501(c)(6) organizations would allow the IRS to impose a
tax on all such previously untaxed sources of ``passive''
income. Contrary to its denomination, the scope of the tax is
clearly much broader than just ``investment income.''
II. Taxation of Section 501(c)(6) Organizations Under the
Administration Budget Proposal: Treating Professional
Associations Like Social Clubs.
Under the Administration's proposal, Section 501(c)(6)
organizations would be taxed on all ``passive'' income in
excess of $10,000. This proposed tax would not be imposed on
exempt income that is set aside to be used exclusively for
charitable and educational purposes. Funds set aside in this
manner by Section 501(c)(6) organizations could be taxed,
however, if those funds are ultimately used for these purposes.
In addition, the proposal would tax gains realized from the
sale of property used in the performance of an exempt function
unless the funds are reinvested in replacement property.
Essentially, the budget proposal would bring Section
501(c)(6) organizations under the same unrelated business
income rules that apply to Section 501(c)(7) social clubs,
Section 501(c)(9) voluntary employees' beneficiary
associations, and Section 501(c)(20) group legal services
plans. These organizations receive less favorable tax treatment
due to Congress' belief that they have fundamentally different,
and less publicly beneficial purposes than other tax-exempt
organizations. The Clinton Administration proposes to equate
trade associations, individual membership societies, and other
such voluntary membership organizations with country clubs,
yacht clubs, and health clubs.
Social clubs, for example, are organized under Section
501(c)(7) for the pleasure and recreation of their individual
members. As case law and legislative history demonstrate,
social clubs were granted tax exemption not to provide an
affirmative tax benefit to the organizations, but to ensure
that their members are not disadvantaged by their decision to
join together to pursue recreational opportunities. Receiving
income from non-members or other outside sources is therefore a
benefit to the individual members not contemplated by this type
of exemption.
With regard to associations exempt under Section 501(c)(6),
however, Congress intended to provide specific tax benefits to
these organizations to encourage their tax-exempt activities
and public purposes. These groups are organized and operated to
promote common business and professional interests, for example
by developing training material, providing volunteer services
to the public, or setting and enforcing safety or ethical
standards. In fact, the tax code prohibits Section 501(c)(6)
organizations from directing their activities at improving the
business conditions of only their individual members. They must
enhance entire ``lines of commerce;'' to do otherwise
jeopardizes the organizations' exempt status. Social clubs have
therefore long been recognized by Congress as completely
different from professional associations, engaged in different
activities that merit a different exempt status.
Social clubs have always been taxed differently from
associations. This reflects their different functions.
Associations are organized to further the interests of whole
industries, professions, and other fields of endeavor.
``Passive'' income received by an association is reinvested in
tax-exempt activities of benefit to the public, rather than in
recreational/social activities for a limited number of people.
Applying the tax rules for social clubs to associations imposes
unreasonable and unwarranted penalties on those organizations.
For example, under the Administration's proposal, these
organizations would be taxed on all investment income unless it
is set aside for charitable purposes. Income that is used to
further other legitimate organizational activities of value to
the industry, the profession, and the public would therefore be
taxed. In addition, the proposal would tax these organizations
on all gains received from the sale of property unless those
gains are reinvested in replacement property. This tax on gains
would apply to real estate, equipment, and other tangible
property. It would also apply, however, to such vastly diverse
assets as software, educational material developed to assist an
industry or profession, certification and professional
standards manuals, and other forms of intellectual property
which further exempt purposes.
It is important to note that the Administration's proposal
targets only Section 501(c)(6) organizations. No other
categories of tax-exempt organizations would be taxed in this
proposal. The Administration's proposal inappropriately seeks
to impose the tax scheme designed for Section 501(c)(7) social
and recreational clubs only on Section 501(c)(6) associations.
Congress has recognized that organizations exempt in these
different categories serve different purposes and long ago
fashioned a tax exemption scheme to reflect these differences.
The Administration's proposal runs counter to common sense and
would discourage or prevent Section 501(c)(6) organizations
from providing services, including public services, consistent
with the purposes for which these associations were granted
exemption.
III. Taxation of Association Lobbying Activities.
Last year, the Administration's proposal was characterized
by the former Secretary of the Treasury Robert Ruben as a tax
on ``lobbying organizations,'' suggesting that associations
somehow now enjoy a favored tax status for their lobbying
activities. This characterization was and still is incorrect.
Many associations do not conduct any lobbying activity.
Moreover, the lobbying activities of associations have no tax
preferences, advantages, or subsidies whatsoever, and these
expenditures are are fully taxed by virtue of the Omnibus
Budget Reconciliation Act of 1993. That law imposed a tax on
all lobbying activities of trade and professional associations,
either in the form of a flat 35% tax on all funds that the
organization spends on lobbying activities, or as a pass-
through of non-deductibility to individual association members.
Indeed, not only is there no tax benefit or tax exemption
for associations' lobbying activities, either for the members
or for the entities themselves, but the 1993 law provides a tax
penalty on any funds used to lobby. Lobbying tax penalties can
arise in essentially three ways:
1. Proxy Tax. The ``proxy'' tax, an alternative to
informing association members of dues non-deductibility because
of association lobbying, is set at a flat 35% level. This is
the highest level of federal income tax for corporations, paid
only by corporations with net incomes over $18.33 million.
Associations are denied the ``progressivity'' of the income tax
schedule. Therefore, even though no associations ever achieve
nearly that level of income, they must pay the proxy tax as if
they did.
2. Allocation Rule. Under the ``allocation rule,'' all
lobbying expenses are allocated to dues income to determine the
percentage of members' dues that are non-deductible. Most
associations pay for their lobbying expenses using many sources
of income. Increasingly, associations have far more non-dues
income than dues income. The allocation rule, however, requires
association members to pay a tax on all association income used
to conduct lobbying activities, regardless of the percentage of
lobbying actually paid from their dues. Indeed, under the
``allocation rule,'' a business can pay more tax if it joins an
association that lobbies for a particular government policy
than if the business had undertaken the lobbying itself.
3. Estimation Rule. The ``estimation rule'' requires that
associations estimate in advance how much dues income and
lobbying expense they anticipate. The estimation forms the
basis for the notice of dues non-deductibility, which must be
given at the time of dues billing or collection. If the actual
expense proves to be different from the estimates, the
association or its members are subject to very high penalties.
There is no way to ensure freedom from the penalty for
underestimating short of ceasing to spend money on lobbying the
moment the association reaches its estimate. There is no way to
avoid the penalty for overestimating at all.
Associations are therefore already subject to more than tax
neutrality and absence of exemption or subsidy for lobbying
activities. The Administration's proposal would not change any
provision with respect to lobbying activities of these
associations, although it would certainly weaken the financial
resources of associations and reduce their ability to advocate
for industries, professions, and the public. Indeed, the
Administration's characterization of the proposal as one that
addresses ``lobbying organizations'' is tantamount to an
Administration decision to further weaken and suppress the
ability of tax-exempt organizations to lobby at all.
IV. Taxation of Member Dues.
The Administration's proposal has also been justified by
its proponents as eliminating a double tax advantage claimed to
be enjoyed by dues-paying association members. According to the
Administration, association members already receive an
immediate deduction for dues or similar payments to Section
501(c)(6) organizations. At the same time, members avoid paying
taxes on investment income by having the association invest
dues surplus for them tax-free.
This argument is flawed for a variety of reasons:
The argument implies that members voluntarily pay higher
dues than necessary as an investment strategy. While in some
circumstances members of tax-exempt associations can deduct
their membership dues like any other business expense, members
receive no other tax break for dues payments. As discussed
above, they are in fact denied a deduction for any amount of
dues their association allocates to lobbying expenses.
The argument implies that associations overcharge their
members for dues, thereby creating a significant surplus of
dues income. In fact, dues payments usually represent only a
portion of an association's income; and dues are virtually
always determined by a board or committee consisting of
members, who would hardly tolerate excessively high dues.
Finally, associations tend to maintain only modest surpluses to
protect against financial crises, expending the rest on
programs and services. Again, associations are member-governed;
members would typically make certain that their associations do
not accumulate a surplus beyond the minimum that is necessary
and prudent for the management of their associations.
The argument assumes that Section 501(c)(6) organizations
somehow pay dividends to their members. Tax-exempt
organizations do not pay dividends or returns in any form to
their members, let alone for payment of dues. Indeed, an
organization's exempt status may be revoked if any portion of
its earnings are directed to individuals.
In other words, the Administration suggests that
association members are voluntarily paying higher than
necessary dues, solely to avoid paying tax on their own
investment income resulting when not all dues revenues are
expended immediately. This is the same as suggesting that
individuals donate to charities in hopes that the charities
will earn investment income on un-spent donations. It is an
argument that defies common sense and completely misunderstands
the structure and operation of tax-exempt organizations.
V. Expenditures Attributed to Investment and Other ``Passive''
Income Would Generally Qualify As Deductible Expenses If
Incurred by Members of the Association.
The investment income and other ``passive'' income of
associations is used to further the exempt purpose of the
organizations. Most if not all of these expenditures for
association programs and activities, which are made on behalf
of the association's members, would be deductible if carried on
directly by the members. This is because these expenses would
otherwise be regarded as ordinary and necessary business
expenses under Section 162(a) of the tax code or as a
charitable contribution. Therefore, it is inappropriate to
essentially deny this deduction by imposing the UBIT tax on
this income. Under the Administration's proposal, this would in
fact be the indirect result of subjecting the ``passive''
income of Section 501(c)(6) organizations to taxation.
VI. The Administration's Proposed Tax Would Reach All Forms of
``Passive'' Income and Jeopardize Tax-Exempt Programs.
Trade associations, individual membership societies, and
other similar voluntary membership organizations typically
receive only a portion of their income from membership dues,
fees, and similar charges. In many such organizations,
particularly professional societies, there are natural limits
or ``glass ceilings'' on the amounts of dues that can be
charged to members. As a result, these Section 501(c)(6) tax-
exempt organizations have increasingly sought additional
sources of income to enable them to continue their often broad
programs of exempt activities on behalf of businesses,
professions, and the public. One of those additional sources
has been ``passive'' income--rents, royalties, dividends,
interest, and capital gains--that may be earned from a variety
of sources.
Section 501(c)(6) organizations rely heavily on ``passive''
income to support their exempt activities. The proposal would
adversely affect virtually all associations, since most
organizations from time to time receive some amount of rents,
royalties, interest, dividends, or capital gains. These
associations use ``passive'' income to further a host of
beneficial activities, which would be threatened by imposition
of the Clinton Administration's ``investment'' tax. For
example, Section 501(c)(6) tax-exempt associations are
responsible for:
Drafting and disseminating educational materials.
Establishing skills development seminars and programs.
Creating training and safety manuals for various
professions.
Producing books, magazines, newsletters, and other
publications.
Increasing public awareness, knowledge, and confidence in
an industry's or a profession's practices.
Conducting and sponsoring industry research and surveys.
Compiling statistical data for industries and professions,
which is often requested or relied upon by government.
Providing professionals and businesses with new technical
and scientific information.
Developing and enforcing professional safety and health
standards.
Developing and enforcing ethical standards for industry
practice.
Operating accreditation, certification, and other
credentialing programs.
Organizing and implementing volunteer programs.
The Administration's proposal imposes a broad-based,
pervasive, and detrimental penalty on virtually all
associations of any kind or size. A tax on the ``investment
income'' of Section 501(c)(6) organization does not address any
issue of income used for lobbying activities; all such
activities by these organizations is already free of tax
exemption or subsidy of any kind (indeed, it can be subject to
offsetting ``penalty'' taxation). There is no double or special
tax benefit to those who pay dues to associations. Instead, the
Administration's proposal taxes significant sources of funding
that associations use now for highly desirable services to
entire industries, professions, and the public. Treating
Section 501(c)(6) organization in the same manner as social
clubs ignores the special, quasi-public purposes and functions
of associations, and threatens the ability of such
organizations to continue to provide publicly beneficial
services in the future. In summary, this proposal is a threat,
albeit ill-conceived, to the ongoing viability of thousands of
America's membership organizations, and should be rejected by
this Committee.
Thank you for this opportunity to submit this testimony.
ASAE would be happy to supplement this testimony with answers
to any questions you may have.
Bethesda, MD 20824-0776
February 18, 2000
Chairman, Committee on Ways and Means
U.S. House of Representatives
Longworth House Office Building
Washington, DC 20515
Reform of Certain Private Foundation Rules
Dear Mr. Chairman
Relevant web sites have invited public commentary on changes
proposed by the Treasury Department to certain of the federal tax laws
affecting charities and charitable foundations. The comments submitted
herein are personal to the undersigned and do not represent the
comments of my religious society, the Society of Jesus, or the church
where I am now in residence. The undersigned is a graduate of the
University of Bombay (B. Sci. 1940), Woodstock Theological Seminary
(S.J.D., 1952), and New York University (LLM, Tax, 1966).
Tax reduction is certainly to be applauded, especially with respect
to amounts that might otherwise not reach the charitable mainstream. A
review of the excise tax based on investment income, suggests that it
was drafted with minute attention to various details, yet, based upon
an equally careful reading of Treasury Department regulations, the law
omitted certain matters found to be so important that the Treasury
Department took upon itself the task of amending the statute via
regulations.
It would seem prudent that if the excise tax based on investment
income is being analyzed anew for changes which have the net effect of
reducing total tax collections, the Congress should address matters
which were originally omitted from the legislation but now covered, but
not necessarily governed by, applicable regulations. Congress has the
opportunity to decide whether the same public policy considerations
which inhered in writing ameliorative regulations benefiting
foundations should be confirmed by statutory changes aimed primarily at
rate reductions.
It was not a particularly difficult task to read the statute, and
applicable Treasury Department regulations, and find at least one half
dozen gaps between the statutory language and provisions in the
applicable regulations. It is the suggestion of the undersigned that,
because there is no statutory authority supporting ameliorative
regulations cited below, that these matters be addressed by Congress so
that their beneficence is confirmed by statutory support.
The statute says plainly that gross investment income includes
interest, rents, royalties, etc. The law also specifically provides
that gains and losses are includable in income respecting property
``used for'' the production of interest, rents, etc. Nevertheless,
applicable regulation specifically exempt from the capital gains tax
property which is so used but which is also used for a charitable or
educational function by the foundation. The statute does not contain
any such allowance as that granted by the regulation. It would seem
that the statute should do so to protect the property of foundations
which they have chosen to place within the charitable mainstream and,
which at the same time, produces some of the income so designated.
It is worth re-examining whether or not interest earned from loans
by a private foundation to a public charity which allow the borrower to
better conduct its public function should be subject to the excise tax
at all. Certainly, if a private foundation holds a municipality's
indebtedness, the law specifically precludes taxation of such interest
income (but not necessary any capital gain). From a tax policy
standpoint, encouraging private foundations to lend monies to
religious, scientific and charitable institutions for enhancement of
their proper purposes by excluding the interest revenues would quite
likely reduce borrowing costs of such public institutions for obvious
reasons including the ancillary consideration that it increases
competitors in the marketplace for such institutional indebtedness.
Creating such a modest incentive for foundations to lend (tax free)
monies to public institutions is also beneficial because such
institutions would then avoid the tortuous processes now extant to
qualify their debt for municipal status allowed by other Code
provisions.
If a parishioner of mine, God forbid, is obligated by a court
decree to pay alimony or child support and transfers property to
satisfy any such obligation, there is irrefutable judicial authority
which supports the income taxation of the transferor based upon the
gain inherent in his transfer of property to satisfy his obligation.
There is no significant difference between an ordinary debt and the
annual mandatory pay out of private foundations (now fixed at 5%). Case
law would deem a distribution of appreciated property by a foundation
to satisfy this pay out obligation as a sale or exchange. The statute
specifically provides that ``net investment income shall be determined
under the principles of subtitle A.'' Despite the specific language of
the cited Code provision, Internal Revenue regulations specifically
provide that a distribution of appreciated property, treated as a
qualifying distribution, is not a ``sale'' or other disposition, i.e.,
not a taxable event. While this certainly is a salutary regulation and
helpful to the private foundation community, it is nowhere to be found
within the statute and directly contradicts the literal rule, meaning
that the Treasury Department set itself above Congressional draftsmen
in addressing the problem it discovered. To allow such regulation to
continue without statutory support and in contradiction of law, does
not promote the integrity of statutory authority nor does it conform
Treasury behavior to expected norms. It is my suggestion that this
particular provision, upon review and analysis, be added by law to
preserve some foundation principal and make the statutory language more
principled.
Apart from these regulatory flaws notated above, though helpful as
they are, there are other statutory considerations addressed by
Treasury Department regulations which also amend the law but to the
detriment of the private foundation community. Again, the regulations
have chosen to ignore language expressly written by Congress and seek
revenue protecting regulations which are incongruous to the relief
described above. It almost seems as if there were two complete sets of
draftsmen for these regulations, those who favored reducing the
exposure and liability of private foundations and those which favored
their taxation. Whichever group was involved, it is time for Congress
to reevaluate whether or not all these particular omissions (as
corrected by regulations) should be confirmed or repealed in that they
run counter to the present philosophy exhibited by the President's tax
plan to reduce the tax burden on private foundations.
The specific statutory language precludes ``capital loss
carryovers'' in connection with the computation of net capital gain
income. Based upon a careful reading of the rules governing capital
gain taxation, there is a plain distinction between a carryover,
provided for by existing law, and a carryback, not now provided for by
the excise tax on investment income. Despite the absence of the term
``carryback'' in the statute, the applicable regulations have
nevertheless chosen to insert that word and that principle to dilute
the effect of the Congressional omission by expressly providing that a
current year's capital loss may not be used to reduce taxable gains
realized in a prior taxable year. It is suggested that this policy
question be resolved in favor of foundations and the policy of tax
relief evidenced by the tax reduction proposal expanded to allow the
use of net capitol losses in prior or future taxable years. It is
therefore suggested that the ``no carry forward'' barrier for losses be
amended to grant such minor relief for the future. One has to merely
open the pages of the many ``bear'' journals to see some see the stock
market as quite unstable. Denying the full utilization of net capital
losses acts as a hindrance to prudent financial investments by
foundation managers and their professional advisors.
The statute specifically provides that the tax on capital gains
applies only with respect to property ``used for'' the production of
interest, dividends, royalties, etc. Despite this express provision
limiting the type of property whose capital gain is subject to tax, it
appears from the tax literature, and text writers, that the government
asserts the right to tax property which yields none of these forms of
investment income. The authority for such assertion of liability arises
from regulations which authorize the taxation of capital gains which
arise solely through appreciation although the property is not or was
not actually so used.
Real estate is commonly acquired for investment purposes, though
not income producing via rents or royalties, and often held solely for
its appreciation potential. It seems that with sharp change in
investment philosophy for charities, viz, moving towards a total return
portfolio, no longer balanced between ``income'' and capital
appreciation, a revised tax statute should assure the foundation
community that capital gains from property which yielded, during the
taxable year, no interest, no dividends, no rents or no royalties, are
exempt from capital gains tax when such are realized.
One last provision should be addressed because it again runs
completely counter to the statement in the statute that the
``principles of subtitle A'' are to be followed in determining
liability respecting the excise tax on investment income. The rules
governing the income taxation of trusts, which make charitable
distributions, are very clear. If a trust has a governing instrument
which provides for a distribution to a charitable organization, or for
charitable purposes, the trust is entitled to an income tax charitable
deduction for the amount paid for that purpose. The income tax rules
governing such payments specifically preclude the inclusion of any such
amounts in the income of the donee charity and also remove from the
donee charity the onus of the characterization of the amount so
distributed. Thus, if a decedent, in year 2000, upon death created and
funded a charitable lead trust, the amounts distributed by the
charitable lead trust, to a private foundation, would be deductible by
the charitable lead trust in the computation of its taxable income.
Under the provisions of existing law, because the trust claimed and was
entitled to claim a charitable deduction, the includability and
characterization rules, otherwise invoked by a trust distribution, are
specifically barred from application by law (sec. 663(a)). Nonetheless,
Treasury Department regulations would treat the annuity amount received
by a private foundation, in for example, 2005, as subject to the 4940
tax. This regulation purports to distinguish between trusts making
charitable distributions which were funded before 1969 and those funded
after 1969, which appears to be a highly arbitrary determination
(unless some law occurred at that time which authorized such a
distinction). But even if such a law did so provide, there is nothing
within sec. 4940 which cross references to the trust taxation
provisions so as to preclude the application of sec. 663(a) to a
charitable lead trust distribution. But Treasury Department regulations
demand that the amounts which are received by a private foundation from
a post 1969 charitable lead trust be included in the computation of tax
liability under Sec. 4940. Again, this is yet another example of these
regulations, taken in sum, violating basic legal precept that
interpretative regulations should follow closely the statutory text.
Regulations, according to the esteemed Carl Lewellyn, are an agency's
performance of ``interstitial rites'' and not a revision of principles
Congress chose (or forgot) to enact. Regulations do not represent an
opportunity of the Treasury Department to alter congressional policies
or congressional language which was omitted by law, whatever the reason
for the omission. These Treasury regulations -cited above -are contrary
to principle, embodied in the Code, and need to be taken into account
in your consideration of rate reduction.
Yours in Christ,
Rev. VBB, SJ
Statement of Center for a Sustainable Economy
Embargoed until 9:00 a.m. Thursday, February 3.
Contact: Andrew Hoerner, 202-234-9665, [email protected]
Organization: Center for a Sustainable Economy
Full Text: The full text of the study can be downloaded
from http://www.sustainableeconomy.org/resources.html
Context: Next week the President will release a new package
of tax incentives for clean energy as part of his climate plan.
These credits have been controversial--embraced by Al Gore, and
attacked by, e.g., the Cato Institute, as uneconomic. This
study finds that the economic benefits of such credits outweigh
the cost by more than five times--even ignoring the
environmental benefits.
Study Finds Economic and Environmental Benefits from Tax Incentives for
Energy Efficiency and Renewable Energy
In a ground-breaking approach to measuring the costs and
benefits of technology investments, the Center for a
Sustainable Economy (CSE) released a study today showing net
economic gains in addition to the environmental benefits
expected from the President's proposed tax credits for energy
efficiency. The U.S., long recognized as world leader in
innovation and industry, has fallen behind its competitors in
the areas of energy efficiency and renewable energy. ``This
study shows that measures to protect the climate can also
benefit the economy,'' says study author J. Andrew Hoerner.
``We found the tax credits would have non-environmental
economic benefits that pay for the credits five times over.''
The U.S. has been lagging behind Europe and Japan in the
deployment of many clean energy technologies. The
Administration's proposed tax incentives would help reverse
this trend by making it easier for Americans to invest in
efficient homes, vehicles, building equipment, and renewable
energy, such as wind and biomass.
The Climate Change Technology Initiative included tax
incentives with an estimated revenue cost of $6.4 billion.\1\
The purpose of these incentives was to promote a range of
energy efficiency and renewable energy technologies, including
high-mileage vehicles, energy-efficient buildings and homes,
cogeneration (combined heat and power) facilities, and solar,
wind and biomass energy. In order to evaluate the economic
costs and benefits of the credits, CSE estimated the price and
quantity of each technology produced with and without the
credit, based on a detailed survey of over 80 experts in the
six technologies from industry, academia, NGOs and government.
``This methodology is a way to represent the consensus of the
best thinking from experts on these technologies,'' said
Hoerner.
---------------------------------------------------------------------------
\1\ Estimate by U.S. Joint Committee on Taxation of
Administration's FY2000 proposals (released in February 1999). CSE's
estimate of the cost is $5.7 billion.
---------------------------------------------------------------------------
The study, Assessing Tax Incentives for Clean Energy: A
Survey of Experts Approach, by J. Andrew Hoerner and Avery
Gilbert, has the potential to breach the stalemate that has
long characterized debate over federal incentives for clean
energy technologies. By assessing the long-term market
transformation effect of the tax credits (as part of a larger
clean energy policy), the study found that an expenditure of
$5.7 billion on the tax incentives would:
Cause reductions in the price of the technologies
receiving the credits that are greater then the cost of the
credit to the government;
Have non-environmental economic benefits that
exceed the cost of the credits (The present value of the non-
environmental economic benefits will be roughly five times the
cost of the credit over the 2000-2018 period. In addition,
consumer savings from reduced energy bills would amount to $74
billion between 2000-2018);
Cut local air pollution emissions to a degree that
would save Americans two times as much in health care costs as
the U.S. government would spend on the credits.
Result in 116 million metric tons of carbon
emissions reductions between 2000-2018. Although the carbon
dioxide emission reductions from the credits in 2012 are still
small (3 to 4 percent of the emission reductions that would be
required under the Kyoto Protocol), the equipment installed as
a result of the credits will continue to produce emissions
savings over lives ranging up to 60 years. When these lifetime
reductions are considered, carbon savings are achieved at
approximately $11/ton. This compares favorably with the cost of
achieving emission reductions through international trading as
estimated by the Council of Economic Advisors.
It has often been claimed that most of the benefits from
credits such as these go to people who would have purchased the
equipment anyway. This study confirms that, during the period
of the credit, the direct benefits go primarily to the
taxpayers who would have purchased the equipment or energy in
any case. The study nonetheless finds that the benefits to
those who actually take the credit are greater than the cost of
the credit and that the benefits to society at large in the
form of lower prices for clean energy technologies and
improvements in related technologies, as well as local
environmental benefits, are also greater than the cost to the
government of the credits.
Center for a Sustainable Economy is a non-profit non-partisan
research and policy organization that promotes innovative
market-based approaches to achieving a sustainable economy--one
that integrates long-term economic prosperity, environmental
quality and social fairness.
Assessing Tax Incentives for Clean Energy Technologies:
--A Survey of Experts Approach--
Abstract
Some analysts regard tax incentives for environmentally
beneficial technologies as necessary to jumpstart new clean
technologies; others see them as wasteful subsidies to the
benefited industries. The magnitude of public benefits from a
particular tax incentive provision depends on the nature of the
market, the impact of the provision on the process of
technological change, and the value of the environmental harm
averted. Whether public benefits are greater or less than the
revenue cost of a given tax subsidy is an empirical question
that must be decided on a case-by-case basis.
This paper uses a survey-of-experts (single-round Delphi
Analysis) approach to estimating the impact of the tax
incentive portion of the Climate Change Technology Initiative
(CCTI) proposed by the Administration as part of the fiscal
2000 budget. Based on the responses of a panel of 81 experts
(at least ten per technology) drawn roughly equally from
industry, government, academia and the non governmental
organization (NGO) community, we provide mean forecasts for
quantity and price of each of the technologies covered by the
CCTI tax incentives with and without the tax package. These
price and quantity estimates are then used to calculate the
increase in consumer surplus in the market for that technology.
We also asked the panel to estimate any spillover benefits from
credit-induced technological progress on the efficiency of
products not receiving the credit.
To be effective the tax credits cannot be enacted alone.
Instead they must be part of a larger policy effort to
stimulate the targeted technologies. Because this is true we
did not attempt to estimate the impact of the credit absent
additional policies that help counter other types of barriers
to the penetration of the technologies. Instead, we assumed
that a host of measures and policies to facilitate the market
penetration of the technologies would be introduced and then
asked our panel of experts what the additional penetration
might be with a tax credit.
We conclude first that the credits are likely to have a
revenue cost about 13 percent less than estimated by the
Congress's Joint Committee on Taxation (JCT). This modest
change disguises much greater disagreement on a provision-by-
provision basis, with our estimates of the cost of the solar
and the wind and biomass credits being more than double JCT's
estimates, with all other provisions costing significantly
less. Four of the six proposed credits would provide non-
environmental economic benefits to the public more than
sufficient to offset the cost of the credits: the credits for
fuel-efficient vehicles, energy-efficient homes, energy-
efficient building equipment, and combined heat and power
systems. The credits for wind and biomass power and for rooftop
solar systems have estimated non-environmental economic
benefits to consumers comparable to their revenue cost.
Based on the expert forecasts of the quantity of each
technology adopted we then estimated the energy savings
attributable to each credit for each fuel type. The
environmental value of these fuel savings were then monetized
based on the high, medium and low estimates from a literature
search and assessment by Viscusi, et al. (1994). These are
local U.S. environmental benefits and do not include any
benefit from reductions in impacts on the global climate. We
conclude that, based on non-environmental benefits and local
environmental benefits alone, the benefit/cost ratio is greater
than one for all six credits, ranging from 1.5 to 1 (solar) to
75 to 1 (vehicles). These estimates use market-rate
discounting. If lower social discount rates are used, the
benefit is even higher.
However, it should be observed that in every case the
precise level of public benefit is highly uncertain. Moreover,
most of the benefits from accelerated technology development
accrue from the continued use of that technology after the
credits expire. In some cases, especially the vehicles credit,
other energy policies need to be adjusted to prevent the
effectiveness of the credit benefits from being undermined.
Finally, the value of the local environmental benefit from the
electricity oriented technologies (CHP, wind and biomass, PV's,
and some heating and cooling equipment) is greatly reduced if
the technologies are presumed to displace new natural gas fired
generating plants rather than the average fuel mix.
In addition, we estimate the CCTI tax incentive package
would reduce carbon emissions by 116 million metric tons over
the forecast period 2000-2018. Estimates of the value of this
reduction are provided on a credit-by-credit basis for a range
of alternative carbon emission damage values. The cost of
credit-induced carbon savings averages eleven dollars per ton
of carbon saved over the lifetime of the equipment, a value
that compares favorably with the cost of abatement through
international trading as estimated by the President's Council
of Economic Advisors.
The following table summarizes the present value of the
costs and benefits of the CCTI tax incentives. It assumes that
a package of low-cost technology promotion measures is enacted
along with the CCTI incentives.
Value of Non-environmental and Environmental Benefits from the Tax Credits,
2000-2018 (millions 1999$)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Non-Environmental Costs and Environmental Benefits
---------------------------------------------------------------- Benefits --------------------------------------------------------------------------------------------
------------------------------------ Local Environmental Benefits Climate Related Benefits
--------------------------------------------------------------------------------------------
Consumer Local $5/ton $5/ton 20$/ton 0$/ton 100$/ton 100$/ton
Expenditure Surplus Spillover Local Environmental Direct spillover Direct Spillover Direct Spillover
Spillover Benefits** Environmental Benefits Carbon Carbon Carbon Carbon Carbon Carbon
Benefit (Spillover) Benefit Benefit Benefit Benefit Benefit Benefit
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Vehicles....................................................... 1,181 20,197 67,232 550 517 43 40 172 161 859 807
Homes.......................................................... 35 115 728 33/7* 0.05/0* 0.8/.6* 0.0/0.0* 3/2* 0.02/ 17/14* 0.1/0.0*
0.01*
Building....................................................... 108 146 N/A 190/18 N/A 6/5 N/A 24/19 N/A 120/96 N/A
Eqpmt..........................................................
CHP............................................................ 208 4,674 N/A 5,016/46 N/A 92/58 N/A 366/229 N/A 1831/ N/A
1144
Solar.......................................................... 358 406 N/A 132/8 N/A 9/7 N/A 38/30 N/A 189/151 N/A
Wind &......................................................... 3,718 2,014 5,962 5,800/53 N/A 106/66 N/A 422/264 N/A 2112/ N/A
Biomass........................................................ 1320
Total.......................................................... 5,608 27,552 73,921 11,721/682 517 256/180 40 1,025/ 161 5,127/ 807
716 3,584
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
*The second figure in each cell is the value of benefit when we assume that electricity savings displaces emissions only from natural gas combustion rather than the forecast average fuel mix.
** Only the economic value of the spillover benefits from hybrid vehicles, energy efficient homes, and biomass are included in this table Spillovers from wind and solar technologies are not
included because of the difficulty distinguishing social benefits from mere redistribution of income.
Statement of Clark/Bardes, Dallas, TX
Introduction
Clark/Bardes appreciates the opportunity to present this
statement to the House Ways and Means Committee for the record
of its hearing on the Administration's FY 2001 budget
proposals. Our statement focuses specifically on a proposal
that would increase taxes on companies purchasing insurance
covering the lives of their employees.
Clark/Bardes is a publicly traded company headquartered in
Dallas, Texas, and with offices around the country. We design,
market, and administer insurance-based employee benefit
financing programs. Our clients, which include a broad range of
businesses, use insurance products as assets to offset the
liabilities of employee benefits and to supplement and secure
benefits for key executives.
Clark/Bardes strongly opposes the Administration's proposed
tax increase on ``corporate-owned life insurance'' (``COLI'').
The same proposal also was floated by the Administration in its
FY 1999 and 2000 budget submissions and wisely was rejected by
Congress. Perhaps in recognition of the fact that Congress has
found no coherent tax policy justification for such a change,
the Administration has branded COLI as a ``corporate tax
shelter''--an egregious characterization intended to build
visceral support for the proposal. Regardless of the
Administration's rhetoric, the reasons for rejecting the COLI
tax increase remain the same:
Employer-owned life insurance remains an effective
means for businesses to finance their growing retiree health
and benefit obligations.
The Administration's proposal shares none of the
same tax policy concerns that drove Congressional action on
COLI in 1996 and 1997 legislation.
The current-law tax treatment of COLI was
sanctioned explicitly by Congress in the 1996 and 1997
legislation.
The Administration's proposal is a thinly
disguised attempt to tax the ``inside buildup'' on insurance
policies--i.e., a tax on a long-standing means of savings.
The Administration's proposal represents yet
another move by the Administration--along a slippery slope--to
deny deductions for ordinary and necessary business expenses.
Use of Employer-Owned Life Insurance
Before turning to the Administration's proposal, Clark/
Bardes believes it is important to provide background
information on employer-owned life insurance--a business
practice that does not appear to be well understood.
Many employers, large and small, provide health and other
benefits to their retired employees. While ERISA rules
generally make ``dedicated'' funding impossible, employers
often seek to establish a method of financing these
obligations. This allows them not only to secure a source of
funds for these payments but also to offset the impact of
financial accounting rules that require employers to include
the present value of the projected future retiree benefits in
their annual financial statements.
Life insurance provides an effective means for businesses
to finance their retiree benefits. Consultants, like Clark/
Bardes, and life insurance companies work with employers to
develop programs to enable the employers to predict retiree
health benefit needs and match them with proceeds payable under
the life insurance programs.
A simplified example may help to illustrate. ABC Company
guarantees its employees a generous health benefits package
upon retirement. Like all employers, ABC Company is required to
book a liability on its balance sheet for benefits costs
related to the eventual retirement of its employees, and needs
to find ways to fund these obligations. As a solution, ABC
Company takes out a series of life insurance policies on its
employees. It pays level insurance premiums to the insurance
carrier each year. The cash value on the life insurance policy
accumulates on a tax-deferred basis and can be identified as a
specific source of funds to meet benefit liabilities. In the
event that the contract is surrendered, ABC Company pays tax on
any gain in the policy. In the event that covered employees
die, ABC Company receives the death benefit and uses these
funds to offset the cost of benefits payments to its retired
employees. Actuaries are able to match closely the amount of
insurance necessary to fund ABC Company's liabilities.
The Administration's COLI proposal effectively would take
away an employer's ability to finance retiree benefit programs
using life insurance, and thus could force businesses to
severely limit or discontinue these programs. It is ironic that
the President's proposal would hamstring a legitimate means of
funding post-retirement benefits when a major focus of Congress
is to encourage private sector solutions to provide for the
needs of our retirees.
The Administration's COLI Proposal
The Administration's proposal to tax employer-owned life
insurance should be viewed in light of the basic tax rules
governing life insurance and interest expense and recent
changes made by Congress to the tax treatment of COLI.
Since 1913, amounts paid due to the death of an insured
person have been excluded from Federal gross income. The
present-law provision providing this exclusion is section 101
of the Internal Revenue Code of 1986, as amended (the
``Code''). Amounts paid upon the surrender of a life insurance
policy are taxable to the extent the amount received exceeds
the aggregate amount of premiums or other consideration paid
for the policy, pursuant to section 72(e) of the Code.
Section 163 of the Code generally allows deductions for
interest paid on genuine indebtedness. However, sections
264(a)(2) and (a)(3) of the Code, enacted in 1964, prohibit
deductions if the interest is paid pursuant to (i) a single
premium life insurance contract, or (ii) a plan of purchase
that contemplates the systematic direct or indirect borrowing
of part or all of the increases in the cash value of such
contract, unless the requirements of an applicable exception to
the disallowance rule are satisfied. One of the exceptions to
this interest disallowance provision, known as the ``four-out-
of-seven'' rule, is satisfied if no part of four of the annual
premiums due during a seven-year period (beginning with the
date the first premium on the contract is paid) is paid by
means of indebtedness.
The Tax Reform Act of 1986 (the ``1986 Act'') amended
section 264 of the Code to limit generally deductions for
interest paid or accrued on debt with respect to COLI policies
covering the life of any officer, employee, or individual who
is financially interested in the taxpayer. Specifically, it
denied deductions for interest to the extent that borrowing
levels on corporate-owned policies exceeded $50,000 of cash
surrender value per insured officer, employee, or financially
interested individual.
Congress in the Health Insurance Portability and
Accountability Act of 1996 (the ``1996 Act'') eliminated
deductions for interest paid on loans taken against the tax-
free earnings under the life insurance contract. Specifically,
the 1996 Act denied a deduction for interest paid or accrued on
any indebtedness with respect to any life insurance policies
covering an officer, employee, or financially interested
individual of the policy owner. The 1996 Act provided a phase-
out rule for indebtedness on existing COLI contracts,
permitting continued interest deductions in declining
percentages through 1998. After 1998, no deductions were
permitted.
The 1996 Act provided an exception for certain COLI
contracts. Specifically, the Act continued to allow deductions
with respect to indebtedness on COLI covering up to 20 ``key
persons,'' \1\ defined generally as an officer or a 20-percent
owner of the policy owner, subject to the $50,000 indebtedness
limit, and further subject to a restriction that the rate of
interest paid on the policies cannot exceed the Moody's
Corporate Bond Yield Average-Monthly Corporates for each month
interest is paid or accrued. Other than this one exception,
there is no longer any ability for a corporation to deduct
interest on a life insurance policy covering its officers,
directors, employees, or 20-percent owners.
---------------------------------------------------------------------------
\1\ For many companies, the effective key person limit under this
rule is five employees. See section 264(b)(3).
---------------------------------------------------------------------------
The Taxpayer Relief Act of 1997 (the ``1997 Act'') added
section 264(f) to the Code. This provision generally disallows
a deduction for the portion of a taxpayer's total interest
expense that is allocated pro rata to the excess of the cash
surrender value of the taxpayer's life insurance policies over
the amounts of any loans with respect to the policies,
effective for policies issued after June 8, 1997. However,
section 264(f)(4) provides a broad exception for policies
covering 20-percent owners, officers, directors, or employees
of the owner of the policy. Thus, the interest deduction
disallowance provision in the 1997 Act generally affected only
COLI programs covering the lives of non-employees.
The COLI proposal in the Administration's FY 2001 budget,
submitted on February 7, 2000, would extend the section 264(f)
interest deduction disallowance to COLI programs covering the
lives of employees. \2\ The proposal therefore would apply a
proportionate interest expense disallowance based on all COLI
cash surrender values. The exact amount of the interest
disallowance would depend on the ratio of the average cash
values of the taxpayer's non-leveraged life insurance policies
to the average adjusted bases of all other assets.
---------------------------------------------------------------------------
\2\ By eliminating the section 264(f)(4) exception that currently
exempts COLI programs covering the lives of employees, officers, and
directors.
---------------------------------------------------------------------------
Lack of Tax Policy Justification
The Treasury Department, in its ``Green Book'' explanation
of the revenue proposals in the Administration's FY 2001
budget, implies that the COLI measures taken by Congress in
1996 and 1997 were incomplete in accomplishing their intended
goals. A closer inspection of the tax policy considerations
that gave rise to the 1996 and 1997 changes would suggest
otherwise.
The 1996 Act changes to the tax treatment of COLI focused
on leveraged COLI transactions (i.e., transactions involving
borrowings against the value of the life insurance policies),
which Congress believed represented an inappropriate and
unintended application of the tax rules. The ``Blue Book''
explanation of the 1996 Act, prepared by the staff of the Joint
Committee on Taxation, states that leveraged COLI programs
``could be viewed as the economic equivalent of a tax-free
savings account owned by the company into which it pays itself
tax-deductible interest.'' \3\ The Blue Book further states:
---------------------------------------------------------------------------
\3\ Joint Committee on Taxation, General Explanation of Tax
Legislation Enacted in the 104th Congress (JCS-12-96), December 18,
1996, p. 363.
---------------------------------------------------------------------------
. . .Congress felt that it is not appropriate to permit a
deduction for interest that is funding the increase in value of
an asset of which the taxpayer is the ultimate beneficiary as
recipient of the proceeds upon the insured person's death.
Interest paid by the taxpayer on a loan under a life insurance
policy can be viewed as funding the inside buildup of the
policy. The taxpayer is indirectly paying the interest to
itself, through the increase in value of the policy of which
the taxpayer is the beneficiary.\4\
---------------------------------------------------------------------------
\4\ Id, at 364.
---------------------------------------------------------------------------
The 1997 Act COLI provision grew out of concerns over plans
by a particular taxpayer, Fannie Mae, to acquire corporate-
owned life insurance on the lives of its mortgage holders. The
1997 Act changes, therefore, specifically targeted COLI
programs developed with respect to non-employees. Both the
House Ways and Means Committee Report and the Senate Finance
Committee Report on the 1997 Act discuss an example involving a
Fannie Mae-type fact pattern:
If a mortgage lender can . . . buy a cash value life
insurance policy on the lives of mortgage borrowers, the lender
may be able to deduct premiums or interest on debt with respect
to such a contract, if no other deduction disallowance rule or
principle of tax law applies to limit the deductions. The
premiums or interest could be deductible even after the
individual's mortgage loan is sold to another lender or to a
mortgage pool. If the loan were sold to a second lender, the
second lender might also be able to buy a cash value life
insurance contract on the life of the borrower, and to deduct
premiums or interest with respect to that contract.\5\
---------------------------------------------------------------------------
\5\ H.R. Rep. No. 105-148, 105th Cong., 1st Sess. p. 501; S. Rep.
No. 105-33, 105th Cong., 1st Sess., p. 186.
---------------------------------------------------------------------------
The COLI proposal in the Administration's FY 2001 budget
lacks any similarly compelling tax policy justification. Unlike
the 1996 Act provision targeting leveraged COLI programs, the
Administration's proposal would apply where there is no link
between loan interest and the COLI program.\6\ And unlike the
1997 Act provision targeting the use of COLI with respect to
non-employees, this proposal does not involve a newly conceived
use of COLI.
---------------------------------------------------------------------------
\6\ Current law is quite specific that interest deductions
resulting from both direct and indirect borrowing, i.e., using the
policy as collateral, are disallowed. Sec. 264(a)(3).
---------------------------------------------------------------------------
In explaining the rationale underlying the proposal, the
Treasury Department argues that the ``inside buildup'' on life
insurance policies in COLI programs gives rise to ``tax
arbitrage benefits'' for leveraged businesses.\7\ Treasury
argues that businesses use inside buildup on COLI policies to
fund deductible interest payments, thus jumping to the
conclusion that COLI considerations govern decisions regarding
when businesses incur debt. This view is clearly erroneous.
Businesses incur debt for business reasons, such as business
expansion.
---------------------------------------------------------------------------
\7\ General Explanation of the Administration's Fiscal Year 2001
Revenue Proposals, Department of the Treasury, February 2000, p.137.
---------------------------------------------------------------------------
COLI is Not a ``Tax Shelter''
Clark/Bardes strongly objects to the Administration's
characterization of non-leveraged COLI as a ``corporate tax
shelter.'' The penalty provisions of the Internal Revenue Code
define a tax shelter as any entity, plan, or arrangement with
respect to which tax avoidance or evasion is a significant
purpose.\8\ A separate proposal in the Administration's FY 2001
budget proposes a new definition of ``corporate tax shelter''
under section 6662 that would apply to ``attempts to obtain a
tax benefit'' in a ``tax-avoidance transaction,'' defined as
any transaction in which the reasonably expected pre-tax profit
is insignificant relative to the reasonably expected net tax
benefits.\9\
---------------------------------------------------------------------------
\8\ Section 6662(d)(2)(C)(iii).
\9\ As a separate matter, Clark/Bardes believes the
Administration's proposed new definition of ``corporate tax shelter''
is unnecessary, ill-advised, and could be broadly applied by IRS agents
to attack many legitimate business transactions.
---------------------------------------------------------------------------
It is difficult to see how traditional COLI programs might
reasonably be viewed as meeting any of these ``corporate tax
shelter'' definitions. As discussed above, the Administration's
proposal would deny interest deductions on borrowings totally
unrelated to COLI, for example, where a company owning life
insurance policies on the lives of employees borrows money to
construct a new manufacturing plant, or conversely, where a
company that borrowed ten years ago to construct a plant now
considers purchasing life insurance to help finance retiree
benefits. It is difficult to see how these disparate actions
could be collapsed and viewed as a tax-avoidance transaction.
Does Treasury seriously suggest that a company holding life
insurance that decides to borrow to fund construction of a new
plant is motivated by tax considerations? The Treasury proposal
would completely disregard the obvious business purpose
underlying such a decision.
Under a broader view, a ``tax shelter'' might be thought of
as an arrangement involving an unintended application of the
tax laws. It is impossible to argue that current COLI programs
are unintended. Few other areas of the tax law have received as
thorough scrutiny in recent years. In the 1996 Act, Congress
explicitly allowed COLI programs to continue so long as they
were not leveraged. In the 1997 Act, Congress carefully crafted
a specific exception (designed to preserve longstanding use of
unleveraged COLI) to the pro rata interest expense disallowance
provisions for COLI programs covering employees. In other
words, current COLI programs involve an intended application of
the tax law.
Attack on ``Inside Buildup,'' Savings
The Administration's COLI proposal, at its core, is not
about ``tax shelters'' at all. Rather, it is a thinly veiled
attack on the very heart of traditional permanent life
insurance--that is, the ``inside buildup'' of credits (or cash
value) within these policies that permits policyholders to pay
level premiums over the lives of covered individuals. Although
couched as a limitation on interest expense deductions, the
proposal generally would have the same effect as a direct tax
on inside buildup. Thus, the proposal would reverse the
fundamental tax treatment of level-premium life insurance that
has been in place since 1913.
Congress in the past has rejected proposals to alter the
tax treatment of inside buildup, and for good reason. The
investment element inherent in permanent life insurance is a
significant form of savings. Congress and the Administration in
recent years have worked together in the opposite direction,
considering new incentives for savings and long-term investment
and removing obvious obstacles. It is odd that the
Administration at this time would propose making it more
difficult to save and invest through life insurance.
Inappropriate Limitation on Business Deductions
In some respects, Treasury's proposed denial of deductions
for interest expenses for companies owning life insurance is
not surprising. This proposal comes on the heels of other
Clinton Administration proposals to chip away at deductions for
expenses that long have been treated as ordinary and necessary
costs of doing business. Another recent example is the
provision in the Administration's FY 2001 budget that would
deny deductions for damages paid by companies to plaintiffs
groups.
But the proposal is troubling nonetheless, as illustrated
by a simple example. The XYX company in 1998 borrows funds to
build a new manufacturing facility. The XYZ company in 1998 and
1999 is able to deduct interest paid on these borrowings. In
2000, the XYZ company, responding to concerns over mounting
future retiree health obligations, purchases insurance on the
lives of its employees. IRS agents tell the XYZ company that it
has just entered into a ``corporate tax shelter.'' Suddenly,
the XYZ company finds that a portion of the interest on the
1998 loan is no longer viewed by the government as an ordinary
and necessary business expense. XYZ therefore is taxed,
retroactively, on its 1998 borrowing.
The proposal becomes even more troubling when one considers
the logical extensions of the Administration's rationale, which
seems to be to deny interest deductions when a taxpayer at the
same time enjoys the benefits of tax deferral. Might the IRS,
using the same reasoning, someday seek to deny home mortgage
interest deductions for individuals who also own life
insurance? Might the government deny deductions for medical
expenses for individuals that enjoy tax-preferred accumulations
of earnings in 401(k) accounts or IRAs?
Conclusion
Clark/Bardes respectfully urges the Committee on Ways and
Means to reject the Administration's misguided COLI proposal,
as it did in 1998 and 1999. As discussed above, the
Administration once again has failed to articulate a clear or
compelling tax policy concern over the current-law rules, and
has sought to couch COLI, altogether inappropriately, as a
``tax shelter.'' If enacted, the Administration's proposal
would represent a significant departure from current law and
longstanding tax policy regarding the treatment of life
insurance. It would have a significantly adverse impact on the
ability of businesses to solve a variety of needs including the
ability to finance meaningful retiree health benefits. It also
would provide a disincentive for savings and long-term
investment and would represent yet another attack on deductions
for ordinary and necessary business expenses.
Statement of the Coalition for the Fair Taxation of Business
Transactions \1\
The Coalition for the Fair Taxation of Business
Transactions (the ``Coalition'') is composed of U.S. companies
representing a broad cross-section of industries. The Coalition
is opposed to the broad-based ``corporate tax shelter''
provisions proposed by the Administration in their FY2001
budget because they believe that the proposals, if enacted,
would have a far-reaching effect that unnecessarily harms
legitimate business transactions. To the extent that abuses
exist, current administrative remedies are available and
sufficient to curtail overly aggressive tax shelter activity.
In addition, IRS has been very successful in attacking tax
shelters through the courts, which themselves have issued
criteria for assessing potential tax shelters that should prove
to be effective deterrents to abuse. Finally, if Congress feels
compelled to legislate in this area, they should narrowly limit
the category of transactions classified as corporate tax
shelters so as not to penalize legitimate business
transactions. This would necessitate recognizing the business
purpose of the transaction.
---------------------------------------------------------------------------
\1\ This testimony was prepared by Arthur Andersen on behalf of the
Coalition for the Fair Taxation of Business Transactions.
---------------------------------------------------------------------------
This paper contains the Coalition's specific concerns with
the President's FY2001 corporate tax shelter proposals. The
Coalition has previously submitted testimony to the House Ways
and Means and Senate Finance Committees with respect to the
proposals contained in the Administration's FY2000 Budget,
Treasury's White Paper and the Joint Committee Study.
I. Introduction
The Administration's FY2001 Budget, submitted to Congress
on February 7, 2000, contains several proposals concerning the
definition of and the penalties for corporate tax shelters.
These recommendations fall into two general categories: those
that affect corporate taxpayers that engage in tax shelter
activity and those that affect other parties, such as tax
shelter promoters and tax advisers.
Last year, on July 1, 1999, the Department of Treasury
issued its much-publicized ``White Paper'' \2\ on corporate tax
shelters. Treasury's White Paper analyzes corporate tax shelter
activity and proposes recommendations for modifying the
Administration's corporate tax shelter proposals originally
proposed in February 1999 as part of the FY2002 Budget. Many of
Treasury's White Paper modifications have been incorporated in
the Administration's FY2001 budget and are an improvement over
the recommendations in the FY2000 budget. However, the
substance of the Administration's underlying proposals remains
problematic. The recommendations continue to characterize too
broad a classification of activities as tax shelters. To this
end, Treasury has proposed a set of recommendations that,
instead of narrowly stopping abusive shelter schemes, will hit
legitimate transactions, impose penalties on unsuspecting
taxpayers, require burdensome disclosures and generally allow
IRS agents to call into question virtually any transaction
undertaken by a corporate taxpayer, regardless of the purpose,
if it reduces the corporation's taxes.
---------------------------------------------------------------------------
\2\ Department of the Treasury, The Problem of Corporate Tax
Shelters: Discussion, Analysis and Legislative Proposals, July 1999.
---------------------------------------------------------------------------
Furthermore, we believe the IRS currently has the
necessary tools to challenge abusive transactions and
additional statutory changes are unwarranted. The IRS has the
authority to issue administrative pronouncements (notices,
rulings, or other announcements) to address perceived abusive
transactions. In fact, the number of announcements the IRS has
issued in the past few years addressing perceived tax shelter
activity has been substantial. In addition, Treasury and the
IRS have a wide range of general anti-abuse provisions already
available to combat the perceived proliferation of corporate
tax shelters. For example, if a taxpayer's method of accounting
does not clearly reflect income, section 446(b) of the Code
authorizes the IRS to disregard the taxpayer's method of
accounting and to compute the taxpayer's income under a method
of accounting it believes more clearly reflects income. Under
section 482 of the Code, the IRS can allocate, distribute, or
apportion income, deductions, credits and allowances between
controlled taxpayers to prevent evasion of taxes or to
accurately reflect their taxable income.
Moreover, the IRS has recently announced the formation of a
working group to identify and target corporate tax shelter
activity. This group should enable the IRS to identify tax
shelter activity more quickly and should be a deterrent to
abusive tax shelter activity particularly given IRS' stated
intent to impose penalties more often. This working group
should provide a formidable resource when coupled with existing
IRS authority to issue administrative pronouncements and
general anti-abuse authority available to IRS and Treasury.
Finally, as evidenced by recent court rulings, the IRS can
and does challenge abusive transactions in the courts. The
primary reason why it is so difficult to draft a broad-based
tax shelter rule is because it is extremely difficult to
provide a mechanism to evaluate a corporation's business
purpose in a statutory framework. This is because evaluation of
business purpose is a subjective evaluation.\3\ However, the
courts can and routinely do effectively make this evaluation,
which has resulted in several recent successful challenges of
tax shelters by the IRS. Thus, we believe that the
Administration's corporate tax shelter proposals are not
warranted.\4\
---------------------------------------------------------------------------
\3\ As the Tax Court stated in the recent decision of Saba
Partnership, et. al. v. Commissioner, T.C. Memo 1999-359, ``(a)n
evaluation of the economic substance of the. . .2transactions requires:
(1) A subjective inquiry whether the. . .carried out the transaction
for a valid business purpose other that to obtain tax benefits; and (2)
an objective inquiry whether the. . . transactions had practical
economic effects other than the creation of tax benefits.'' at 111.
\4\ See also Compaq Computer Corporation and Subsidiaries v.
Commissioner of Internal Revenue, 113 T.C. No. 17 (Sept. 21, 1999); ACM
Partnership v. Commissioner, 73 T.C.M. 2189 (1997), aff'd in part,
rev'd in part, 157 F.3d 231 (3d Cir. 1998), cert. denied, 119 S.Ct 1251
(1999); ASA Investerings v. Commissioner, 76 TCM 325 (1998); Laidlaw
Transportation Inc., et al. V. Commissioner, T.C. Memo. 1998-232; The
Limited Inc. v. Commissioner 113 T.C. No. 13 (1999); IES Industries
Inc. v United States 84 AFTR2d Par. 99-5373 (1999); and United Parcel
Service of America v. Commissioner 78 TCM 262 (1999).
---------------------------------------------------------------------------
II. Tax Shelter Definition
Central to the approach taken by the Administration is an
enhanced definition of corporate tax shelter.\5\
---------------------------------------------------------------------------
\5\ Under current law, a tax shelter is any entity, investment,
plan, or arrangement with a significant purpose of avoiding or evading
Federal income taxes. Section 6662(a)(2)(c)(iii).
---------------------------------------------------------------------------
The definition of tax shelter is key to the penalty
regimes contained in the proposals. In the Administration's
budget, once a transaction is characterized as a tax shelter,
the taxpayer can be subject to an increased substantial
understatement penalty (40 percent), unless certain disclosure
requirements are met. In addition, same test would be applied
to disallow tax benefits from transactions that would be deemed
to lack economic substance.
The Administration's FY2001 Budget proposal would modify
the existing tax shelter definition \6\ to provide that a
corporate tax shelter would be any entity, plan, or arrangement
in which a corporation obtained a ``tax benefit'' in a ``tax
avoidance transaction.'' The proposal defines a ``tax benefit''
as a reduction, exclusion, avoidance or deferral of tax (or an
increase in a refund) unless the benefit was ``clearly
contemplated'' by the applicable Code provision. The proposal
defines a ``tax avoidance transaction'' as any transaction in
which the reasonably expected pre-tax profit (determined on a
present value basis, after taking into account foreign taxes as
expenses and transaction costs) of the transaction is
insignificant relative to the reasonably expected net tax
benefits (i.e., tax benefits in excess of the tax liability
arising from the transaction, determined on a present value
basis) of such transaction. Additionally, a financing
transaction would be considered a tax avoidance transaction if
the present value of the tax benefits of the taxpayer to whom
the financing is provided are significantly in excess of the
present value of the pre-tax profit or return of the person
providing the financing.
---------------------------------------------------------------------------
\6\ For transactions entered into before August 6, 1997, a ``tax
shelter'' is defined as a partnership or other entity, an investment
plan or arrangement, or any other plan or arrangement if the principal
purpose of the partnership, entity, plan, or arrangement is the
avoidance or evasion of Federal income tax. The Taxpayer Relief Act of
1997 amended section 6662(d)(2)(C)(ii) to provide a new definition of
tax shelter for purposes of the substantial understatement penalty.
Under this new definition of tax shelter, the tax avoidance purpose of
an entity or arrangement need not be its principal purpose. Now a tax
shelter is any entity, investment, plan, or arrangement with a
significant purpose of avoiding or evading Federal income taxes. The
new definition of tax shelter is effective for transactions entered
into after August 5, 1997.
---------------------------------------------------------------------------
One need look no further than the proposed new definition
of corporate tax shelter to find the genesis of the problems
with the Administration's budget proposals. The Administration
has proposed an objective standard for determining what is a
corporate tax shelter in order to avoid an overdelegation of
authority to the IRS. Nonetheless, the definition remains too
broad. The new definition does not adequately deal with the
numerous day-to-day business transactions that do not lend
themselves to a pre-tax profit comparison that are not
financing transactions.
The Administration excludes tax benefits that are
``clearly contemplated'' from consideration as tax shelters,
but this standard is too vague to provide much relief from the
broad application of the definition. In determining the
application of the ``clearly contemplated'' exception,
Congressional purpose, administrative interpretations, and
interaction of the provision with other provisions are to be
taken into account. This standard would provide an IRS agent
with extraordinary leeway in making a determination that a
transaction did not meet the clearly contemplated standard,
which will inevitably result in increased confrontations
between taxpayers and revenue agents and a backlog of
litigation in the Tax Court.
Thus, the Administration's proposed tax shelter definition
would apply to a broad category of legitimate business
transactions, which do not confer a direct profit stream. For
example, a corporation may need to structure its affairs to
conform to regulatory requirements or may reorganize its
structure to gain access to certain foreign markets. A company
may also restructure or reorganize to gain economies of scale.
These transactions are motivated by business concerns, even
though they do not directly produce a pre-tax economic return
by themselves. If these legitimate transactions are done in a
tax efficient manner, they apparently will be characterized
automatically as a tax shelter because they do not produce a
direct economic return. In addition, it is unclear as to what
type of transaction will be affected by the proposal to deal
with financing transactions other than a ``stepped-down
preferred transaction,'' which has already been addressed in
recent Treasury guidance.\7\
---------------------------------------------------------------------------
\7\ Notice 97-21, 1997-1 C.B. 651 and Prop. Treas. Reg. section
1.7701(l).
---------------------------------------------------------------------------
Although the Administration claims that their tax shelter
definition is rooted in case law, citing ACM Partnership \8\,
Compaq Computer \9\, and Winn-Dixie \10\, the Administration's
test fails to include as essential part of the analysis that is
common to all of these cases--whether despite the fact that
there is little or no direct economic effect of the
transaction, there is a valid business purpose. For example,
the circuit court in ACM Partnership appeal states, ``(T)he
inquiry into whether the taxpayer's transactions had sufficient
economic substance to be respected for tax purposes turns on
both the 'economic substance of the transaction' and the
'subjective business motivation' behind them. However, these
distinct aspects of the economic sham inquiry do not constitute
discrete prongs of a 'rigid two-step analysis,' but rather
represent related factors both of which inform the analysis of
whether the transaction had sufficient substance, apart from
its tax consequences, to be respected for tax purposes.'' \11\
Evaluating business purpose on a facts and circumstances basis
is central to judicial application of the economic substance
doctrine.
---------------------------------------------------------------------------
\8\ ACM Partnership v. Commissioner, 73 T.C.M. 2189 (1997), aff'd
in part, rev'd in part, 157 F.3d 231 (3d Cir. 1998), cert. denied, 119
S.Ct 1251 (1999).
\9\ Compaq Computer Corporation and Subsidiaries v. Commissioner of
Internal Revenue, 113 T.C. No. 17 (Sept. 21, 1999).
\10\ Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. No. 21
(1999).
\11\ ACM at 247.
---------------------------------------------------------------------------
III. Modified Substantial Understatement Penalty
The Administration's budget proposal would increase the
substantial understatement penalty from 20 percent to 40
percent with respect to any item attributable to a corporate
tax shelter.\12\ A corporation can reduce the 40 percent
penalty to 20 percent by fulfilling specific disclosure
requirements. Specifically, a taxpayer would be required to
disclose a tax shelter transaction to the IRS National Office
by filing a statement with the tax return describing the
transaction. If the taxpayer meets a strengthened reasonable
cause standard the penalty can be reduced from 20% to 0, even
if the transaction ultimately is deemed to be a corporate tax
shelter. The reasonable cause exception would be modified and
strengthened by requiring that the taxpayer have a ``strong
chance of sustaining its tax position'' (rather than ``more
likely than not'').
---------------------------------------------------------------------------
\12\ Generally, Section 6662(a) of the Internal Revenue Code
imposes a 20 percent penalty on the portion of an underpayment of tax
attributable to a substantial understatement of income tax.
---------------------------------------------------------------------------
We commend the Administration for some of the improvements
they have made to their FY2000 Budget Proposal. For example, in
response to criticisms that the Coalition and others have made,
they no longer propose eliminating the reasonable cause
exception to the substantial understatement penalty. They also
have eliminated the proposal to require that a tax shelter
disclosure be made both 30 days after the transaction is
completed, as well as with the tax return. Nonetheless, we
remain concerned that the proposed 40 percent penalty is too
harsh given the uncertainty that will result from the vague
definition of ``corporate tax shelter'' in the Administration's
proposal.
Revenue agents, who have no downside, can threaten to
propose adjustments based on alleged corporate tax shelter
transactions to extract unreasonable concessions by the
corporate taxpayer on other issues. Incidents of ``rogue''
revenue agents abusing their authority in efforts to extort
unfair concessions and settlements are not limited to
individual taxpayers. In fact, the higher rate of corporate tax
audits makes this a particularly worrisome proposal. The use of
the increased substantial understatement penalty to obtain
concessions from corporate taxpayers is inconsistent with the
goals expressed in the IRS Restructuring and Reform Act of
1998.
Furthermore, the proposed strengthened reasonable cause
standard is too high a standard to satisfy and is unclear in
its application. The only current standard in the Code that is
similar to the ``strong chance of sustaining its tax position''
is the burden placed on IRS by Sec. 7454(a) and Tax Court Rule
142(b) in a civil fraud case of proving by ``clear and
convincing evidence'' the taxpayer's intent to evade his taxes.
To place such a similar burden on a corporate taxpayer to avoid
the accuracy penalty attributable to a tax shelter is
unwarranted because it places this heavy burden on the
taxpayer, not the IRS who is seeking to impose the penalty.
If it were true that taxpayers are either ignoring or
circumventing the requirements of regulation section 1.6664-4,
codifying the requirements therein would significantly
strengthen the reasonable cause standard and should satisfy the
administration's stated concerns.
IV. Increased Corporate Disclosure Requirements
Under current law, unlike the rules for non-tax shelter
understatement items, disclosure of a corporate tax shelter
item does not provide a basis for avoiding the substantial
understatement penalty. To increase disclosure, the
Administration recommends that the substantial understatement
penalty be reduced if the proposed disclosure requirements are
met. The Administration would require that transactions meeting
certain characteristics be disclosed, whether or not they meet
the definition of corporate tax shelter. A $100,000 penalty
would be applied to each failure to satisfy the disclosure
requirements.
Corporate taxpayers would be required to disclose
transactions that result in a significant tax benefit and have
some combination of the following characteristics
(``filters''): (1) a book/tax difference in excess of a certain
amount; (2) a rescission, unwind or provision insuring tax
benefits; (3) involvement of tax-indifferent parties; (4)
advisor fees in excess of a certain amount or contingent fees;
(5) confidentiality agreement; (6) offering of the transaction
to multiple corporations (if known); and a difference between
the form of the transaction and how it is reported. The
disclosure must be filed with the IRS National Office by the
unextended due date of the tax return and again with each
income tax return that the transaction affects. The disclosure
would be a ``short form'' filed with the National Office and
would require taxpayers to provide a description of the filters
that apply to the transaction, as well as other information. A
$100,000 penalty for each failure to disclose would apply. The
disclosure form must be signed by a corporate officer who would
be made personally liable for misstatements on the form. The
officer could be subject to penalties for fraud or gross
negligence and would be accorded due process rights.
While this enhanced notice requirement is intended to keep
IRS current on the latest tax planning activities of corporate
taxpayers, it is burdensome and a trap for the unwary corporate
taxpayer. Although we believe that the Administration proposed
the use of the ``filters'' to limit the number of transactions
that must be disclosed, the use of these filters may have the
opposite effect because several of the filters can occur with
some frequency in routine business transactions. For example,
non-deductible goodwill can create a book/tax difference, which
is a common occurrence and does not indicate the presence of a
tax shelter. Moreover, with the recently enacted 2-year
limitation on NOL carrybacks, characterizing a taxpayer with a
3-year NOL carryforward as a tax indifferent party could
classify many business combinations as tax shelters subject to
disclosure and possible penalties.
The inequity and burden of this requirement is only
further compounded with the significant $100,000 monetary
penalty. Surely the breadth of the proposed ``filters'' and the
vagueness of the tax shelter definition will cause taxpayers,
including unsophisticated small and medium sized businesses, to
be subject to this very large penalty. As noted above, the wide
scope of business transactions subject to disclosure under this
proposal would be astonishing. If filters are to be used to
narrow the number of transactions that must be disclosed, a
better approach would be to require that a transaction have at
least three of the filter characteristics to trigger the
disclosure requirements. However, we believe that disclosure
made on schedule M-1 \13\ of the corporate tax return,
reconciling discrepancies between how income and losses are
reported for tax and book purposes, should provide the IRS with
the information they need without imposing an unnecessary
additional burden on taxpayers.
---------------------------------------------------------------------------
\13\ Adequate disclosure must meet the requirements of Rev. Proc.
98-62, 1998-52 I.R.B. 23 (12/28/98).
---------------------------------------------------------------------------
Furthermore, the proposal to hold a corporate officer
personally liable for the disclosures, with possible penalties,
does not serve a logical propose. According to Treasury
officials, one of the purposes of having a corporate officer
attest to this information is to have the person most in
control of the facts sign the disclosure. In most cases, the
person most in control of the facts is the tax director. If the
tax director is a corporate officer, he generally is already
signing the tax return under penalties of perjury that to the
best of his knowledge and belief, the return is true, correct
and complete. We do not believe it is appropriate or necessary
to require the attestation of an additional corporate officer
who does not otherwise have control of the facts in the
situation.
Even more troublesome is the possibility that a
transaction that the taxpayer reasonably believes is not a tax
shelter, and therefore does not disclose, is later classified
as a corporate tax shelter. Under the proposed regime, that
taxpayer would be subject to a significant penalty. First, the
tax benefits would be denied. Second, a 40 percent penalty
would apply. Finally, a $100,000 failure to disclose penalty
would be imposed. Thus, in addition to the substantial power
granted to IRS field agents, the higher standards for
reasonable cause and the significantly increased monetary
penalties create substantial risk for both routine business
transactions and legitimate corporate tax planning. Overall,
the regime Treasury has proposed is overly burdensome,
complicated and vague in its practical application.
V. Codification of the Economic Substance Doctrine
The Administration's proposal attempts to codify and
clarify the judicial economic substance doctrine. Under the
proposal, tax benefits would be disallowed from any transaction
in which the reasonably expected pre-tax profit (determined on
a present value basis, after taking into account foreign taxes
as expenses and transaction costs) of the taxpayer from the
transaction is insignificant relative to the reasonably
expected net tax benefits (i.e., tax benefits in excess of the
tax liability arising from the transaction, determined on a
present value basis) of the taxpayer from such transaction.
With respect to financing transactions, tax benefits would be
disallowed if the present value of the tax benefits of the
taxpayer to whom the financing is provided are significantly in
excess of the present value of the pre-tax profit or return of
the person providing the financing.
The proposal would not apply to disallow any claimed loss
or deduction of a taxpayer that had economically been incurred
by the taxpayer before the transaction was entered into. The
proposal would apply to any transaction entered into in
connection with a trade or business or activity engaged in for
profit or for the production of income, whether or not by a
corporation.
As noted above, this proposal would provide IRS agents
with extraordinary power to classify business transactions as
tax shelters. Taxpayers that enter into transactions that have
legitimate business purposes, even though under the
mathematical test of the proposal no pre-tax profit is
quantifiable, would be denied tax benefits and subject to harsh
penalties. The judicially applied economic substance doctrine
looks to both the economic consequences and an analysis of the
intended purposes behind the transaction. This business purpose
analysis is an important means of determining whether a
transaction has no purpose other than the avoidance of tax or
serves a non-tax business purpose. The proposal is clearly
lacking this critical element of the doctrine developed over
the years by the courts.
VI. Administrative Safeguards
Identifying and defining corporate tax shelters is a
nearly impossible task. As evidenced by the various iterations
of tax shelter definition, all of which are extremely broad and
lack a business purpose exception, both taxpayers and IRS
agents are bound to disagree about which transactions are or
are not tax shelters. Thus, especially in light of the proposed
enhanced penalty regimes, taxpayers should be afforded remedies
to protect against the potential abuse of power by IRS agents
under these stricter yet ambiguous tax shelter definitions.
The budget proposals of the Administration do not provide
any safeguards or protections against IRS agents using the new
penalties as leverage to extract other concessions or otherwise
abusing their power as a result of these new higher and
stricter penalties.
In its White Paper, Treasury suggested modifying the
Administration's FY2000 budget proposal to allow any corporate
tax shelter issue raised by an examining agent to be
automatically referred to the National Office of the IRS for
further processing or resolution. This review would facilitate
consistent treatment among various taxpayers and protect
taxpayers from aggressive IRS field agents. It is extremely
unfortunate that the revised FY2001 budget proposals provide no
such relief.
Treasury's White Paper also suggested allowing a taxpayer
to get an expedited ruling on whether a contemplated
transaction is a tax shelter. Again, given the ambiguity in the
definition of tax shelter and the harsh penalty associated with
characterization as a tax shelter, an expedited ruling process
could be helpful.
The proposed overly broad definition of corporate tax
shelter will give examining agents an unwarranted and
unrestrained opportunity to hold corporate taxpayers hostage
during the examination process. Revenue agents, who have no
downside, can threaten to propose adjustments based on alleged
corporate tax shelter transactions to extract unreasonable
concessions by the corporate taxpayer on other issues.
Incidents of ``rogue'' revenue agents abusing their authority
in efforts to extort unfair concessions and settlements are not
limited to individual taxpayers. In fact, the higher rate of
corporate tax audits makes this a particularly worrisome
proposal.
Under the proposal to codify the economic substance
doctrine, revenue agents could disallow any deduction, credit,
exclusion, or other allowance obtained by a corporate taxpayer
based on the determination that a transaction falls within the
vague definition of a ``tax avoidance transaction.'' This
authority could be used to deny a corporate taxpayer a tax
benefit provided by the Code merely because the IRS believes
that the transaction yielded too much tax savings, regardless
of a corporate taxpayer's legitimate business purpose for
entering into the transaction. Again, this is giving an IRS
agent too much discretion and is inconsistent with the IRS
Restructuring and Reform Act. At least, the Treasury's White
Paper recognized and made accommodations along these lines by
proposing National Office review of a tax shelter
characterization, as well as an expected ruling process. An
additional safeguard might be to allow taxpayers to obtain an
early referral to Appeals on an item that is characterized by
an agent as a tax shelter.
VII. Promoters, Tax Advisors and Standards of Practice
In addition to tougher requirements for corporate
taxpayers, the proposals increase the penalties and sanctions
on third parties associated with corporate tax shelters. Among
other reasons, the Administration blames promoters for the
recent increase in corporate tax shelter activity. Currently,
there are a number of Code provisions that impose promoter
penalties. In addition, there are ethical standards to guide
tax advisors that practice before the IRS. In general, to
curtail the proliferation of tax shelter activity and increase
the risk to promoters, the proposals increase and expand
current penalties as well as impose additional penalties.
The Administration's FY 2001 Budget proposes to impose
additional penalties on other parties involved in corporate tax
shelter transactions. The proposal would impose a 25-percent
excise tax on fees received in connection with the purchase and
implementation of a corporate tax shelter (including
underwriting and other fees) and the rendering of certain tax
advice related to a corporate tax shelter. Only persons who
perform services in furtherance of the corporate tax shelter
would be subject to the proposal. The proposal would not apply
to expenses incurred with respect to representing the taxpayer
before the IRS or a court. For example, an adviser that
cautions not to enter into the transaction would not be subject
to the penalty excise tax. In addition, due process procedures
would be provided for parties subject to the excise tax. Again,
we believe the Administration heeded some of the concerns that
the Coalition and others expressed with their FY2000 Budget
Proposals. It is appropriate that this excise tax be imposed
only on the fees associated with furtherance of a corporate tax
shelter and that procedures for due process be provided.
Finally, any income received by a tax-indifferent person
with respect to a corporate tax shelter would be taxable to
such person. To ensure that a tax is paid, all corporate
participants would be made jointly and severally liable for the
tax. A tax-indifferent person would be defined as a foreign
person, a Native American tribal organization, a tax-exempt
organization, or a domestic corporation with a loss or credit
carryforward that is more than three years old.
These proposals rely on the same vague and faulty
definition of ``tax avoidance transaction'' as the previously
discussed proposals. The proposal to impose an excise tax on
fees received in connection with a tax shelter raises numerous
administrative issues. The determination that a transaction
falls within the new definition of corporate tax shelters may
not be made until years after the payment or the receipt of
fees, which raises questions concerning the statute of
limitations and IRS' assessment authority against the ``shelter
provider.''
VIII. Conclusion
Notwithstanding the attempts to address criticisms of the
Administration's budget proposals on corporate tax shelters,
the fundamental problem still remains; the proposals are so
broad in their application that they will still impact
legitimate business transactions. This is primarily because the
proposals focus on the tax result and completely ignore
business purpose. For example, business restructurings designed
to reduce business costs would be characterized as tax shelters
if structured in a tax efficient manner.
The disclosure requirements in the proposals are also too
burdensome. Given the broad application of the disclosure
requirements, taxpayers will have difficulty in identifying
transactions that must be disclosed. Even an inadvertent
failure to disclose will prevent taxpayers from being able to
reduce or eliminate the 40 percent understatement penalty. In
addition, attestation should not be required, other than the
attestation required by a corporate officer in signing a tax
return. Again, because of the breadth of the tax shelter
definition in the proposals, attestation would be required for
numerous transactions. It would be extremely burdensome to
provide a briefing on all of these transactions to a corporate
officer who is not the tax director that is sufficient to make
this individual comfortable in attesting to the facts of these
transactions under penalties of perjury.
A regime that narrowly targets abusive transactions and
encourages disclosure without significant burdens would prove
more effective in curtailing unwanted activity and promoting
voluntary compliance. In addition, administrative safeguards
are needed to protect against the potential abuse of power by
IRS agents. The Administration's proposal does not strike this
essential balance.
We continue to believe that the best way of addressing the
corporate tax shelter issue is through the court system because
in applying the judicial economic substance doctrine the court
will examine whether any business purpose existed.\14\
---------------------------------------------------------------------------
\14\ As noted previously, the IRS has successfully litigated many
cases in this area, including most notably Compaq Computer Corporation
and Subsidiaries v. Commissioner of Internal Revenue, 113 T.C. No. 17
(Sept. 21, 1999); ACM Partnership v. Commissioner, 73 T.C.M. 2189
(1997), aff'd in part, rev'd in part, 157 F.3d 231 (3d Cir. 1998),
cert. denied, 119 S.Ct 1251 (1999) and ASA Investerings v.
Commissioner, 76 TCM 325 (1998).
---------------------------------------------------------------------------
Statement of the Coalition of Service Industries \1\
The Coalition of Service Industries, which represents a
broad range of financial institutions, including both large and
small institutions, strongly opposes the Administration's
proposal to increase penalties for failure to file correct
information returns.
---------------------------------------------------------------------------
\1\ The Coalition of Service Industries (CSI) was established in
1982 to create greater awareness of the major role services industries
play in our national economy; promote the expansion of business
opportunities abroad for US service companies; and encourage US
leadership in attaining a fair and competitive global marketplace. CSI
represents a broad array of US service industries including the
financial, telecommunications, professional, travel, transportation,
information and information technology sectors.
---------------------------------------------------------------------------
The proposed penalties are unwarranted and place an undue
burden on already compliant taxpayers. It seems clear that
most, if not all, of the revenue estimated to be raised from
this proposal would stem from the imposition of higher
penalties due to inadvertent errors rather than from enhanced
compliance. The financial services community devotes an
extraordinary amount of resources to comply with current
information reporting and withholding rules and is not
compensated by the U.S. government for these resources. The
proposed penalties are particularly inappropriate in that (i)
there is no evidence of significant current non-compliance and
(ii) the proposed penalties would be imposed upon financial
institutions while such institutions were acting as integral
parts of the U.S. government's system of withholding taxes and
obtaining taxpayer information.
The Proposal
As included in the President's fiscal year 2001 budget, the
proposal generally would increase the penalty for failure to
file correct information returns on or before August 1
following the prescribed filing date from $50 for each return
to the greater of $50 or 5 percent of the amount required to be
reported.\2\ The increased penalties would not apply if the
aggregate amount that is timely and correctly reported for a
calendar year is at least 97 percent of the aggregate amount
required to be reported for the calendar year. If the safe
harbor applies, the present-law penalty of $50 for each return
would continue to apply.
---------------------------------------------------------------------------
\2\ A similar proposal was included in President Clinton's fiscal
year 1998, 1999 and 2000 budgets.
---------------------------------------------------------------------------
Current Penalties are Sufficient
We believe the current penalty regime already provides
ample incentives for filers to comply with information
reporting requirements. In addition to penalties for
inadvertent errors or omissions,\3\ severe sanctions are
imposed for intentional reporting failures. In general, the
current penalty structure is as follows:
---------------------------------------------------------------------------
\3\ It is important to note that many of these errors occur as a
result of incorrect information provided by the return recipients such
as incorrect taxpayer identification numbers (TINs).
---------------------------------------------------------------------------
The combined standard penalty for failing to file
correct information returns and payee statements is $100 per
failure, with a penalty cap of $350,000 per year.
Significantly higher penalties--generally 20
percent of the amount required to be reported (for information
returns and payee statements), with no penalty caps--may be
assessed in cases of intentional disregard.\4\
---------------------------------------------------------------------------
\4\ The standard penalty for failing to file correct information
returns is $50 per failure, subject to a $250,000 cap. Where a failure
is due to intentional disregard, the penalty is the greater of $100 or
10 percent of the amount required to be reported, with no cap on the
amount of the penalty.
---------------------------------------------------------------------------
Payors also may face liabilities for failure to
apply 31 percent backup withholding when, for example, a payee
has not provided its taxpayer identification number (TIN).
There is no evidence that the financial services community
has failed to comply with the current information reporting
rules and, as noted above, there are ample incentives for
compliance already in place.\5\ It seems, therefore, that most
of the revenue raised by the proposal would result from higher
penalty assessments for inadvertent errors, rather than from
increased compliance with information reporting requirements.
Thus, as a matter of tax compliance, there appears to be no
justifiable policy reason to substantially increase these
penalties.
---------------------------------------------------------------------------
\5\ Also note that, in addition to the domestic and foreign
information reporting and penalty regimes that are currently in place,
for payments to foreign persons, an expanded reporting regime with the
concomitant penalties is effective for payments made after December 31,
1999. See TD 8734, published in the Federal Register on October 14,
1997. The payor community is being required to dedicate extensive
manpower and monetary resources to put these new requirements into
practice. Accordingly, these already compliant and overburdened
taxpayers should not have to contend with new punitive and unnecessary
penalties.
---------------------------------------------------------------------------
Penalties Should Not Be Imposed to Raise Revenue
Any reliance on a penalty provision to raise revenue would
represent a significant change in Congress' current policy on
penalties. A 1989 IRS Task Force on Civil Penalties concluded
that penalties ``should exist for the purpose of encouraging
voluntary compliance and not for other purposes, such as
raising of revenue.'' \6\ Congress endorsed the IRS Task
Force's conclusions by specifically enumerating them in the
Conference Report to the Omnibus Budget Reconciliation Act of
1989.\7\ There is no justification for Congress to abandon its
present policy on penalties, which is based on fairness,
particularly in light of the high compliance rate among
information return filers.
---------------------------------------------------------------------------
\6\ Statement of former IRS Commissioner Gibbs before the House
Subcommittee on Oversight (February 21, 1989, page 5).
\7\ OBRA 1989 Conference Report at page 661.
---------------------------------------------------------------------------
Safe Harbor Not Sufficient
Under the proposal, utilization of a 97 percent substantial
compliance ``safe harbor'' is not sufficient to ensure that the
higher proposed penalties apply only to relatively few filers.
Although some information reporting rules are straightforward
(e.g., interest paid on deposits), the requirements for certain
new financial products, as well as new information reporting
requirements,\8\ are often unclear, and inadvertent reporting
errors for complex transactions may occur. Any reporting
``errors'' resulting from such ambiguities could easily lead to
a filer not satisfying the 97 percent safe harbor.
---------------------------------------------------------------------------
\8\ For example, Form 1099-C, discharge of indebtedness reporting,
or Form 1042-S, reporting for bank deposit interest paid to certain
Canadian residents.
---------------------------------------------------------------------------
Application of Penalty Cap to Each Payor Entity Inequitable
We view the proposal as unduly harsh and unnecessary. The
current-law $250,000 penalty cap for information returns is
intended to protect the filing community from excessive
penalties. However, while the $250,000 cap would continue to
apply under the proposal, a filer would reach the penalty cap
much faster than under current law. For institutions that file
information returns for many different payor entities, the
protection offered by the proposed penalty cap is substantially
limited, as the $250,000 cap applies separately to each payor.
In situations involving affiliated companies, multiple
nominees and families of mutual funds, the protection afforded
by the penalty cap is largely illusory because it applies
separately to each legal entity. At the very least, any further
consideration of the proposal should apply the penalty cap
provisions on an aggregate basis. The following examples
illustrate why aggregation in the application of the penalty
cap provisions is critical.
EXAMPLE I--Paying Agents
A bank may act as paying agent for numerous issuers of
stocks and bonds. In this capacity, a bank may file information
returns as the issuers' agent but the issuers, and not the
bank, generally are identified as the payors. Banks may use a
limited number of information reporting systems (frequently
just one overall system) to generate information returns on
behalf of various issuers. If an error in programming the
information reporting system causes erroneous amounts to be
reported, potentially all of the information returns
subsequently generated by that system could be affected. Thus,
a single error could, under the proposal, subject each issuer
for whom the bank filed information returns, to information
reporting penalties because the penalties would be assessed on
a taxpayer-by-taxpayer basis. In this instance, the penalty
would be imposed on each issuer. However, the bank as paying
agent may be required to indemnify the issuers for resulting
penalties.
Recommendation: For the purposes of applying the penalty
cap, the paying agent (not the issuer) should be treated as the
payor.
EXAMPLE II--Retirement Plans
ABC Corporation, which services retirement plans,
approaches the February 28th deadline for filing with the
Internal Revenue Service the appropriate information returns
(i.e., Forms 1099-R). ABC Corporation services 500 retirement
plans and each plan must file over 1,000 Forms 1099-R. A
systems operator, unaware of the penalties for filing late
Forms 1099, attempts to contact the internal Corporate Tax
Department to inform them that an extension of time to file is
necessary to complete the preparation and filing of the
magnetic media for the retirement plans. The systems operator
is unable to reach the Corporate Tax Department by the February
28th filing deadline and files the information returns the
following week. This failure, under the proposal, could lead to
substantial late filing penalties for each retirement plan that
ABC Corporation services (in this example, up to $75,000 for
each plan).\9\
---------------------------------------------------------------------------
\9\ If the corrected returns were filed after August 1, the
penalties would be capped at $250,000 per plan.
---------------------------------------------------------------------------
Recommendation: Retirement plan servicers (not each
retirement plan) should be treated as the payor for purposes of
applying the penalty cap.
EXAMPLE III--Related Companies
A bank or broker dealer generally is a member of an
affiliated group of companies, which offer different products
and services. Each company that is a member of the group is
treated as a separate payor for information reporting and
penalty purposes. Information returns for all or most of the
members of the group may be generated from a single information
reporting system. One error (e.g., a systems programming error)
could cause information returns generated from the system to
contain errors on all subsequent information returns generated
by the system. Under the proposal, the penalty cap would apply
to each affiliated company for which the system(s) produces
information returns.
Recommendation: Each affiliated group \10\ should be
treated as a single payor for purposes of applying the penalty
cap.
---------------------------------------------------------------------------
\10\ A definition of ``affiliated group'' which may be used for
this purpose may be found in Section 267(f) or, alternatively, Section
1563(a).
---------------------------------------------------------------------------
While these examples highlight the need to apply the type
of penalty proposed by the Treasury on an aggregated basis,
they also illustrate the indiscriminate and unnecessary nature
of the proposal.
CONCLUSION
The Coalition of Service Industries represents the
preparers of a significant portion of the information returns
that would be impacted by the proposal to increase penalties
for failure to file correct information returns. In light of
the current reporting burdens imposed on our industries and the
significant level of industry compliance, we believe it is
highly inappropriate to raise penalties.
Congress has considered and rejected this proposal on three
previous occasions, and we hope it will continue to reject this
unwarranted penalty increase. Thank you for your consideration
of our views.
Statement of the Committee of Annuity Insurers
The Committee of Annuity Insurers is composed of forty-one
life insurance companies that issue annuity contracts,
representing approximately two-thirds of the annuity business
in the United States. The Committee of Annuity Insurers was
formed in 1982 to address Federal legislative and regulatory
issues affecting the annuity industry and to participate in the
development of Federal tax policy regarding annuities. A list
of the member companies is attached at the end of this
statement. We thank you for the opportunity to submit this
statement for the record.
The Administration's proposals relating to the taxation of
life insurance companies and their products are largely a
rehash of last year's discredited budget proposals, which
Congress rejected. All of these proposals remain fundamentally
flawed and should be rejected again. The focus of this
statement, however, is the Administration's proposal to
increase retroactively the so-called ``DAC tax'' imposed under
IRC section 848 and, in particular, the increase proposed with
respect to annuity contracts used for retirement savings
outside of pension plans (``non-qualified annuities'').
Increasing the DAC tax continues to be bad tax policy, and
doing so retroactively would make a bad situation far worse.
As was the case last year, the Administration's proposed
increase in the DAC would have a substantial, adverse effect on
private retirement savings in America. The Administration
continues to show that it does not understand the important
role that annuities and life insurance play in assuring
Americans that they will have adequate resources during
retirement and adequate protection for their families.
Annuities are widely owned by Americans. At the end of
1997, there were approximately 38 million individual annuity
contracts outstanding, nearly three times the approximately 13
million contracts outstanding just 11 years before. The
premiums paid into individual annuities--amounts saved by
individual Americans for their retirement--grew from
approximately $34 billion in 1987 to $90 billion in 1997, an
average annual increase of greater than 10 percent.
Owners of non-qualified annuities are predominantly middle-
income Americans saving for retirement. The reasons for this
are obvious. Annuities have unique characteristics that make
them particularly well-suited to accumulate retirement savings
and provide retirement income. Annuities allow individuals to
protect themselves against the risk of outliving their savings
by guaranteeing income payments that will continue as long as
the owner lives. Deferred annuities also guarantee a death
benefit if the owner dies before annuity payments begin.
The tax rules established for annuities have been
successful in increasing retirement savings. Eighty-six percent
of owners of non-qualified annuities surveyed by The Gallup
Organization in 1999 reported that they have saved more money
than they would have if the tax advantages of an annuity
contract had not been available. Nearly all (93%) reported that
they try not to withdraw any money from their annuity before
they retire because they would have to pay tax on the money
withdrawn.
As discussed below, the proposal contained in the
Administration's FY 2001 budget to increase the DAC tax is in
substance a tax on owners of non-qualified annuity contracts
and cash value life insurance. It would make these products
more expensive and less attractive to retirement savers. It
would also lower the benefits payable to savers and families.
As discussed below, the DAC tax is already fundamentally flawed
and increasing its rate would simply be an expansion of bad tax
policy. The fact that the Administration proposes to increase
the DAC tax retroactively suggests that the proposal is simply
a device to raise a targeted amount of revenue from the
insurance industry.
1. The Administration's DAC proposal is in substance a tax on
the owners of annuities and life insurance.
The Administration's proposal to increase the DAC tax is an
attempt to increase indirectly the taxes of annuity and life
insurance contract owners. Two years ago, the Administration's
proposed direct tax increases on such owners were met with
massive, bipartisan opposition. Last year and again this year,
the Administration seeks to increase indirectly the taxes on
annuity and life insurance contract owners. We urge this
Committee to reject once again the Administration's back door
tax increase on annuity and life insurance contract owners.
IRC section 848 denies life insurance companies a current
deduction for a portion of their ordinary and necessary
business expenses equal to a percentage of the net premiums
paid each year by the owners of certain types of contracts.
These amounts instead must be capitalized and then amortized
over 120 months. The amounts that currently must be capitalized
are 1.75 percent of non-qualified annuity premiums, 2.05
percent of group life insurance premiums, and 7.70 percent of
other life insurance premiums (including noncancellable or
guaranteed renewable accident and health insurance). Under the
Administration's proposal, these categories of contracts would
be modified and the percentages would be dramatically
increased. Specifically, the rate for annuity contracts would
more than double to 4.8 percent, while the rate for individual
cash value life insurance would increase by a third to 10.3
percent.
The DAC tax under section 848 is directly based on the
amount of premiums paid by the owners of the contracts. Thus,
as individuals increase their annuity savings (by paying more
premiums), a company's taxes increase--the higher the savings,
the higher the tax. It is clear that since the enactment of DAC
in 1990, the DAC tax has been passed through to the individual
owners of annuities and life insurance. Some contracts impose
an express charge for the cost of the DAC tax, for example,
while other contracts necessarily pay lower dividends or less
interest to the policyholder. Still other contracts impose
higher general expense charges to cover the DAC tax. (See The
Wall Street Journal, December 10, 1990, ``Life Insurers to Pass
Along Tax Increase.'')
According to the Treasury Department, the increased
capitalization percentages proposed in the Administration's FY
2001 budget will result in increased taxes of $8.29 billion for
the period 2001 -2005 and $11.82 billion for the period 2001
-2010. A large portion of this tax increase will come from
middle-income Americans who are purchasing annuities to save
for retirement and cash value life insurance to protect their
families. According to a Gallup survey conducted in 1999, most
owners of non-qualified annuities have moderate annual
household incomes. About three-quarters (71%) have total annual
household incomes under $75,000. Eight in ten owners of non-
qualified annuities state that they plan to use their annuity
savings for retirement income (81%) or to avoid being a
financial burden on their children (82%).
The Administration's proposal will discourage private
retirement savings and the purchase of life insurance. Congress
in recent years has become ever more focused on the declining
savings rate in America and on ways to encourage savings and
retirement savings in particular. As described above, Americans
have been saving more and more in annuities, which are the only
non-pension retirement investments that can provide the owner
with a guarantee of an income that will last as long as the
owner lives. Life insurance contracts can uniquely protect
families against the risk of loss of income. Increasing the
cost of annuities and cash value life insurance and reducing
the benefits will inevitably reduce private savings and the
purchase of life insurance protection.
2. Contrary to the Administration's claims, an increase in the
DAC tax is not necessary to reflect the income of life
insurance companies accurately.
The Administration claims that the proposed increase in the
DAC tax is necessary to accurately reflect the economic income
of life insurance companies. In particular, the Administration
asserts that ``life insurance companies generally capitalize
only a fraction of their actual policy acquisition costs.'' The
Administration is wrong. As explained below, life insurance
companies already more than adequately capitalize the expenses
they incur in connection with issuing annuity and life
insurance contracts. The Administration's proposal would
further distort life insurance company income simply to raise
revenue.
The current tax rules applicable to life insurance
companies capitalize policy selling expenses not only through
the section 848 DAC tax, but also by requiring (in IRC section
807) reserves for life insurance and annuity contracts to be
based on a ``preliminary term'' or equivalent method. It is a
matter of historical record that preliminary term reserve
methods were developed because of the inter-relationship of
policy selling expenses and reserves. Since the early 1900's,
when preliminary term reserve methods began to be accepted by
state insurance regulators, the relationship between policy
reserves and a life insurance company's policy selling expenses
has been widely recognized. See, e.g., K. Black, Jr. and H.
Skipper, Jr, Life Insurance 565 -69(12th ed. 1994); McGill's
Life Insurance 401 -408 (edited by E. Graves and L. Hayes,
1994).
Under a preliminary term reserve method, the reserve
established in the year the policy is issued is reduced (from a
higher, ``net level'' basis) to provide funds to pay the
expenses (such as commissions) the life insurer incurs in
issuing the contract. The amount of this reduction is known as
the ``expense allowance,'' i.e., the amount of the premium that
may be used to pay expenses instead of being allocated to the
reserve. Of course, the life insurance company's liability for
the benefits promised to the policyholder remains the same even
if a lower, preliminary term reserve is established. As a
result, the amount added to the reserve in subsequent years is
increased to take account of the reduction in the first year.
In measuring a life insurance company's income, reducing
the first year reserve deduction by the expense allowance is
economically equivalent to computing a higher, net level
reserve and capitalizing, rather than currently deducting, that
portion of policy selling expenses. Likewise, increasing the
reserve in subsequent years is equivalent to amortizing those
policy selling expenses over the subsequent years. Thus, under
the current income tax rules applicable to life insurance
companies, policy selling expenses are capitalized both under
the section 848 DAC tax and through the required use of
preliminary term reserves. The Administration's FY 2001 budget
proposal ignores this combined effect.
This relationship between policy selling expenses and
preliminary term reserves has been recognized by Congress. In
accordance with the treatment mandated by the state regulators
for purposes of the NAIC annual statement, life insurance
companies have always deducted their policy selling expenses in
the year incurred in computing their Federal income taxes.
Until 1984, life insurance companies also computed their tax
reserves based on the reserve computed and held on the annual
statement. However, under the Life Insurance Company Income Tax
Act of 1959 (the ``1959 Act''), if a company computed its
annual statement reserves on a preliminary term method, the
reserves could be recomputed on the higher, net level method
for tax purposes. Because companies were allowed to compute
reserves on the net level method and to deduct policy selling
expenses as incurred, life insurance companies under the 1959
Act typically incurred a substantial tax loss in the year a
policy was issued.
When Congress was considering revisions to the tax
treatment of life insurance companies in 1983, concern was
expressed about the losses incurred in the first policy year as
a result of the interplay of the net level reserve method and
the current deduction of first year expenses. In particular,
there was concern that a mismatching of income and deductions
was occurring. As a consequence, as those who participated in
the development of the Deficit Reduction Act of 1984 (the
``1984 Act'') know, Congress at that time considered requiring
life insurance companies to capitalize and amortize policy
selling expenses.
Congress chose not to change directly the tax treatment of
policy selling expenses, however. Rather, recognizing that the
effect of the use of preliminary term reserve methods is
economically identical to capitalizing (and amortizing over the
premium paying period) the expense allowance by which the first
year reserve is reduced, Congress decided to alter the
treatment of selling expenses indirectly by requiring companies
to use preliminary term methods, rather than the net level
method, in computing life insurance reserves. See, e.g., Jt.
Comm. on Taxation, General Explanation of the Tax Reform Act of
1986, at p. 595 (relating to amendments to section 832(b)(7))
(Under the 1984 Act, life insurance reserves ``are calculated .
. . in a manner intended to reduce the mismeasurement of income
resulting from the mismatching of income and expenses.'').
In summary, life insurance companies are already
overcapitalizing policy selling expenses for income tax
purposes because of the combination of the current DAC tax and
the mandated use of preliminary term reserves. In these
circumstances, increasing the DAC capitalization percentages
will not result in a clearer reflection of the income of life
insurance companies. To the contrary, increasing the
percentages as the Administration proposes would further
distort life insurance company income simply to raise revenue.
3. Contrary to the Administration's suggestion, an increase in
the DAC tax is inconsistent with GAAP accounting.
The Administration's explanation of the DAC proposal
suggests that increases in the DAC percentages are consistent
with generally accepted accounting principles (GAAP). The
Administration states that ``[l]ife insurance companies
generally capitalize only a fraction of their actual policy
acquisition costs. . . . In contrast, when preparing their
financial statements using generally accepted accounting
principles (GAAP), life companies generally capitalize their
actual policy acquisition costs, including but not limited to
commissions.'' See Treasury Department, General Explanation of
the Administration's Fiscal Year 2001 Revenue Proposals 170-71
(February, 2000). This explanation is disingenuous. The
Administration fails to disclose that, while GAAP accounting
does require actual acquisition costs to be capitalized, GAAP
accounting does not mandate the use of preliminary term
reserves. In fact, no system of insurance accounting ``doubles
up'' on capitalization by requiring a combination of
capitalization of actual policy acquisition costs combined with
the use of preliminary term reserves. Thus, far from promoting
consistency with GAAP accounting, the Administration's proposal
to increase the DAC tax would exacerbate the distortion that
already exists under current law.
Apart from the foregoing, the Administration's reference to
GAAP accounting is misplaced. In 1990 when the DAC tax was
first enacted, Congress expressly considered and rejected GAAP
as a basis for accounting for life insurance company policy
selling expenses. Instead, Congress chose a proxy approach of
amortizing a percentage of premiums over an arbitrary 10 year
period, rather than capitalizing actual selling expenses and
amortizing them over the actual life of the contracts. In
short, when Congress enacted the DAC tax in 1990, it knew that
the proxy percentages did not capitalize the same amount of
acquisition expenses as does GAAP accounting. However, as
discussed above, the combination of the current DAC percentages
with the mandated use of preliminary term reserves already
results in two different capitalization mechanisms. If GAAP
accounting is the appropriate model for taxing life insurance
companies, as the Administration suggests, then the DAC tax
should be repealed, not increased.
4. The Administration's proposal to increase the DAC tax
retroactively is punitive and suggests that the Administration
is simply seeking to raise a targeted amount revenue from the
insurance industry
Last year, the Administration's proposal to increase the
DAC tax was strongly criticized and rejected by Congress. Not
only is the Administration resurrecting this discredited
proposal, but now it seeks to apply the tax increase
retroactively to 1990 under the guise of a ``change in
accounting method.'' Retroactive tax increases are bad tax
policy and violate basic notions of fairness. Moreover, in this
case a retroactive increase in the DAC tax would have a severe
punitive effect on insurers, which priced their products based
on the law in place when those products were sold.
The Administration offers no explanation for why the
proposed increase in the DAC tax should be treated as a change
in accounting method. When the DAC tax was first enacted in
1990, Congress specifically stated that the DAC tax was not a
change in accounting method. The proposal to treat the proposed
increase in the DAC capitalization percentages as a change in
accounting method, and thus apply the DAC tax increase
retroactively, suggests that the Administration's true motive
is simply to raise a targeted amount of revenue from the life
insurance industry. The retroactive DAC proposal was contrived
to achieve this overriding goal. Singling the insurance
industry out for a tax increase of this magnitude ($11.82
billion over 10 years) is entirely inappropriate. The insurance
industry has and continues to pay more than its fair share of
corporate income taxes.
In conclusion, the Committee of Annuity Insurers urges the
Committee to reject the Administration's proposal to increase
the section 848 DAC tax. The proposal is a disguised tax on the
owners of annuities and life insurance contracts. Furthermore,
the proposal lacks any sound policy basis and further distorts
the income of life insurance companies.
The Committee of Annuity Insurers Washington, D.C. 20004
Aetna Inc., Hartford, CT
Allmerica Financial Company, Worcester, MA
Allstate Life Insurance Company, Northbrook, IL
American General Corporation, Houston, TX
American International Group, Inc., Wilmington, DE
American Investors Life Insurance Company, Inc., Topeka, KS
American Skandia Life Assurance Corporation, Shelton, CT
Conseco, Inc., Carmel, IN
COVA Financial Services Life Insurance Co., Oakbrook
Terrace, IL
Equitable Life Assurance Society of the United States, New
York, NY
Equitable of Iowa Companies, DesMoines, IA
F & G Life Insurance, Baltimore, MD
Fidelity Investments Life Insurance Company, Boston, MA
GE Financial Assurance, Richmond, VA
Great American Life Insurance Co., Cincinnati, OH
Hartford Life Insurance Company, Hartford, CT
IDS Life Insurance Company, Minneapolis, MN
Integrity Life Insurance Company, Louisville, KY
Jackson National Life Insurance Company, Lansing, Ml
Keyport Life Insurance Company, Boston, MA
Life Insurance Company of the Southwest, Dallas, TX
Lincoln Financial Group, Fort Wayne, IN
ManuLife Financial, Boston, MA
Merrill Lynch Life Insurance Company, Princeton, NJ
Metropolitan Life Insurance Company, New York, NY
Minnesota Life, St. Paul, MN
Mutual of Omaha Companies, Omaha, NE
Nationwide Life Insurance Companies, Columbus, OH
New York Life Insurance Company, New York, NY
Ohio National Financial Services, Cincinnati, OH
Pacific Life Insurance Company, Newport Beach, CA
Phoenix Home Mutual Life Insurance Company, Hartford, CT
Principal Financial Group, Des Moines, IA
Protective Life Insurance Company, Birmingham, AL
ReliaStar Financial Corp., Minneapolis, MN
Security First Group, Los Angeles, CA
SunAmerica, Inc., Los Angeles, CA
Sun Life of Canada, Wellesley Hills, MA
Teachers Insurance & Annuity Association of America--
College Retirement
Equities Fund (TIAA-CREF), New York, NY
Travelers Insurance Companies, Hartford, CT
Zurich Kemper Life Insurance Companies, Chicago, IL
Statement of Dorthy S. Ridings, Council on Foundations
On behalf of the Council on Foundations, thank you for this
opportunity to submit comments on the President's fiscal year
2001 budget proposals. The Council on Foundations is a
membership organization representing the collective interests
of more than 1,900 community, family, independent and company
foundations as well as corporate giving programs. For more than
40 years, the Council has taken a keen interest in how federal
tax laws support and promote philanthropy. President Clinton's
proposed budget for fiscal year 2001 contains several proposals
to encourage philanthropy. While we generally support them all,
the Council wishes to comment on two that are of particular
interest to its members: the proposal to clarify the public
charity status of donor-advised funds and the proposal to
simplify the annual tax on private foundation investment income
imposed by section 4940. We look forward to working with the
Committee to make technical improvements to these two much-
needed changes that will ensure their objectives are truly
accomplished.
Donor-Advised Funds
The first proposal would clarify the public charity status
of organizations offering donor-advised funds. Specifically, it
would provide that any organization that operates one or more
donor-advised funds as its primary activity could qualify as a
public charity only if it met three requirements: (1) the
organization is free from any material restriction on its
authority to manage and make distributions from the fund; (2)
distributions from the donor-advised funds go only to public
charities, private operating foundations or governmental
entities; and (3) annual distributions equal or exceed 5% of
the aggregate fair market value of the assets the organization
holds in donor-advised funds.
From the time community foundations were formed, more than
85 years ago, donors have made recommendations regarding the
charitable projects or organizations that they consider worthy
of support. Donor-advised funds offer a valuable way for a
community foundation to establish a relationship with a donor
and to encourage that person to take a continuing interest in
the community's needs.
Recent developments, including the formation of new
charities that make extensive use of donor-advised funds, have
persuaded the Council of the need for clear and consistent
rules for donor-advised funds, wherever they may be maintained.
We are pleased that the President also recognizes this need.
However, we believe that his specific recommendations raise
several critical issues that, unless resolved, will interfere
with legitimate and long-standing charitable activities carried
on by community foundations and other public charities with
donor-advised funds. Because these issues are vital to the
interests of community foundations, Congress should not act
until there has been adequate time to review the President's
suggestions, and to understand their implications for the wide
range of charities that have donor-advised funds.
The Council on Foundations would be happy to work with the
members of the Committee and with staff in defining these
issues and finding appropriate solutions to them.
1. Definition of donor-advised fund. There is a need to
clarify this definition so that both community foundations and
the Internal Revenue Service can easily determine which funds
are ``donor-advised.''
2. Permissible donees. Many community foundations operate
programs that make grants and award scholarships to individuals
for charitable purposes. Many community foundations also make
grants for exclusively charitable purposes to both U.S. and
foreign organizations that are not recognized as exempt under
section 501(c)(3) of the Internal Revenue Code. Frequently
these programs are begun at the recommendation of individuals
and businesses that have created donor-advised funds, as in the
case of the many community foundations that offer local
businesses the ability to create a donor-advised fund to
provide educational scholarships for employees and their
families. Community foundations should retain the ability to
make distributions to individuals, to domestic non-charities,
and to foreign organizations as long as they can demonstrate
that distributions are used for exclusively charitable
purposes.
3. Sanctions. The primary sanction in the President's
budget proposal is loss of public charity status, either for
the organization as a whole or for its donor-advised funds. The
Council believes that a graduated set of penalties, analogous
to those imposed on private foundations, would provide the
Internal Revenue Service with a more flexible compliance tool,
while protecting community foundations from the inadvertent
loss of public charity status. Sanctions also should be
appropriately distributed between the exempt organization and
the donor/advisor, depending on which was in the best position
to prevent the offence from occurring.
4. Preventing abuse. Community foundations want to be sure
that donor-advised funds are used exclusively for bona fide
philanthropy, not as a mechanism to get tax benefits without
achieving charitable results. A limited rule that treats donor/
advisors as disqualified persons with respect to distributions
from their funds may help accomplish the goal of preventing
distributions that confer an improper benefit on such
individuals. There also may be some benefit in a five percent
distribution requirement, although it, too, should be tailored
to prevent real abuse.
The Council looks forward to working with the Committee and
its staff to address these concerns. We are optimistic that the
proposal can be revised successfully, and that once enacted, it
will encourage significant philanthropic activity.
Reforming the Section 4940 Tax
The second proposal would reform the annual tax on private
foundation investment income, replacing the current two-tier
tax structure with a single rate. The Council on Foundations
welcomes this change as a much-needed simplification, and we
express our thanks to the Department of Treasury for
recognizing that the current system is badly in need of
adjustment. The current two-tier system actually has the
unintended effect of penalizing foundations that make the extra
effort to increase their annual grantmaking significantly in a
given year. Such a decision forces the foundation to choose
between two negative options: 1) Increase its long-term
spending percentage (thus endangering its ability to maintain
the real value of its assets), or 2) return to its normal
spending percentage and be required to pay a higher level of
tax (two percent) for the next five years. Lowering the
effective private foundation investment income tax will
automatically cause an overall increase in foundation grants
and other charitable distributions. Because foundations are
given credit toward their payout for taxes paid under section
4940, reducing the tax automatically requires foundations to
distribute more dollars to meet charitable needs.
While we strongly support amending the code to adopt a
single, flat-percentage excise tax, we urge serious
consideration of a lower rate, preferably 1.0 percent. Even
though we recognize that a flat excise tax of 1.0 percent will
result in a higher revenue loss to Treasury, we have learned
from many of our members that a 1.25 percent flat tax will be a
tax increase to them. Small and mid-sized foundations, in
particular, usually can qualify for the 1.0 percent rate under
the current system. To do so, these foundations must slightly
increase their charitable spending each year. Ironically, with
a flat, 1.25 percent rate, those foundations that have been
slowly increasing their spending levels will be hit with a tax
increase.
Again, we thank you for the opportunity to present our
views. We look forward to working with the Committee in
accordance with these comments to seek enactment of these
proposals.
Statement of the Equipment Leasing Association, Arlington, VA
INTRODUCTION
The Equipment Leasing Association, (ELA) is submitting this
statement for the record to express our concerns regarding the
proposed ``corporate tax shelter proposals'' included in the
Clinton Administration's proposed FY 2001 Budget. ELA has over
850 member companies throughout the United States who provide
financing for all types of businesses in all types of markets.
Large ticket leasing includes the financing of transportation
equipment such as aircraft, rail cars and vessels. Middle
market lessors finance high-tech equipment including main frame
computers and PC networks, telecommunications equipment and
medical equipment such as MRIs (magnetic resonance imaging) and
CT (computed tomography) systems. Lessors in the small ticket
arena provide financing for equipment essential to virtually
all businesses such as phone systems, pagers, copiers, scanners
and fax machines.
WHAT TYPE OF COMPANY LEASES?WHAT TYPE OF COMPANY LEASES?
More companies, particularly small businesses, acquire new,
state of the art equipment through leasing than through any
other type of financing. In a survey of the winners of the
Small Business Administration's State Small Business Contest
last May, ELA found that 85% of small businesses lease
equipment and that 89% of these companies plan to lease again.
Companies that lease tend to be smaller, growth-oriented and
focused on productivity--these are companies long on ideas, but
often, short on capital.
WHY COMPANIES LEASEWHY COMPANIES LEASE
Companies choose lease financing for several reasons:
*Leasing permits 100% financing;
*Leasing permits a close matching of rental payments to the
revenue produced by the use of the equipment;
*Leasing allows companies to keep their debt lines open for
working capital rather than tying it up in capital
expenditures;
*Companies that lease know that they make money by using
the equipment, not owning it;
*Leasing allows a company to focus on its core business--
they don't have to worry about maintenance, upgrading or asset
disposition;
*Leasing minimizes concerns about the technological
obsolescence of the company's equipment;
*Leasing shifts asset management risk to the lessor, away
from the user.
Leasing by commercial enterprises increases productivity
and stimulates economic growth. While the federal and state tax
codes provide various incentives to invest in new equipment,
many companies find they are not in a financial position to
utilize the incentives. However, through leasing, the intended
incentives to invest can be passed through to the company using
the equipment in the form of lower rental payments because the
leasing company utilizes the intended investment incentives.
The use of leasing in this manner has long been intended by
Congress.
LEASING CREATES JOBSLEASING CREATES JOBS
It is estimated that each increase of $1 billion in
equipment investment creates approximately 30,000 jobs (Brimmer
Report). In 1999 alone, the equipment leasing industry financed
over $200 billion in equipment acquisition and it is
anticipated that equipment lessors will finance over $230
billion in new equipment acquisition in 2000.
STATE AND LOCAL GOVERNMENTS LEASE TOO
It is not only commercial enterprises that lease equipment.
Tax-exempt entities such as states, cities, counties and other
subdivisions around the U.S. often lease various types of
equipment in an effort to keep taxpayer costs down. Equipment
leased by local governments includes 911 emergency phone
systems, computers, school buses and police vehicles. Tax-
exempt hospitals often lease their emergency vehicles and high-
cost, sophisticated diagnostic medical equipment, in an effort
to keep health care costs down.
Lessors also lease equipment to other tax-exempt entities
such as foreign corporate enterprises or individuals. Examples
include automobile fleet leasing, leases of tractors and
trailers, and leases of aircraft (both commercial and
corporate). Further, many domestic lessees have the right to
sublease assets into foreign markets in times when the
equipment may be surplus. Very often, these subleases are to
entities in foreign markets which have the need for the asset.
THE ADMINISTRATION'S ``CORPORATE TAX SHELTER'' PROPOSALS
REPRESENT A SIGNIFICANT CHANGE IN U.S. TAX
An analysis of the Administration's sweeping and vague
corporate tax shelter proposals raises the concern that leasing
transactions which conform to long standing tax policy and
Congressional intent could be negatively impacted by the
Administration's proposals. If this is the case, these
proposals represent a significant change in longstanding U.S.
leasing tax policy, overturning longstanding I.R.S ruling
polices set forth in Revenue Procedures 75-21 and 75-78, as
well as established judicial precedent. Without a clear
exclusion of leasing transactions that meet the standards of
current law from the sweeping new corporate tax shelter
proposals, ELA must oppose these proposals and urges Congress
to reject them.
ELA has long supported two fundamental principles of
federal tax policy. First, the form of financing chosen to
facilitate the acquisition of assets, whether loans or leases,
should be respected as long as economically valid. Second, is
the principle that the tax treatment of an owner of an asset
should not differ whether the asset is used directly by the
owner or leased to another end-user. Again, in their current
form, the Administration's proposals appear to violate these
two principles and have already had a chilling effect on
equipment acquisition in certain markets. Therefore, ELA
opposes them and urges Congress to reject them.
ADMINISTRATION'S ANTI-LEASING SERVICE CONTRACT PROPOSAL
The service contract rules set forth in Section 7701(e) of
the Code were enacted as part of the original Pickle
legislation in 1984. These rules set forth explicit statutory
standards based on clear economic distinctions for
distinguishing leases from so-called service contracts. A lease
of equipment is in fact different than a service contract and
Congress clearly intended that an agreement that qualifies as a
service contract would not be treated as a lease for purposes
of the Pickle legislation or for any other tax purpose. The
Administration's proposal would repeal this clear distinction
and expand the scope of an already discriminatory statute that
inhibits U.S. global competitiveness and no longer furthers a
legitimate policy objective. Further, the proposed legislation
overlooks significant business purposes that give rise to use
of service contracts. Service contracts involve a tradeoff
between rights and risks. Relative to a lessor, the service
provider enjoys more control over the asset used to generate
such services, but also assumes additional performance and
operational risk with respect to such asset. The parties'
preferences as to the division of rights and risks with respect
to property determine the form of contractual arrangement they
choose. The service contract arrangement has long been
commercially recognized, particularly within certain industries
including the utilities and shipping industries. Congress
should reject the Administration's most recent misguided
assault on leasing as it did in both 1998 and 1999. (See the
enclosed 1999 letter signed by 26 members of the House Ways and
Means Committee to Chairman Archer and Ranking Member Rangel.)
Clearly, the Administration's proposal goes far beyond what
is necessary to prevent perceived abusive transactions as it
encroaches upon non-abusive transactions that are permitted
under current law. In fact, in light of the 1986 depreciation
rules providing for straight-line depreciation over the class-
life of foreign use property (which were intended to replicate
economic depreciation), we believe that the Pickle depreciation
rules, insofar as they relate to foreign lessees, are no longer
necessary or appropriate and do not reflect sound tax policy.
Consequently, we urge Congress to reject this proposal and
encourage the Treasury Department to support a depreciation
rule which does not discriminate between property owned by a
U.S. taxpayer that is used outside the U.S. and property owned
by a U.S. taxpayer that is leased to a foreign person. In both
cases the income is fully taxable.
In applying the Pickle rules, Treasury regulations adopted
in 1996 (Treas. Reg. Section 1.168 (i)-2 (b) (1)) provide that
the lease term will be deemed to include certain periods beyond
the original duration of the lease. Under these regulations the
lease term includes both the actual lease term and any period
of time during which the lessee (or a related person) (i)
agreed that it would or could be obligated to make a payment of
rent or a payment in the nature of rent or (ii) assumed or
retained any risk of loss with respect to the property
(including, for example, holding a note secured by the
property). Clearly, these regulations extend beyond the reach
of the statute and should be overturned.
ADMINSTRATION'S PROPOSAL CONFLICTS WITH U.S. TRADE POLICY
If enacted, this proposal will have a devastating impact on
U.S. companies currently involved in selling assets to foreign
entities where lease financing has been a significant feature
of the marketplace, for example, manufacturers of aircraft and
aircraft engines. As such, the proposal is contrary to long-
established policies of promoting U.S. exports and is in direct
conflict with the Congressional objective of developing a U.S.
trade policy which will provide U.S. companies with the ability
to compete on a level playing field with their foreign
competitors. If enacted, this legislation will severely inhibit
the ability of U.S. exporters and financial institutions to
compete effectively on a global scale. If U.S. companies are
not able to compete on cross-border leases, tax revenues
currently going to the U.S. Treasury will be lost to foreign
Treasuries, as all leases, including cross-border leases,
generate more taxable income than deductions over the life of
the lease agreement.
HISTORY OF THE ``PICKLE'' RULES
As part of the Deficit Reduction Act of 1984, Congress
amended the Code to limit the depreciation available for
property leased to a tax-exempt entity to straight line
depreciation over the longer of the property's class life or
125% of the lease term. These provisions, referred to as the
Tax-Exempt Entity Leasing Rules or the ``Pickle'' rules, were
enacted in response to a series of leasing and similar
transactions which passed a significant portion of the economic
benefit of the Accelerated Cost Recovery System (ACRS)
depreciation deductions through to various U.S. federal, state
and local governmental entities and tax-exempt organizations.
At that time, Congress was concerned that investment
incentives, such as depreciation under ACRS, were being turned
into unintended benefits for tax-exempt entities. These
restrictions were extended to foreign persons not subject to
U.S. tax on their operations as Congress concluded that it
would be inappropriate to subsidize foreign persons that were
not U.S. taxpayers by permitting accelerated depreciation for
property leased to them.
However, as part of the Tax Reform Act of 1986, Congress
limited depreciation on foreign use property to the straight-
line method over an asset's class life. Thus, after 1986,
property used predominantly outside the United States by an
U.S. taxpayer was not entitled to accelerated depreciation.
Consequently, the changes in generally applicable depreciation
rules enacted in 1986 rendered the Pickle rules unnecessary in
order to achieve the 1984 policy objective of not passing
accelerated depreciation through to foreign persons not subject
to U.S. income tax. Nevertheless, the Pickle rules were not
amended in 1986 or subsequently.
THE PICKLE RULES ARE DISCRIMINATORY AND ANTI-COMPETITIVE AND
SHOULD BE CONFORMED TO THE TAX ACT OF 1986 TO MAKE THE U.S.
LEASING INDUSTRY GLOBALLY COMPETITIVE
The Pickle rules discriminate against property owned by a
U.S. taxpayer which is used in its leasing business outside the
United States, as compared to the same property owned by a U.S.
taxpayer, and used in a non-leasing business outside the U.S.
For example, a U.S. owner of an item of equipment operated
outside the U.S. would be entitled to straight-line
depreciation over the asset's class life, even though the
benefit of that depreciation would be reflected in the price of
the goods or services provided to non-U.S. taxpayers. By
contrast, a U.S. lessor of the same item of equipment if leased
to a foreign entity would be limited by Pickle depreciation to
straight-line depreciation over the longer of the property's
class life or 125% of the lease term.
If U.S. companies are to compete effectively in a global
marketplace, Congress should enact a depreciation rule which
does not discriminate between property owned by a U.S. taxpayer
which is used outside the United States, and property owned by
a U.S. taxpayer and leased to a foreign person. In both cases,
the income is fully taxable. This policy can be accomplished by
simply conforming the 1984 Pickle rules to the Tax Reform Act
of 1986.
PROPOSAL TO ``DISALLOW INTEREST ON DEBT ALLOCABLE TO TAX-EXEMPT
OBLIGATIONS'' WILL INCREASE STATES' AND MUNICIPALITIES' COST OF
CAPITAL
ELA also opposes the Administration's proposal to
``disallow interest on debt allocable to tax-exempt
obligations,'' as the elimination of the 2% de minimis rule
will impair the ability of state and local governments to raise
capital. While non-financial corporations may not account for a
large percentage of total municipal securities outstanding,
these corporate buyers do play a vital role in three important
market segments: 1) short term municipal investments, 2) state
and local government housing and student loan bonds, and 3)
municipal leasing transactions.
CONCLUSION
Congress, the Treasury Department and the courts have long
recognized that companies financing the acquisition of
equipment through a loan are the recipients of various tax
incentives. These same bodies also have long recognized that
equipment acquired through leasing involves the transfer of tax
benefits from the user of the equipment to the owner-lessor. As
a direct result of these sound tax policies, American citizens
are the beneficiaries of the most modern and productive economy
in the world. While equipment lessors would undoubtedly be
negatively impacted by the proposed changes discussed above,
the ultimate impact will be to drive up the cost of capital
equipment acquisitions for all businesses, particularly small
businesses.
For over three decades, ELA members have provided lessees
with various financing options within the spirit and intent of
U.S. tax policy. In 1999 alone, the equipment leasing industry
invested in excess of $200 billion in productive assets.
However, the uncertainty caused by the Administration's
proposals has already slowed down the market. To minimize
further market disruptions and maintain strong economic growth
while Congress deliberates the FY 2001 budget, we urge the
respective Chairmen of the House Ways and Means and Senate
Finance Committees to publicly state that the effective date
for any tax code amendments restricting the use of incentives
will be the date of enactment.
Statement of David Benson, Ernst & Young LLP, and LaBrenda Garrett-
Nelson, Washington Counsel, P.C., Global Competitiveness Coalition 2000
The Global Competitiveness Coalition (the ``Coalition'') is
a group of about 30 U.S.--based multinational business
enterprises representing a broad cross section of American
businesses.
Introduction
The proposed hybrid branch regulations that were issued
pursuant to Notice 98-35 in July of last year provided for a
six-year-plus ``moratorium'' on the application of rules that
would restrict the ability to use hybrid branch arrangements to
reduce foreign tax without triggering subpart F inclusions. The
Coalition believes the Ways and Means Committee should reject
the proposal relating to ``identified tax havens,'' to the
extent the proposal has the potential to alter Treasury's
agreement to allow the Congress an opportunity to deal with
hybrid branch arrangements during the ``moratorium'' on the
finalization of hybrid branch regulations.
Summary of the Administration's ``Identified Tax Haven'' proposal
The Administration's proposal would require the reporting
of payments to, and restrict tax benefits for income flowing
through, ``Identified Tax Havens.''
Under the proposed reporting requirement, all payments
(including money and tangible and intangible property) to
entities (including corporations, partnerships and disregarded
entities, branches, trusts and estates), accounts or
individuals resident or located in Identified Tax Havens would
be reported on the taxpayer's annual income tax return.
Jurisdictions would be considered tax havens and included on
the list of Identified Tax Havens to be published by the
Secretary of the Treasury based on certain criteria, including,
but not limited to, whether a jurisdiction (1) imposes no or
nominal taxation, either generally or on specific classes of
capital income, and (2) has strict confidentiality rules and
practices, and/or has ineffective information exchange
practices. The proposal would not apply to payments if: (1) the
Identified Tax Haven has in force with the U.S. an agreement
providing for the exchange of tax information that is effective
for both criminal tax and civil tax administration purposes,
(2) the payee certifies to the payor that, through a legally
effective confidentiality waiver or otherwise, information
about the payment would be available to the IRS upon request,
or (3) the payment is less than $10,000 (subject to an anti-
abuse rule requiring related payments to be aggregated). A
penalty of 20 percent of the amount of the payment would be
imposed on payors who fail to report.
The proposal affecting tax benefits would deny foreign tax
credits (FTCs) for taxes paid to Identified Tax Havens and
would apply the FTC limitation rules separately to income
earned in or through an Identified Tax Haven. The proposal also
would reduce by a factor (similar to the international boycott
factor) a taxpayer's (1) otherwise allowable FTC or foreign
sales corporation benefit attributable to income from an
Identified Tax Haven, and (2) the income, attributable to an
Identified Tax Haven, that is otherwise eligible for deferral.
This reduction of tax benefits would be based on a fraction,
the numerator of which is the sum of the taxpayer's income and
gains from an Identified Tax Haven, and the denominator of
which is the taxpayer's total non-U.S. income and gains. The
proposal would be effective for taxable years beginning after
the date of enactment.
Although the proposal is generally effective for payments
made after the date of enactment, because the proposal is
limited to jurisdictions to be included on a published list;
the proposal would only apply to taxable years beginning after
the publication of the list.
Unresolved Issues Regarding the Identification of Tax Havens
At a Treasury briefing on February 7, 2000, the Acting
Assistant Secretary for Tax Policy (Jon Talisman) acknowledged
that this proposal was based on work done with the OECD.
Indeed, elements of the proposal can be traced to the
recommendations included in the OECD's 1998 report entitled
``Harmful Tax Competition: An Emerging Global Issue.'' For
example, one of the OECD recommendations is to deny a tax
benefit to ``foreign source income that has benefited from tax
practices deemed as constituting harmful tax competition;'' and
another recommendation encourages OECD countries to ``undertake
programs to intensify exchange of relevant information
concerning transactions in tax havens.'' It is unclear whether
Treasury intends to build on the on-going work being done by
the OECD ``Forum on Harmful Tax Practices'' to compile a list
of tax havens, nor is it clear whether this proposal is
intended to reach preferential tax regimes that may be
available to particular activities in countries that are not
generally viewed as tax havens.
The Concern About Hybrid Branch Arrangements
As currently described, the Administration's proposal on
Identified Tax Havens would implement substantive changes
consistent with indications of Treasury's continuing discomfort
with hybrid branch arrangements. The Coalition is particularly
concerned that the proposal can be read to indicate that
Treasury may continue to seek to attack the use of hybrid
branch arrangements by proposing changes to ancillary rules,
notwithstanding the events that led up to the effective
withdrawal of Notice 98-35 and the issuance of the proposed
hybrid branch regulations having a substantially delayed
effective date in July of last year.
The Coalition's concern is based in part on public
statements by senior Treasury officials. For example, at the
IRS/GWU international tax conference last December, one
official stated that, in general, transactions resulting in
differing U.S. and foreign tax results are against the policy
of our tax rules, a statement that was made in the course of a
discussion of a hybrid branch arrangement. More recently,
Treasury's continuing concern with the use of such entities was
noted by a member of Treasury's Office of International Tax
Counsel, at a February 3 meeting of the International Tax and
Finance Forum. A more tangible indication of Treasury's views,
and basis for the Coalition's concern, is the issuance in late
November 1999 of proposed regulations that would invalidate
certain elections to treat foreign entities as hybrid branches
(in the absence of an identified abuse).\1\
---------------------------------------------------------------------------
\1\ Representatives of the Coalition testified at an IRS hearing on
these regulations in January, and will submit written comments (on or
before February 28, 2000) urging withdrawal of the regulations.
---------------------------------------------------------------------------
Potential Impact on Existing Hybrid Branch Arrangements
Where a taxpayer has already entered into a hybrid branch
arrangement, there is a question about whether the
Administration's Budget proposal on Identified Tax Havens could
apply to effectively negate the benefits of the hybrid branch
arrangement--a result that would appear to be contrary to the
moratorium on restricting the use of hybrid branch
arrangements. Depending on how Treasury decides to define a tax
haven, this result could occur in a fairly common situation
where a hybrid branch located in a high-tax jurisdiction makes
deductible interest or royalty payments to a controlled foreign
corporation (``CFC'') located in a low-tax jurisdiction. Under
current law, the CFC would not have a subpart F inclusion
because the interest or royalty payment would be a nullity for
U.S tax purposes. Under the Administration's proposal, however,
the income otherwise eligible for deferral might be included in
the CFC's income if the CFC is located in a country on
Treasury's list of tax havens.
Conclusion
Treasury has agreed to refrain from finalizing regulations
that would restrict the use of hybrid branch arrangements
during a six-year-plus moratorium. Therefore, the Committee
should reject the ``Identified Tax Haven'' proposal because it
has the potential to alter Treasury's agreement.
Statement of Home Care Coalition
On behalf of the Home Care Coalition, thank you for the
opportunity to provide comments on the President's budget
proposal for fiscal year 2001. The Home Care Coalition was
founded in 1991 to unite the efforts of home care providers,
family caregivers, health care professionals, manufacturers,
consumers, and consumer advocacy organizations. The Coalition
has become a major voice in support of home health care, which
is often patient-preferred and more cost-effective than
institutional care. As the only national organization
representing providers, consumers and manufacturers of home
health services, we urge you to support proposals to help
America's caregiving families.
This year, the President has placed more emphasis on
providing home and community-based services through Medicaid
and making assisted living facilities available to lower income
elderly. Once again, he has called for the creation of a
National Family Caregivers Support Program and non-subsidized
long-term care insurance for federal employees, retirees and
their families. In addition, a number of bills have been
introduced in this Congress to expand access to long-term care
insurance and provide relief to family caregivers.
The Home Care Coalition urges this Committee to act this
year to support programs needed to relieve the burdens on
family caregivers and to increase access to the home and
community-based services so essential to the well being of
millions of frail elderly, disabled and chronically ill
Americans.
Who we are
The Home Care Coalition (HCC) is comprised of the
following:
Consumers of Home Care: Not all home care beneficiaries are
alike. As a result, their at-home needs are wide and varied.
Those with chronic conditions such as emphysema require the
constant assistance of oxygen systems to make breathing easier.
Consumers in the final stages of complications brought about by
diseases such as AIDS require extensive levels of care. Active
elderly persons who may be recuperating from an injury need
products and services for an interim period until they
recuperate. Younger persons with disabilities may require fewer
products and services, but may need them for a lifetime.
Family Caregivers: People who cannot completely care for
themselves because of an illness or disability rely heavily on
family members to provide a wide range of services. Typically,
family caregivers provide assistance with basic needs such as
feeding, toileting, and dressing, as well as transportation,
shopping, and cooking. Family caregivers give injections,
change dressings, and help with rehabilitative exercises. They
teach, advocate, and provide emotional support. Family
caregivers provide these services out of feelings of love and a
sense of duty. They are not paid for their services. It is
estimated that there are over 25 million family caregivers in
the United States, providing three-fourths of all home care
services. Family caregivers make the difference between someone
being alive and having a life.
Home Health Providers: Home health providers include
individuals such as skilled nurses, rehabilitation specialists,
therapists, pharmacists, physicians, nutritionists, medical
social workers, home health aides, and homemakers. Health care
services in the home setting provide a continuum of care for
individuals who no longer require hospital or nursing home
care, or to avoid an unnecessary hospital or nursing home
admission. The range of home care services includes skilled
nursing; respiratory, occupational, speech, and physical
therapy; intravenous drug therapy; enteral nutrition; hospice
care; emotional, physical, and medical care; assistance in the
activities of daily living; skilled assessments; teaching; and
financial assistance.
Home Medical Equipment (HME) Manufacturers: Manufacturers
of home medical equipment (HME) are committed to producing
quality products that promote the ability of persons with acute
and chronic health conditions and disabilities to lead
productive lives in their homes and communities. Products
include everything from disposable items such as bandages to
high-tech equipment such as power-driven wheelchairs, infusion
therapy pumps and home oxygen delivery systems. As HME
manufacturers produce advances in medical technology (e.g.,
telemedicine), home care will become even more cost-effective
than it is today.
Home Medical Equipment Providers: Home medical equipment
(HME) providers supply the equipment and related services that
help consumers meet their therapeutic goals. Pursuant to the
physician's prescription, HME providers deliver medical
equipment to a consumer's home, set it up, maintain it, and
educate and train the consumer and caregiver in its use. HME
providers also interact with physicians and other home care
providers as the consumer improves and his/her needs evolve. In
addition, specialized providers of home infusion manage complex
intravenous services, including chemotherapy and nutrition
therapies, in the home.
Hospital Discharge Planners: Hospital discharge planners
are health care professionals who are involved in the
coordination of continuing care services for consumers and
their families in all health care settings. The discharge
planner is proactive in the health care delivery planning
process and will begin an assessment of the consumer's needs
either in the ambulatory care setting, at home prior to an
admission for elective surgery, or within 24 hours of an acute
care admission. This proactive perspective allows discharge
planners to develop a plan of care that decreases the length of
the hospital stay and reduces unnecessary acute care
admissions. The discharge planner facilitates the progress of
consumers and their families along the health care continuum
whether it be home care, hospice, or inpatient care.
Family Caregivers and today's long-term care system
Family caregivers are literally underpinning our healthcare
system. The National Family Caregivers Association reports that
approximately 80% of all home care services are provided by
family caregivers who are not reimbursed for their time and
effort. They are family, friends and neighbors who stand by
those they love as they face chronic illness or disability.
Their help can take many forms: physical assistance with daily
activities from going to the bathroom to going to the drug
store; monitoring medical devices from IVs to ventilators; and
providing emotional, financial, legal and spiritual support.
The National Family Caregivers Association conducted a
study in 1997 that revealed the human face of caregiving. The
results highlighted the experiences of today's ``sandwich
generation'' that is increasingly asked to care for their
ailing parents at the same time that they are juggling the
demands of their own families and careers. More than 25 million
individuals across the nation provide caregiving services. The
vast majority of caregivers are married women over the age of
35; in fact, more than one in five women between the ages of 35
-64 are family caregivers. The majority of caregivers spend at
least 40 hours a week in caregiving activities, mainly in their
own homes. Nearly 70% of caregivers are providing care for
their spouse or parent. Not only are the hours long, and the
time spent considerable, 78% of caregivers expect to be active
in caregiving for five years or more.
The United Hospital Fund of New York estimates that it
would cost at least $196 billion a year to replace the vital
services provided by family caregivers. The economic value of
this ``invisible'' health care sector dwarfs the costs of both
paid home health care ($32 billion) and nursing home care ($83
billion). Without the free and loving care provided by our
nation's caregivers, the national health care system would be
much sicker than it is today.
The need for family caregiver support
The need for caregiving is exploding at the same time that
the number of available caregivers is evaporating. The aging of
the baby boom generation will only make this situation more
dire. People over 85 years of age are the fastest growing
segment of the population, and they are also the group most
likely to need care. By 2020, there will be 14 million elderly
in need of long-term care. It won't be long before every family
in America is involved in family caregiving.
Unfortunately, caregiving takes a high economic toll on
America's families and businesses. Caregivers report that they
suffer from headaches, sleeplessness and backaches as a direct
result of their caregiving activities. Depression among
caregivers is three times the norm for people in their age
group. More than three-quarters of all family caregivers report
they receive no consistent help from other family members, and
feelings of isolation and lack of understanding from others are
common. It is a sad fact that more people enter nursing homes
because of caregiver burnout rather than an exacerbation of
their own condition.
A recent study by the Center for Women and Aging and the
National Alliance for Caregiving shows that family caregivers
can lose over $650,000 in wages, pensions and Social Security
because of their caregiving responsibilities. Lost wages,
promotions and career opportunities are the normal consequence
of family caregiving. In addition, a study conducted by the
Alzheimer's Association in 1998 found that Alzheimer's disease
alone costs US businesses $26 billion a year in caregiver
absenteeism. The Alzheimer's Association reports that increased
use of respite care at mild and moderate stages of Alzheimer's
has shown to delay nursing home placement significantly, at a
net savings of $600 to $1,000 a week.
Clearly, America's caregivers are in need of support. In
addition, it is in the best interest of the health care system
to help families care for their loved ones in their homes for
as long a period as possible. Numerous studies have shown that
simple caregiver interventions, such as respite care,
counseling education and supportive services can have a major
impact on the well being of caregivers and patients.
The President's proposal would provide state governments
access to a network that provides respite care and other
caregiver support services, information about community-based
long-term care services, and counseling and support services.
The Administration estimates that this program would assist
approximately 250,000 families nationwide. In addition, the
President proposes a $3,000 tax credit for individuals or
families that care for individuals with three or more
limitations in activities of daily living (ADLs) or a
comparable cognitive impairment.
The Home Care Coalition believes that these proposals
represent a critical first step in acknowledging the vital role
that family caregivers play in our nations health care system.
We can not assure the future of Medicare and there is no way to
control the costs of Medicaid, if we let the family caregiving
system collapse. We urge this committee to revisit the issues
of family caregiver tax credits and caregiver support programs
this year.
Access to home and community-based services
The Omnibus Budget Reconciliation Act of 1981 established a
program that allows states to apply for waivers (known as
1915(c) waivers) to reimburse home and community-based services
for beneficiaries who would otherwise be institutionalized. In
order to qualify for a waiver, the cost of institutionalization
must be explicitly calculated and shown to be greater than the
home and community-based services. Therefore, individuals must
be shown to be deficient in at least three activities of daily
living (e.g., bathing, dressing, toileting, transferring,
continence, or eating) to qualify for a waiver. As states
search for new and innovative means of controlling Medicaid
costs, 1915(c) waivers have become more and more popular. There
are currently 240 waiver programs in effect across the nation.
The President's budget includes a proposal to enable states
to provide services to nursing-home qualified beneficiaries at
300% of the Supplemental Security Income (SSI) limit without
requiring a federal 1915(c) waiver. This proposal would
encourage states to implement these popular and cost-saving
programs.
We are very concerned, however, about funding for the Title
XX Social Services Block Grant Program, which funds adult day
services, home and community care and adult protective services
in many states. Two years ago, the program was funded at a
level of $2.38 billion. The program was cut to $1.775 billion
and, much to our surprise, President Clinton has proposed
freezing spending at this lower level, far below the
Administration's request last year of $2.38 billion.
The Home Care Coalition urges the Committee to support the
President's proposal to recognize the effectiveness of home and
community-based services by eliminating the need for 1915(c)
waivers. However, we hope that you will back up this
recognition by opposing drastic reductions in funding for the
Title XX Social Services Block Grant.
Conclusion
The services provided by home health care providers--be
they formal providers or informal family caregivers--are vital
to America's chronically ill, frail elderly and disabled. These
services are also key to securing the financial viability of
the Medicare Program. The Home Care Coalition urges this
Committee to recognize the importance of family caregivers by
enacting long-term care proposals such as those proposed by the
President this year. The Coalition looks forward to working
with this Committee to address the many issues facing home
health care.
Statement of Independent Sector
Independent Sector (is) is a coalition of more than 700
national organizations and companies representing the vast
diversity of the nonprofit sector and the field of
philanthropy. Its members include many of the nation's most
prominent and far-reaching nonprofit organizations, leading
foundations, and Fortune 500 corporations with strong
commitments to community involvement. This network represents
millions of volunteers, donors, and people served in
communities around the world. is members work globally and
locally in human services, education, religion, the arts,
research, youth development, health care, advocacy, democracy,
and many other areas. is is the only organization to represent
a network so broad.
America's ``independent sector'' is a diverse collection of
more than one million charitable, educational, religious,
health, and social welfare organizations. It is these groups
that create, nurture, and sustain the values that frame
American life and strengthen democracy. In 1980, a group of
visionary leaders, chaired by the Honorable John W. Gardner,
became convinced that if the independent sector was to continue
to serve society well, it had to be mobilized for greater
cooperation and influence. Thus a new organization, named to
celebrate the independent sector's unique role apart from
government and business, was formed to preserve and enhance and
protect a healthy, vibrant independent sector.
There are a number of initiatives relating to the nonprofit
sector in the Administration's FY 2001 budget that we would
like to bring to the committee's attention. These include a
charitable deduction for nonitemizers, an increased limit for
individual donations of appreciated assets, and taxation on the
investment income of associations. IS would like to present the
following comments to the committee.
Nonitemizer Deduction
The President's budget would create a charitable deduction
for taxpayers who do not itemize their deductions. These
individuals would be able to deduct fifty percent of their
annual charitable contributions above a $1,000 floor, $2,000
for joint returns, through 2005. That floor will be lowered to
$500, $1,000 for joint returns, beginning in 2006.
IS has long been supportive of any legislative effort to
encourage charitable giving, particularly by permitting
nonitemizers to deduct their generous gifts. The Charitable
Giving Tax Relief Act, H.R. 1310, introduced by Representative
Philip Crane (R-IL) and cosponsored by William Coyne (D-PA),
Wally Herger (R-CA), and Karen Thurman (D-FL), is a case in
point. This legislation is similar to the President's proposal
with the exception that the $500 floor would become effective
immediately. The bill currently has 122 bipartisan cosponsors,
including 18 members of the Ways and Means Committee.
Charitable giving is a transfer of private resources for
public purposes. Giving to charities promotes individual choice
as well as public responsibility among nonprofit organizations.
In a recent study, Giving and Volunteering in the United
States, 1999, IS found that the average annual household
contribution made by nonitemizers is $619. By creating a
deduction for nonitemizers we would be recognizing those
taxpayers who give above and beyond average levels.
The nonitemizer deduction is also based on generosity and
sacrifice, not personal gain. Individuals are motivated to make
charitable contributions primarily by their altruistic nature.
However, as with any decision related to the use of limited
resources, the amount a person gives to charitable causes will
be influenced by the cost to them of giving. The cost of giving
can be significantly changed by the tax treatment of the gift.
This deduction would restore fairness to the tax code for
nonitemizers who give generously. Currently, nonitemizers
represent more than two-thirds of American taxpayers B over 84
million people. Americans who don't itemize on their returns
would have a new opportunity to deduct some of their charitable
contributions. In 1986, the tax deduction expired due to a
sunset provision in the law. IS believes that it is time our
public policies recognize those who give significant portions
of their income to the causes they care about.
This is also an example of effective and meaningful tax
policy. It recognizes the contributions of individuals and
families while it also acknowledges the contributions
charitable organizations make to communities.
We are grateful for the Administration's efforts to include
incentives for charitable giving in his budget, and we urge you
to support HR 1310.
Limitation on Individual Gifts of Appreciated Property
The President's budget includes a provision that would
increase the limitation on the charitable deduction for gifts
of appreciated property to charity. Current law permits
taxpayers who itemize to take a deduction for gifts of
appreciated property to a public charity or private foundation.
However, the deduction is limited to a percentage of the
taxpayer's adjusted gross income (AGI). We believe that the
lowered value of the gift will discourage individuals from
making the donation to the charity of their choice.
Presently, the charitable deduction is limited to thirty
percent of AGI for gifts of appreciated property to charities,
and to twenty percent for such gifts to private foundations.
The Administration's proposal would increase these limits to
fifty and thirty percent, respectively. This would become
effective for gifts made after December 31, 2000.
As more Americans are acquiring additional income and
assets as a result of the strong performance of the stock
market, we hope the government will encourage these individuals
to give a portion of their new wealth to charitable causes. For
many Americans, donating gifts of appreciated property is a
common form of philanthropy. We urge the committee to enhance
this incentive by fully recognizing these generous
contributions.
Association Investment Income Tax
The Clinton Administration has proposed once again to place
an income tax on the investments made by trade associations
(501(c)(6) organizations). Identical to the provision
introduced by the President last year, the tax affects all
trade associations with income exceeding $10,000 during any tax
year. The tax is levied on the interest, dividend, royalty, and
rental income of associations and essentially alters section of
the tax code that had previously granted such groups exempt
from taxation.
While the membership of many trade associations consists
primarily of for-profit entities, some associations include
substantial numbers of nonprofit organizations. We have
concerns about this proposal since it erodes the principle of
exempting from tax passive income earned by nonprofit
organizations.
IS joins the American Society of Association Executives
(ASAE) in opposing this misguided proposal. While the
Administration maintains that this provision would close a
loophole in the tax code encouraging members of associations to
pay higher dues in order to claim a tax deduction, associations
are not permitted to pay dividends to their members, and
therefore are more likely to keep their dues levels at a
minimum. In addition, investment income helps an association
enhance the services it provides its members while creating
reserve funds for the future.
Conclusion
Mr. Chairman, we appreciate the opportunity to submit these
comments to the committee, and look forward to working with you
and your staff on these matters.
Statement of the Leasing Coalition, PricewaterhouseCoopers LLP
I. Introduction
On behalf of a group of companies in the leasing industry
(hereinafter the ``Leasing Coalition''), PricewaterhouseCoopers
appreciates the opportunity to present this written statement
to the House Ways and Means Committee in conjunction with its
February 9, 2000, hearing on the Administration's FY 2001
budget proposals.
Our comments center on tax increases proposed by the
Administration that would overturn the carefully constructed
body of law, built over decades, governing the tax treatment of
leasing transactions. These proposals include a leasing-
industry specific measure that would further penalize U.S.
companies using leasing to finance the export of manufactured
goods abroad.\1\ The Leasing Coalition also has strong concerns
about the impact on leasing transactions of several general
Administration proposals relating to ``corporate tax
shelters,'' including a proposal empowering IRS agents to deny
tax benefits in ``tax-avoidance transactions.'' \2\
---------------------------------------------------------------------------
\1\ General Explanations of the Administration's Fiscal 2001
Revenue Proposals, Department of the Treasury, February 2000, at 137-8.
\2\ Id. at 124.
---------------------------------------------------------------------------
In these comments, the Leasing Coalition discusses the
rationale underlying the present-law tax treatment of leasing
transactions and examines the impact of the Administration's
proposals on commonplace leasing arrangements. We also discuss
the adverse impact these proposals would have on the
competitiveness of American businesses, on exports, and on the
cost of capital.
We conclude by urging Members of the House Ways and Means
Committee to reject the Administration's tax proposals that
would adversely affect the leasing industry. These proposals
inappropriately would overturn the longstanding body of tax law
governing common leasing transactions, branding these
legitimate business transactions as ``corporate tax shelters.''
Instead of considering proposals at this time that would impair
the competitiveness of the leasing industry, we respectfully
suggest that the Administration and the Congress consider ways
to help U.S. companies that use leasing as a form of financing
expand in the global marketplace.
II. The Leasing Industry
Leasing is an increasingly common means of financing
investment in equipment and other property. It is estimated
that approximately 30 percent of all domestic equipment
investment is financed through leasing rather than outright
acquisition.\3\ Approximately 80 percent of U.S. companies
lease some or all of their equipment.\4\ The leasing industry
in 1998 financed more than $180 billion in equipment
acquisitions, an amount that exceeded $200 billion in 1999.\5\
---------------------------------------------------------------------------
\3\ U.S. Department of Commerce.
\4\ Equipment Leasing Association.
\5\ U.S. Department of Commerce.
---------------------------------------------------------------------------
Lessees, or the users of the property, find leasing an
attractive financing mechanism for a number of reasons. Because
a lease allows 100-percent financing, the lessee is able to
preserve cash that would be necessary to buy or make a
downpayment on a piece of equipment. Moreover, lessees
generally are able to secure financing under a lease at a lower
cost than under a loan. A lessee also may wish to use the asset
only for a short period of time, and may not want to risk
having the value of the equipment decline more quickly than
expected -or become obsolete--during this period of use. For
financial statement purposes, leasing can be preferable in that
it allows the lessee to secure off-balance sheet reporting with
respect to the asset. Finally, the lessee may find rental
deductions for lease payments more beneficial, from a timing
perspective, than depreciation deductions taken over a certain
schedule (e.g., double-declining balance).
Leasing also provides a number of business advantages to
lessors. Manufacturing companies (e.g., automobile, computer,
aircraft, and rolling stock manufacturers) may act as lessors
through subsidiary companies as a means of providing their
goods to customers. Financial institutions like banks, thrifts,
and insurance companies engage in leasing as a core part of
their financial intermediation business. As the owner of the
equipment, the lessor is able to take full deductions for
depreciation. Currently, more than 2,000 companies act as
equipment lessors.\6\
---------------------------------------------------------------------------
\6\ Equipment Leasing Association.
---------------------------------------------------------------------------
Leasing also promotes exports of U.S. equipment, and thus
helps U.S. companies compete in the global economy. Many lease
transactions undertaken by U.S. lessors are cross-border
leases, i.e., leases of equipment to foreign users. These
involve all types of equipment, including tankers, railroad
cars, machine tools, computers, copy machines, printing
presses, aircraft, mining and oil drilling equipment, and
turbines and generators. Many of these leases are supported in
one form or another by the Export-Import Bank of the United
States, which insures the credit of foreign lessees. Further,
U.S. manufacturers demand global leasing solutions in support
of their export activities.
III. Present-Law Treatment of Leases
A substantial body of law has developed over the last forty
years regarding the treatment of leasing transactions for
federal income tax purposes. At issue is whether a transaction
structured as a lease is respected as a lease for tax purposes
or is recharacterized as a conditional sale of the property. If
the transaction is respected as a lease for tax purposes, the
lessor is treated as the owner of the property and therefore is
entitled to depreciation deductions with respect to the
property. The lessor also is entitled to interest deductions
with respect to any financing of the property, and recognizes
income in the form of the rental payments it receives. The
lessee is entitled to a business deduction for the rental
payments it makes with respect to the property. On the other
hand, if the transaction is recharacterized as a conditional
sale, the purported lessee is treated as having purchased the
property in exchange for a debt instrument. The purported
lessee is treated as the owner of the property and is entitled
to depreciation deductions with respect to the property. In
addition, the purported lessee is entitled to interest
deductions for a portion of the amount it pays under the
purported lease. The purported lessor recognizes gain or loss
on the conditional sale and recognizes interest income with
respect to a portion of the amount received under the purported
lease. The purported lessor is entitled to interest deductions
with respect to any financing of the property.
Guidance regarding the determination whether a transaction
is respected as a lease for tax purposes is provided pursuant
to an extensive body of case law. There also have been
significant IRS pronouncements addressing this determination,
which have been maintained for more than 25 years. Finally,
statutory provisions provide specific rules regarding the tax
consequences of certain leasing transactions.
A. Case law
The determination whether a transaction is respected as a
lease for tax purposes generally is made based on the substance
of the transaction and not its form.\7\ This substantive
determination focuses on which party is the owner of the
property that is subject to the lease (i.e., which party has
the benefits and burdens of ownership with respect to the
property).\8\ In addition, the transaction must have economic
substance or a business purpose in order to be classified as a
lease for tax purposes.\9\
---------------------------------------------------------------------------
\7\ Helvering v. F. & R. Lazarus & Co., 308 U.S. 252 (1939).
\8\ Estate of Thomas v. Commissioner, 84 T.C. 412 (1985).
\9\ Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184 (1983),
aff'd in part and rev'd in part, 752 F.2d 89 (4th Cir. 1985); Frank
Lyon Co. v. United States, 435 U.S. 561 (1978).
---------------------------------------------------------------------------
The most important attributes of ownership are the upside
potential for economic gain and the downside risk of economic
loss based on the residual value of the leased property.\10\
The presence of a fair market value purchase option in a lease
agreement should not impact the determination of tax
ownership.\11\ Moreover, the fact that such an option is fixed
at the estimated fair market value should not by itself cause
the lease to be treated as a conditional sale.\12\ However,
where a lessee is economically or legally compelled to exercise
the purchase option because, for example, the option price is
nominal in relation to the value of the property, the lease
likely would be treated as a conditional sale.\13\
---------------------------------------------------------------------------
\10\ Swift Dodge v. Commissioner, 692 F.2d 651 (9th Cir. 1982),
rev'g, 76 T.C. 547 (1981).
\11\ Lockhart Leasing Co. v. Commissioner, 54 T.C. 301, 314-15
(1970), aff'd 446 F.2d 269 (10th Cir. 1971).
\12\ See Frank Lyon Co. v. United States, supra.
\13\ Oesterreich v. Commissioner, 226 F.2d 798 (9th Cir. 1955),
rev'g, 12 T.C.M. 277 (1953).
---------------------------------------------------------------------------
Another important indicia of ownership for tax purposes is
the holding of legal title; this factor, however, is not
determinative.\14\ The right to possess the property throughout
its economic useful life also is an attribute of ownership for
tax purposes. For example, the entitlement of the lessee to
possession of the property for its entire useful life would be
a strong indication that the lessee rather than the lessor
should be considered the owner of the property for tax
purposes.\15\
---------------------------------------------------------------------------
\14\ Coleman v. Commissioner, 87 T.C. 178, 201 (1986), aff'd 883
F.2d 303 (3d Cir. 1987).
\15\ Pacific Gamble Robinson v. Commissioner, 54 T.C.M. 915 (1987).
---------------------------------------------------------------------------
The economic substance test finds its genesis in the
Supreme Court opinion in Frank Lyon Co. There, the United
States Supreme Court determined that a sale and leaseback
should not be disregarded for federal income tax purposes if
the transaction:
is a genuine multi-party transaction with economic
substance which is compelled or encouraged by business or
regulatory realities, is imbued with tax-independent
considerations, and is not shaped solely by tax-avoidance
features that have meaningless labels attached. . . Expressed
another way, so long as the lessor retains significant and
genuine attributes of the traditional lessor status, the form
of the transaction adopted by the parties governs for tax
purposes.\16\
---------------------------------------------------------------------------
\16\ Id. at 583.
---------------------------------------------------------------------------
The IRS challenged the sale-leaseback transaction in Frank
Lyon on the grounds that it was a sham. However, the Court
concluded that, in the absence of specific facts evidencing a
sham transaction motivated solely by tax-avoidance purposes, a
lessor need only possess ``significant and genuine attributes
of traditional lessor status,'' evidenced by the economic
realities of the transaction, in order for a lease to be
respected for federal income tax purposes. The Court recognized
that there can be many business or economic reasons for
entering into a lease. Legal, regulatory, and accounting
requirements, for example, can serve as motivations to lease an
asset. Instead of trying to identify one controlling factor,
the Court used the same test as the other leasing cases--that
all facts and circumstances must be considered in determining
economic substance. Further, the Court noted that ``the fact
that favorable tax consequences were taken into account by Lyon
on entering into the transaction is no reason for disallowing
those consequences.'' \17\
---------------------------------------------------------------------------
\17\ Id. at 561.
---------------------------------------------------------------------------
In the wake of Frank Lyon, the Tax Court has refined the
analysis of whether a lease should be respected for tax
purposes. Under Rice's Toyota World, Inc. v. Commissioner, and
its progeny, the Tax Court will disregard a lease transaction
for lack of economic substance only if (i) the taxpayer had no
business purpose for entering into the transaction other than
to reduce taxes, and (ii) the transaction, viewed objectively,
offered no realistic profit potential. Further elaborating on
this standard, the Tax Court in Mukerji v. Commissioner \18\
set forth the test that in subsequent cases has been used to
determine whether a lease should be disregarded for tax
purposes:
---------------------------------------------------------------------------
\18\ 87 T.C. 926 (1986).
---------------------------------------------------------------------------
[u]nder such test, the Court must find ``that the taxpayer
was motivated by no business purpose other than obtaining tax
benefits in entering into the transaction, and that the
transaction had no economic substance because no reasonable
possibility of a profit exists.'' \19\
---------------------------------------------------------------------------
\19\ Id. at 959 Rice's Toyota World, supra, at 91).
---------------------------------------------------------------------------
Once business purpose is established, a lease transaction
should not be classified as a ``sham.'' A finding of no
business purpose, however, is not conclusive evidence of a sham
transaction. The transaction will still be valid if it
possesses some economic substance. The Tax Court has developed
an objective test for economic substance. A lease will meet the
threshold of economic substance and will be respected when the
net ``reasonably expected'' residual value and the net rentals
(both net of debt service) will be sufficient to allow
taxpayers to recoup their initial equity investment.\20\
Applying this analysis, the Tax Court in several cases has
concluded that a purported lease transaction was devoid of
business purpose and lacked economic substance because the
taxpayers could not reasonably expect to recoup their capital
from the projected non-tax cash flows in the lease.\21\
---------------------------------------------------------------------------
\20\ See Mukerji, supra.
\21\ See Goldwasser v. Commissioner, 56 T.C.M. 606 (1988); Casebeer
v. Commissioner, 54 T.C.M. 1432 (1987); and James v. Commissioner, 87
T.C. 905 (1986).
---------------------------------------------------------------------------
Most recently, outside the context of leasing transactions,
the Tax Court in Partnership v. Commissioner \22\ had the
opportunity to apply a form of economic substance test. There,
the Tax Court stated that ``the doctrine of economic substance
becomes applicable, and a judicial remedy is warranted, where a
taxpayer seeks to claim tax benefits, unintended by Congress,
by means of a transaction that serves no economic purpose other
than tax savings.'' \23\ The court further found that the
taxpayer could not have hoped to recover its initial investment
and its costs under any reasonable economic forecast. This
proposition that the economic substance test cannot be
satisfied if a taxpayer cannot demonstrate a reasonable
expectation of pre-tax profit is consistent with the long-
standing body of case law regarding lease transactions.
---------------------------------------------------------------------------
\22\ 73 T.C.M. (1997), aff'd in part and rev'd in part, 157 F.3d
231 (3d Cir. 1998), cert. denied, 1999 U.S. LEXIS 1899 (Mar. 22, 1999).
\23\ Id. at 130.
---------------------------------------------------------------------------
B. Administrative pronouncements
Through revenue rulings and other administrative
pronouncements, the IRS has identified certain principles and
factors it considers relevant in determining whether a
transaction should be treated for tax purposes as a lease or as
a conditional sale.
In Rev. Rul. 55-540,\24\ the IRS indicated that conditional
sale treatment is evidenced where the lessee effectively has
the benefits and burdens of ownership for the economic life of
the property, as demonstrated by, for example, the application
of rentals against the purchase price or otherwise to create an
equity interest, the identification of a portion of rentals as
interest, the approximate equality of total rentals and the
cost of the property plus interest, or the existence of nominal
renewal or purchase options. The passage of legal title itself
is not determinative.
---------------------------------------------------------------------------
\24\ 1955-2 C.B. 39. See also Rev. Rul. 55-541, 1955-2 C.B. 19.
---------------------------------------------------------------------------
In addition, the IRS has issued a series of revenue
procedures setting forth guidelines that must be satisfied to
obtain an advance ruling that a ``leveraged lease'' (a
transaction involving three parties--a lessor, a lessee, and a
lender to the lessor) will be respected as a lease for tax
purposes.\25\ According to Rev. Proc. 75-21, the guidelines set
forth therein were published:
---------------------------------------------------------------------------
\25\ See Rev. Proc. 75-21, 1975-1 C.B. 715 (setting forth several
requirements that must be satisfied for the Service to rule that a
transaction is a lease for tax purposes); Rev. Proc. 75-28, 1975-1 C.B.
752 (specifying information that must be submitted pursuant to Rev.
Proc. 75-21); Rev. Proc. 76-30, 1976-2 C.B. 647 (providing that the
Service will not issue an advance ruling if the property subject to the
``lease'' is limited use property); Rev. Proc. 79-48, 1979-2 C.B. 529
(modifying Rev. Proc. 75-21 to allow the lessee to pay for certain
improvements).
---------------------------------------------------------------------------
to clarify the circumstances in which an advance ruling
recognizing the existence of a lease ordinarily will be issued
and thus to provide assistance to taxpayers in preparing ruling
requests and to assist the Service in issuing advance ruling
letters as promptly as practicable. These guidelines do not
define, as a matter of law, whether a transaction is or is not
a lease for federal income tax purposes and are not intended to
be used for audit purposes. If these guidelines are not
satisfied, the Service nevertheless will consider ruling in
appropriate cases on the basis of all the facts and
circumstances. (Emphasis added.)
Thus, the IRS guidelines are intended only to provide a
list of criteria that if satisfied ordinarily will entitle a
taxpayer to a favorable ruling that a leveraged lease of
equipment will be respected as a lease for tax purposes.
With respect to economic substance, the IRS guidelines set
forth a profit test that will be met if:
the aggregate amount required to be paid by the lessee to
or for the lessor over the lease term plus the value of the
residual investment [determined without regard to the effect of
inflation] exceed an amount equal to the sum of the aggregate
disbursements required to be paid by or for the lessor in
connection with the ownership of the property and the lessor's
equity investment in the property, including any direct costs
to finance the equity investment, and the aggregate amount
required to be paid to or for the lessor over the lease term
exceeds by a reasonable amount the aggregate disbursements
required to be paid by or for the lessor in connection with the
ownership of the property.\26\
---------------------------------------------------------------------------
\26\ Rev. Proc. 75-21, supra.
---------------------------------------------------------------------------
The IRS guidelines do not specify any particular amount of
profit that a lease must generate.\27\
---------------------------------------------------------------------------
\27\ The IRS guidelines understate the actual profit earned over
the lease term by failing to adjust the residual value of the
investment for inflation. The advance ruling practice of the IRS from
1975 has been to require a pre-tax profit, cash on cash return, that
approximates the inflation rate projected for the leased asset.
---------------------------------------------------------------------------
The IRS itself has not relied exclusively on the criteria
set forth in the IRS guidelines when analyzing the true lease
status of a lease transaction. Moreover, the courts have not
treated the IRS guidelines as determinative when analyzing
whether a transaction should be respected as a lease for tax
purposes.\28\ Rather, the IRS guidelines are viewed as
constituting a ``safe harbor'' of sorts. Accordingly,
satisfaction of the conservative rule set forth by the
applicable IRS guideline with respect to a particular criterion
usually is viewed as an indication that the transaction should
not be challenged on such a criterion.
---------------------------------------------------------------------------
\28\ In a footnote in Frank Lyon, supra at n. 14, the Supreme Court
specifically recognized that the IRS guidelines ``are not intended to
be definitive.'' Moreover, in Estate of Thomas v. Commissioner, 84 T.C.
412, 440 n. 15 (1985), the Tax Court viewed the failure to satisfy all
the IRS guidelines as not determinative because the facts and
circumstances demonstrated that the transaction satisfied the
``spirit'' of the guidelines.
---------------------------------------------------------------------------
The IRS in March 1999 issued Rev. Rul. 99-14, with respect
to a narrow class of relatively recent cross-border leasing
transactions commonly referred to as ``LILO'' transactions. The
IRS ruled that a taxpayer may not deduct rent and interest paid
or incurred in connection with a LILO transaction that lacks
economic substance.
C. Statutory provisions
The party that is treated as the owner of the leased asset
is entitled to depreciation deductions in respect of such
asset. The Deficit Reduction Act of 1984 enacted the ``Pickle''
rules (named after one of the sponsors of the provision,
Representative J.J. Pickle), which restrict the benefits of
accelerated depreciation in the case of property leased to a
tax-exempt entity.
The Pickle rules generally provide that, in the case of any
``tax-exempt use property'' subject to a lease, the lessor
shall be entitled to depreciate such property using the
straight-line method and a recovery period equal to no less
than 125 percent of the lease term.\29\ Tax-exempt use
property, for this purpose, generally is tangible property
leased to a tax-exempt entity, which is defined to include any
foreign person or entity.\30\
---------------------------------------------------------------------------
\29\ I.R.C. section 168(g).
\30\ I.R.C. section 168(h).
---------------------------------------------------------------------------
In applying the Pickle rules, Treasury regulations adopted
in 1996 provide that the lease term will be deemed to include
certain periods beyond the original duration of the lease.
Under these regulations, which extend beyond the reach of the
statutory provision, the lease term includes both the actual
lease term and any period of time during which the lessee (or a
related person) (i) agreed that it would or could be obligated
to make a payment of rent or a payment in the nature of rent or
(ii) assumed or retained any risk of loss with respect to the
property (including, for example, holding a note secured by the
property).\31\
---------------------------------------------------------------------------
\31\ Treas. Reg. Section 1.168(i)-2(b)(1).
---------------------------------------------------------------------------
IV. Administration's FY 2001 Budget Proposals
The Administration's FY 2001 budget includes several
proposals that could have the effect of completely rewriting
longstanding tax law on leasing transactions. These proposals,
if enacted, would replace the substantial and specific body of
law regarding leasing transactions that has developed over the
last forty years with broad and largely undefined standards
that could be used by IRS revenue agents to challenge
traditional leasing transactions undertaken by companies
operating in the ordinary course of business in good-faith
compliance with the tax laws. Moreover, the proposal that would
modify the tax rules applicable to cross-border leasing would
penalize U.S. lessors and would further hamper the ability of
U.S.-based multinationals to compete in export markets.
A. Proposal to codify the economic substance doctrine
The proposal would authorize the IRS to disallow any deduction,
credit, exclusion, or other allowance obtained in a ``tax-avoidance
transaction.'' A ``tax avoidance transaction'' is defined generally as
any transaction in which the reasonably expected pre-tax profit is
insignificant relative to the reasonably expected net tax benefits. A
financing transaction would be considered a tax-avoidance transaction
if the present value of the tax benefits of the taxpayer to whom the
financing is provided significantly exceed the present value of the
pre-tax profit or return of the person providing the financing.
This proposal creates the entirely new and vague concept of a
``tax-avoidance transaction.'' The inclusion of so many subjective
concepts in this definition precludes it from operating as an objective
test. As an initial matter, what constitutes the ``transaction'' for
purposes of this test? \32\ Next, what are the mechanics for computing
pre-tax economic profits and net tax benefits and for determining
present values (e.g., what discount rate should be used, particularly
where rentals, residuals, and their tax benefits have significantly
different risk and reward profiles?)? Further, where is the line drawn
regarding the significance of the reasonably expected pre-tax economic
profit relative to the reasonably expected net tax benefits? Moreover,
is the determination of ``insignificance'' transaction-specific; stated
otherwise, does the form of the transaction affect the determination of
what will be considered ``insignificant'' for these purposes? The
presence of these same vague and undefined elements in the concept of a
tax-avoidance financing transaction renders that test equally
subjective.
---------------------------------------------------------------------------
\32\ By itself, the determination of the scope of the transaction
is both extremely complex and vitally important to the application of
this test. Some of the questions to be resolved include: Do the
qualified nonrecourse indebtedness rules control the determination of
whether debt is considered part of a transaction? If recourse debt is
taken into account in defining the transaction, how is the
appropriately allocable amount of such debt to be determined? In
addition, in defining the transaction, will an implicit charge for the
use of capital be taken into account? Will allocations of internal
expenses and corporate overhead to the transactions be required?
Moreover, will a lease of multiple assets or multiple classes of assets
be treated as a single transaction or multiple transactions? All of
these questions and more must be answered in order to determine the
scope of the transaction, which would be only the starting point in
applying this test.
---------------------------------------------------------------------------
Under this proposal, once the IRS had used its unfettered authority
to determine independently that a taxpayer had engaged in a tax-
avoidance transaction, the IRS would be entitled to disallow any
deduction, credit, exclusion, or other allowance obtained by the
taxpayer in such transaction. Thus, even though a taxpayer's
transaction has economic substance and legitimate business purpose, the
IRS would be empowered to deny the tax savings to the taxpayer if
another route to achieving the same end result would have resulted in
the remittance of more tax. In other words, if an IRS revenue agent
believed for any reason that a taxpayer's transaction was too tax
efficient, he or she would have the power to strike it down, even if
the actual pre-tax return on the transaction satisfied any objective
benchmark for appropriate returns. That power could be invoked without
regard to the legitimacy of the taxpayer's business purpose for
entering into the transaction or the economic substance underlying the
transaction.
In the context of leasing transactions, this proposal effectively
could wipe out the entire body of law that has developed over the last
forty years. A leasing transaction that is scrutinized and passes
muster under the benefits and burdens of ownership, business purpose,
and economic substance tests could run afoul of this vague new
standard. This proposal would completely disregard the presence of a
business purpose, ignoring the business reality that lease transactions
often are motivated by criteria that would not be taken into account
under this new standard. It would replace the traditional economic
analysis of lease transactions with this new and largely undefined
standard. The long-standing law regarding the treatment of leasing
transactions allows taxpayers to employ prudent tax planning to
implement business objectives while giving the IRS the tools it needs
to address potentially abusive transactions. The extraordinary power
that would be vested both in Treasury and in individual IRS revenue
agents is unnecessary and would create substantial uncertainty that
would frustrate commerce done through traditional leasing transactions.
B. Proposal to increase depreciation life by service term of tax-exempt
use property
The proposal would require lessors of tax-exempt use
property to include the term of optional service contracts and
other similar arrangements in the lease term for purposes of
determining the recovery period under the Pickle rules.
As an initial matter, it should be noted that the reach of
the proposal is not clear. The proposal does not define
optional service contracts and does not provide any guidance
regarding what would fall within the reach of the proposal as
an ``other similar arrangement.''
The proposed legislation overlooks significant business
purposes that give rise to use of service contracts. Service
contracts involve a tradeoff between rights and risks. Relative
to a lessor, the service provider enjoys more control over the
asset used to generate such services, but also assumes
additional performance and operational risk with respect to
such asset. The parties' preferences as to the division of
rights and risks with respect to property determine the form of
contractual arrangement they choose. The service contract
arrangement has long been commercially recognized, particularly
within certain industries such as the utility, specified
manufacturing, and shipping industries.
This proposal would exacerbate the anti-competitive impact
of the Pickle rules by further limiting depreciation deductions
for U.S. lessors financing assets being sold or developed in
overseas markets. Domestic manufacturers, distributors, and
retailers alike avail themselves of export leasing, not only as
a pure financing vehicle for major equipment sales, but also as
a powerful sales tool to promote equipment sales abroad. The
proposal would put these U.S. companies at a further
disadvantage compared to foreign-based companies that are able
to offer lease financing for their goods on more favorable
terms. The proposal similarly would adversely affect the
ability of U.S. financial institutions to compete
internationally with foreign lenders and financiers.
The service contract issue was addressed explicitly at the
time the Pickle rules were enacted in 1984. Code section
7701(e), which was enacted with the Pickle rules, provides
rules regarding the distinction between a service contract and
a lease, and further specifically provides that certain service
contracts will not be subject to potential recharacterization
as leases. This proposal would reverse the safe harbor provided
in 1984 for service contracts with respect to certain solid
waste disposal, energy, and water treatment facilities and
would subject these facilities to the penalty of delayed
depreciation. Moreover, the proposal would further extend the
reach of the Pickle rules to other services contracts and to
any arrangement that constitutes an ``other similar
arrangement,'' a concept which has not been defined. When the
Pickle rules were enacted in 1984, their reach was limited by
the rules of Code section 7701(e). Removing those limitations
and expanding the reach of the Pickle rules would further
impair the ability of U.S. leasing companies to compete in the
global economy. As discussed further below, given the
increasingly competitive global environment for leasing, this
is not the time to remove those carefully considered
limitations and expand the reach of the Pickle rules.
V. Administration's Proposals Are Anti-Competitive
A. Impact on Common Transactions
Consider a standard domestic leveraged lease under which an
airline carrier enters into a ``sale-leaseback'' transaction in
order to finance a newly manufactured aircraft. Under this
transaction, the airline carrier purchases the aircraft from
the aircraft manufacturer and immediately sells it to an
institutional investor. The investor finances the acquisition
through an equity investment equal to 25 percent of the $100
million purchase price and a fixed-rate nonrecourse debt
instrument from a third-party lender equal to the remaining 75
percent. Immediately after the sale, the investor leases the
aircraft to the airline carrier pursuant to a net lease for a
term of 24 years. Upon the expiration of the lease term, the
aircraft will be returned to the investor (the lessor). During
year 18 of the lease, the airline carrier (the lessee) will
have an option to purchase the aircraft from the investor for a
fixed amount, which will be set at an amount greater than or
equal to a current estimate of the then-fair market value of
the aircraft. As the tax owner of the aircraft, the lessor is
entitled to depreciation deductions in respect of the aircraft
and deductions in respect of the interest that accrues on the
loan.
The lease in this example complies with applicable case law
and with the cash flow and profit tests set forth in Rev. Proc.
75-21. In fact, the sum of the rentals and the expected
residual value exceeds the aggregate disbursements of the
lessor and the lessor's equity investment, together with
applicable costs, by approximately $18 million (or 18 percent
of the asset purchase price).
Even though this transaction complies with the established
body of leasing law, it appears that it potentially could be
characterized as a ``tax-avoidance transaction'' under the
Administration's proposal, discussed above. As noted above, the
manner in which the proposal would test whether a transaction
is or is not a ``tax-avoidance transaction'' is capable of
numerous different interpretations and appears to be highly
subjective. Under a range of potential applications of the
proposal to this transaction, it might be determined that the
lessor would reasonably expect an annual pre-tax return
anywhere in the range of 2.5 percent to 5.5 percent. On an
after-tax basis, the lessor might be determined to reasonably
expect an annual return anywhere in the range of 6.5 percent to
8.5 percent. Depending on the particular manner in which the
proposed test might be applied, the differential between the
pre-tax and the after-tax returns could be large enough to
suggest that an IRS agent might take the position that the
discounted value of the reasonably expected pre-tax profit is
not sufficient under the proposed test when compared to the
discounted value of the reasonably expected net tax benefits.
Regardless of how the test is applied, however, the tax
advantages received by the lessor in this example are identical
to the tax benefits that would be received by any owner of the
property financing the property in a similar manner and in the
same tax bracket. If the tax benefits are disallowed only for
lessors, leasing will be put at a disadvantage relative to
direct ownership. There is no sensible policy that would
declare a leasing transaction to lack economic substance where
the same cash flows and tax benefits would occur for any
similarly situated direct owner of such an asset.
B. Impact on Global Competitiveness and U.S. Exports
The ability of U.S. equipment manufacturers to compete in
global markets depends in part on their ability to arrange
financing terms for their potential customers that are
competitive with those that can be arranged by foreign
producers. The Administration's budget proposals would make it
much more difficult and potentially impossible to arrange
financing on competitive terms.
For example, consider the case of a U.S. aircraft
manufacturer seeking to expand into the European market.\33\ A
European airline may find cost to be a final determining factor
in comparing an aircraft manufactured by a U.S. company with
one produced by a European manufacturer. Financing provisions,
such as lease terms, directly influence the cost. The U.S.
manufacturer's ability to sell its aircraft to the European
airline may be contingent on its ability to assist the airline
with arranging a suitable lease that is competitive with the
lease terms that can be offered with respect to the European
aircraft.
---------------------------------------------------------------------------
\33\ About half of the aircraft flown in Europe are leased rather
than owned by airlines.
---------------------------------------------------------------------------
A U.S. aircraft manufacturer would have to take into
account the current U.S. tax law in determining the rate at
which it could offer a European airline a short-term operating
lease or a long-term financial lease. In contrast, a European
aircraft manufacturer, if it worked through a German investor,
for example, might be able to offer financing to the airline at
a much lower rate. A chief reason for this disparity is the
favorable tax treatment of leased property under German law,
including significantly accelerated depreciation for the lessor
even when the lessee is a tax-exempt entity under German tax
law. Under the present Pickle rules, a U.S. export lease on
U.S. equipment cannot compete with a German lease on similar
German equipment. The availability of favorable lease rules in
foreign jurisdictions, such as the German rules, already
hinders the ability of U.S. companies to compete in the global
market. Changes to the rules further impairing the tax
treatment of export leasing will further disadvantage U.S.
leasing companies and U.S. manufacturers vis-à-vis their
foreign counterparts.
If enacted, the Administration's budget proposals would
tilt the balance in these competitive financing situations even
further against the U.S. manufacturer. For leasing-intensive
industries, the proposals could make it prohibitive to expand
in existing markets or to enter emerging markets on a
competitive basis. Because the Administration's proposals
effectively would make U.S.-manufactured goods in leasing-
intensive industries more expensive in foreign markets, these
measures could be expected to have an adverse effect on
American exports.
A significant percentage of American exports is
attributable to leasing. While no exact data regarding this
percentage is available, consider that data discussed in
section II, above, indicated that nearly one third of all
equipment investment, at least on a domestic basis, is financed
through leasing. Further, consider that exports of equipment in
1998 represented 44 percent of all goods exported by the United
States.\34\ Moreover, the share of exported goods accounted for
by equipment has been rising steadily since 1980. Despite the
strong showing of U.S. exported equipment, we live in a highly
competitive world and face worldwide competition in our export
markets and at home for these products.
---------------------------------------------------------------------------
\34\ U.S. Department of Commerce, Bureau of Economic Analysis,
Survey of Current Business, January 2000.
---------------------------------------------------------------------------
In certain sectors most likely to be leasing-intensive,
exports are accountable for a substantial share of domestic
production. For example, in 1996 exports accounted for 50
percent of U.S. production of aircraft, aircraft engines, and
other aircraft parts; 28 percent of U.S. production of
construction equipment; 31 percent of U.S. production of farm
machinery; 40 percent of U.S. production of machine tools; and
56 percent of U.S. production of mining machinery.\35\ In the
absence of these exports, domestic employment in these
equipment-producing industries would be substantially reduced.
---------------------------------------------------------------------------
\35\ U.S. Department of Commerce, International Trade
Administration.
---------------------------------------------------------------------------
The Administration's proposals also would impede the
ability of U.S.-based financial institutions to compete in the
worldwide leasing market. If enacted, the Administration's
proposals would give foreign-based financial institutions a leg
up in providing financing. The impact of these proposals on the
U.S. financial sector, an important part the U.S. economy,
should not be overlooked.
C. Impact on Start-Ups and Companies in Economic Downturn
Some companies that directly own their assets may find that
they have a higher cost of capital than their competitors due
to special tax circumstances. For example, companies in a loss
position (as is the case for many businesses in the start-up
phase) and companies paying AMT (which often hits companies
experiencing economic downturns) often have a higher cost of
capital because they cannot immediately claim all of the
depreciation allowances provided under the tax law. These
companies may be at a competitive disadvantage relative to
other firms. Some regard it as unfair that a company in the
start-up phase or recovering from an economic downturn faces
higher costs for new investment than its competitors.
Through leasing, a company in these circumstances often can
achieve a cost of capital comparable to that of its
competitors. Leasing helps to ``level the playing field''
between companies in an adverse tax situation and their
competitors by equalizing the cost of capital. For certain
assets, leasing can lower the cost of capital for a firm in
this tax situation by as much as one percentage point. This can
mean the difference between successfully competing and
bankruptcy. Rehabilitation or liquidation in bankruptcy can be
more detrimental to U.S. revenues than the granting of ordinary
depreciation and interest deductions.
By denying the benefits of leasing, the Administration's
proposals would further increase the cost of capital for
companies in such circumstances. As a result, the economy
suffers real losses. Investment may be allocated not on the
basis of who is the most efficient or productive producer, but
who is in the most favorable tax situation. In the absence of
leasing, a company in a loss position--facing a higher cost of
capital than its competitors--might not be able to undertake
new investment even if, in the absence of taxes, it would be
the most efficient firm.
VI. Reforms Needed to Strengthen Competitiveness of U.S. Leasing
Industry
As discussed above, the leasing industry is important to
the American economy. U.S. manufacturers use leasing as a means
to finance exports of their goods in overseas markets, and many
have leasing subsidiaries that arrange for such financing. Many
U.S. financial companies also arrange for lease financing as
one of their core financial intermediation services.
Ultimately, the activities of these companies support U.S. jobs
and investment.
The present-law Pickle rules place the American leasing
industry at a competitive disadvantage in overseas markets.
Because of the Pickle rules and their adverse impact on cost
recovery, U.S. lessors are unable in many cases to offer U.S.-
manufactured equipment to overseas customers on terms that are
competitive with those offered by foreign counterparts. Many
European countries, for example, provide favorable lease rules
for home-country lessors leasing equipment manufactured in the
home country. The 1996 Treasury regulations regarding
replacement leases compound this competitive disadvantage faced
by the U.S. leasing industry. It is unclear why the
Administration, through the proposals in its FY 2001 budget
submission, would choose to further increase these competitive
disadvantages.
Rather than follow the Administration's lead, the Leasing
Coalition respectfully submits that Congress should consider
reversing course. Specifically, we would ask that Congress
explore whether, in light of the globalization of the economy,
there is any tax policy or economic rationale for the present-
law Pickle rules. The Leasing Coalition knows of no such
legitimate rationale, and urges repeal of the Pickle rules
applicable to export leases, which serve only to penalize the
U.S. leasing industry. As an immediate step, we also would call
on Congress to overturn the 1996 Treasury regulations that
treat the lease term, for purposes of the Pickle rules, as
including periods beyond the actual lease term. These
regulations have no basis in the legislative history underlying
enactment of the Pickle rules and have no policy justification.
These changes would greatly strengthen the competitiveness of
the U.S. leasing industry.
VII. Conclusion
The Leasing Coalition urges Members of the House Ways and
Means Committee to reject the Administration's tax proposals
that would adversely affect the leasing industry. As discussed
above, we believe these proposals inappropriately would
overturn the longstanding and carefully crafted body of tax law
governing common leasing transactions and would have a
deleterious impact on the U.S. economy. Moreover, we find it
highly objectionable that these common and legitimate business
transactions effectively are being cast by the Administration
as ``corporate tax shelters.''
The Leasing Coalition appreciates the concern that a
bipartisan majority of Ways and Means Committee Members
expressed, in a June 9, 1999, letter to Committee Chairman
Archer and Ranking Member Rangel, over the impact that the
Administration's FY 2000 budget proposals would have had on the
leasing industry and our ability to compete internationally.
Those same concerns hold equally true today with respect to the
Administration's FY 2001 budget proposals.
Instead of considering proposals at this time that would
impair the competitiveness of the leasing industry and
industries that manufacture goods commonly acquired through
lease arrangements, we respectfully would suggest that the
Administration and Congress consider ways to help U.S.
companies that use leasing as a form of financing expand in the
global marketplace. The Congress should act to reverse the
overreaching 1996 Treasury regulations regarding replacement
leases and, further, should consider repeal of the Pickle rules
themselves.
Statement of the National Association of Real Estate Investment Trusts
As requested in Press Release No. FC-17 (February 2, 2000),
the National Association of Real Estate Investment
Trusts (``NAREIT'') respectfully submits these
comments in connection with the Committee on Ways and Means'
hearing on the President's Fiscal Year 2001 Budget
(``Budget''). NAREIT thanks the Chairman and the Committee for
the opportunity to share its views on several important issues
affecting REITs and publicly traded real estate companies.
NAREIT's comments address (1) the Budget's proposal to
increase a real estate investment trust's (``REIT'')
distribution requirement to avoid the 4% excise tax; (2) the
Budget's proposal to modify the treatment of closely held
REITs; and (3) the Budget's proposal to made permanent the
ability to deduct remediation expenses for Brownfields sites.
We appreciate the opportunity to present these comments.
NAREIT is the national trade association for REITs and
publicly traded real estate companies. Members are REITs and
publicly traded businesses that own, operate and finance
income-producing real estate, as well as those firms and
individuals who advise, study and service these businesses.
REITs are companies whose income and assets are mainly
connected to income-producing real estate. By law, REITs
regularly distribute most of their taxable income to
shareholders as dividends. NAREIT represents over 200 REITs and
publicly traded real estate companies that own over $250
billion of real estate assets, as well as over 2,000 industry
professionals who provide a range of legal, investment,
financial and accounting-related services to these companies.
Executive Summary
Excise Tax. The Budget's proposal to increase the
distribution requirement to avoid the 4% excise tax ignores the
capital intensive nature of REITs, as well as the practical
differences between REITs and mutual funds in timely
calculating the required distribution amounts. Further, this
proposal would effectively nullify Congress' decision reached
only a few months ago to restore the general distribution
requirement from 95% to 90%, effective in 2001.
Closely Held REITs. The Budget proposes to prevent any
entity from owning 50% or more of the vote or value of a REIT's
stock. NAREIT does not oppose the Administration's intention to
craft a new ownership test intended to correspond to a REIT's
primary mission: to make investment in income-producing real
estate accessible to ordinary investors. However, we believe
that the Administration's proposal is too broad, and therefore
should be narrowed to prevent only non-REIT C corporations from
owning 50% or more of a REIT's stock (by vote or value). In
addition, the new rules should not apply to so-called
``incubator REITs'' that have proven to be a viable method by
which small investors can access publicly traded real estate
investments. Last, the proposal should not apply to publicly
traded REITs when one person owns less than 80% of the vote or
value of a REIT's stock because it would deter legitimate
business transactions.
Brownfields Expenses. The Budget proposes to make permanent
the provision contained in the Tax Relief Extension Act of 1999
that allows a taxpayer to deduct remediation expenses for
Brownfields sites. NAREIT strongly supports this proposal, but
also recommends that Congress extend the expensing treatment to
properties that do not currently fit within the definition of a
``qualified contaminated site.''
Background on REITs
A REIT is a corporation or business trust combining the
capital of many investors to own, operate or finance income-
producing real estate, such as apartments, shopping centers,
offices and warehouses. REITs must comply with a number of
requirements, some of which are discussed in detail in this
statement, but the most fundamental of these are as follows:
(1) REITs must pay at least 95% of their taxable income to
shareholders (90% after 2000); (2) most of a REIT's assets must
be real estate; (3) REITs must derive most of their income from
real estate held for the long term; and (4) REITs must be
widely held.
In exchange for satisfying these requirements, REITs (like
mutual funds) benefit from a dividends paid deduction so that
most, if not all, of a REIT's earnings are taxed only at the
shareholder level. On the other hand, REITs pay the price of
not having retained earnings available to meet their business
needs. Instead, capital for growth and significant capital
expenditures largely comes from new money raised in the
investment marketplace from investors who have confidence in
the REIT's future prospects and business plan.
Congress created the REIT structure in 1960 to make
investments in large-scale, significant income-producing real
estate accessible to investors from all walks of life. Based in
part on the rationale for mutual funds, Congress decided that
the only way for the average investor to access investments in
larger-scale commercial properties was through pooling
arrangements.
In much the same ways as shareholders benefit by owning a
portfolio of securities in a mutual fund, the shareholders of
REITs can unite their capital into a single economic pursuit
geared to the production of income through commercial real
estate ownership. REITs offer distinct advantages for smaller
investors: greater diversification through investing in a
portfolio of properties rather than a single building and
expert management by experienced real estate professionals.
REITs are owned primarily by individuals, with 49% of REIT
shares owned directly by individual investors and 37% owned by
mutual funds, which are mostly owned by individuals.
I. REIT DISTRIBUTION REQUIREMENTS
Background. Under current law, to maintain their tax
status, REITs are required to distribute 95% of their taxable
income while mutual funds are required to distribute 90% of
taxable income. The Tax Relief Extension Act of 1999 (the
``1999 Act'') reduced the distribution requirement for REITs
from 95% of taxable income to 90% of taxable income for years
beginning after December 31, 2000.
In addition to the distribution requirement necessary to
maintain their tax status, both REITs and mutual funds are
subject to a 4% excise tax on the difference between their
``required distribution'' for a calendar year and their
``distributed amount'' for that year. For REITs, the required
distribution under current law equals the sum of 85% of
``ordinary income'' for the calendar year (essentially, REIT
taxable income for the year without reduction for the dividends
paid deduction and without reference to capital gain or loss)
plus 95% capital gain net income for that calendar year. For
mutual funds, the required distribution equals 98% of a its
``ordinary income'' plus 98% of its capital gain net income.
For example, a REIT that generates $100x in ordinary income
in 1999 must distribute at least $95x to its shareholders to
receive a dividends paid deduction for 1999. However, if a REIT
makes an election under I.R.C. Sec. 858, the Code treats as
paid in 1999 any dividend declared before it files its tax
return (due, with extensions, on September 15, 2000) and paid
in 2000 before its first regular dividend payment date after
such declaration. To avoid the 4% excise tax for 1999, the REIT
must distribute at least $85x during 1999 or, under the ``look
back'' rule of I.R.C. Sec. 857(b)(8), in January of 2000 if
the dividend is declared in the last quarter of 1999.
Budget Proposal. The Administration proposes that in order
to a REIT not to be assessed the 4% excise tax, its required
distribution would be increased to the sum of 98% of its
ordinary income and 98% of its capital gain net income. The
Administration believes that this provision is necessary in
order to conform the REIT excise tax to the mutual fund excise
tax rules.
NAREIT Analysis and Position. While REITs were modeled
after mutual funds, REITs have evolved separately as investment
vehicles. The Budget would ignore Congress' recognition last
year of the special capital needs of REITs and the increased
difficulties a REIT faces in accurately calculating its taxable
income during a taxable year.
Congress has mandated that REITs concentrate on owning and
operating real estate. Unlike mutual funds that have relatively
low overhead because they own the securities of other
companies, REITs must continually invest capital into its
projects for both upkeep and to prevent them from becoming
obsolete. Reinvestment needs span the gamut of ordinary upkeep
such as painting to capital expenditures (such as a installing
new roof or repaving a parking lot) to renovations needed to
meet customer demand (such as installing fiber optic lines for
telecommunications). Thus, REITs have clear reasons why they
need to retain more capital than mutual funds.
In addition, it takes considerable more time for a REIT to
compute its taxable income than does a mutual fund. A mutual
fund only needs to tabulate the dividends or capital gains from
its portfolio, and the sources of this public information are
manifold in this Age of the Internet. Conversely, a REIT must
rely on non-public sources of information for which it does not
control.
A REIT that owns shopping malls illustrates this lag time
of information. A significant source of a typical retail REIT's
annual taxable income is ``percentage rents,'' under which the
REIT landlord receives base rent throughout the year and then
additional rent if the tenant generates sales at the REIT's
property above an agreed threshold. The Christmas Holiday
Season is by far the biggest sales period for most shopping
malls, and a retail REIT cannot compute its taxable income
until its tenants have informed it of their sales and the
consequent percentage rents. Since the Code does not compel the
tenants to provide this information by any deadline, often a
retail REIT does not receive the necessary breakdown of
percentage rents until February or March. Accordingly, the REIT
can approximate by year-end how much it needs to distribute to
satisfy the current 85% requirement, but would be hard pressed
to reach the precision required by a 98% requirement, as
proposed in the Budget.
The increased distribution proposal would vitiate much of
the benefits of Congress' decision in the 1999 Act to lower the
95% distribution requirement to 90%. To avoid the 4% excise
tax, REITs very well could be compelled to distribute more than
necessary during a taxable year because they would not have the
necessary information to estimate 98% of their taxable income.
This would be the opposite of what Congress authorized by
restoring the 90% distribution requirement.\1\ Accordingly,
NAREIT strongly opposes this provision.
---------------------------------------------------------------------------
\1\ Since REITs likely would distribute extra amounts during a
taxable year so the excise tax would not be imposed, it is unclear how
this provision would raise any revenues. We note that the 90% rule was
scored in the 1999 Act as a revenue raiser, so that any proposal such
as that contained in the Budget that would deter a REIT from paying
corporate taxes on its undistributed amounts would appear to be a
revenue loser.
---------------------------------------------------------------------------
II. CLOSELY HELD REITS
Background and Current Law. As discussed above, Congress
created REITs to make real estate investments easily and
economically accessible to the small investor. To carry out
this purpose, Congress mandated two rules to ensure that REITs
are widely held. First, five or fewer individuals cannot own
more than 50% of a REIT's stock.\2\ In applying this test, most
entities owning REIT stock are ``looked through'' to determine
the ultimate ownership of the stock by individuals. Second, at
least 100 persons (including corporations and partnerships)
must be REIT shareholders. Neither test apply during a REIT's
first taxable year, and the ``five or fewer'' test only applies
in the last half of each subsequent taxable year of the REIT.
---------------------------------------------------------------------------
\2\ I.R.C. Sec. 856(h)(1). There is no apparent reason why the
proposed ownership test similarly should not be aimed at limiting more
than 50% stock ownership, rather than 50% or more as now proposed.
---------------------------------------------------------------------------
Budget Proposal. The Administration appears to be concerned
about non-REITs establishing ``captive REITs'' and REITs
engaging in transactions which the Administration finds
abusive, such as the ``liquidating REIT'' structure curtailed
by the 1998 budget legislation.\3\ The Budget proposes changing
the ``five or fewer'' test by imposing an additional
requirement. The proposed new rule would prevent any ``person''
i.e., a corporation, partnership or trust, including a pension
or profit sharing trust) from owning stock of a REIT possessing
50% or more of the total combined voting power of all classes
of voting stock or 50% or more of the total value of shares of
all classes of stock. Certain existing REIT attribution rules
would apply in determining such ownership, and the proposal
would be effective for entities electing REIT status for
taxable years beginning on or after the date of first committee
action.
---------------------------------------------------------------------------
\3\ NAREIT supported the Administration's and Congress' move to
limit the tax benefits of liquidating REITs.
---------------------------------------------------------------------------
NAREIT Analysis and Position. NAREIT agrees that the REIT
structure is meant to be widely held and that it should not be
used for abusive tax avoidance purposes. Therefore, NAREIT
supports the intent of the proposal. Nevertheless, we are
concerned that the Budget proposal casts too broad a net. A
limited number of exceptions are needed to allow certain
``entities'' to own a majority of a REIT's stock. For instance,
NAREIT certainly agrees with the Administration's decision to
exclude a REIT's ownership of another REIT's stock from the
proposed new ownership limit.\4\ NAREIT would like to work with
Congress and the Administration to ensure that any action to
curb abuses does not disallow transactions necessary to foster
the future REIT marketplace and to recognize the widely held
nature of certain non-REIT entities.
---------------------------------------------------------------------------
\4\ If the proposed test remains applicable to all persons owning
more than 50% of a REIT's stock, then Congress should apply the
exception for a REIT owning another REIT's stock by examining both
direct and indirect ownership so as not to preclude an UPREIT owning
more than 50% of another REIT's stock. NAREIT supports the rule
providing such clarification that was contained in the Taxpayer Refund
and Relief Act of 1999.
---------------------------------------------------------------------------
First, an exception should be allowed to enable a REIT's
organizers to have a single large investor for a temporary
period, such as in preparation for a public offering of the
REIT's shares. Such an ``incubator REIT'' sometimes is majority
owned by its sponsor to allow the REIT to accumulate a track
record that will facilitate its going public. The Budget
proposal is silent on this important approach which, in turn,
could curb the emergence of new publicly traded REITs in which
small investors may invest. NAREIT supports the incubator REIT
exception that was included as part of the Taxpayer Refund and
Relief Act of 1999.\5\
---------------------------------------------------------------------------
\5\ NAREIT recommends that the 10% annual growth requirement
contained in the Taxpayer Refund and Relief Act of 1999 as proposed
section 856(l)(4)(v) be replaced with a requirement that the REIT not
lease more than half of its properties to the principal owner of the
REIT's stock.
---------------------------------------------------------------------------
Second, there is no reason why a partnership, mutual fund,
pension or profit-sharing trust or other pass-through entity
should be counted as one entity in determining whether any
``person'' owns 50% of the vote or value of a REIT. A
partnership, mutual fund or other pass-through entity usually
is ignored for federal tax purposes. The partners in a
partnership and the shareholders of a mutual fund or other
pass-through entity should be considered the ``persons'' owning
a REIT for purposes of any limits on investor ownership.
Similarly, the Code already has rules preventing a ``pension
held'' REIT from being used to avoid the unrelated business
income tax rules, and therefore the new ownership test should
not apply to pension or profit-sharing plans.\6\ Instead,
NAREIT suggests that the new ownership test apply only to non-
REIT C corporations that own more than 50% of a REIT's
stock.\7\ NAREIT is encouraged by the Budget's proposal for a
``limited look-through rule'' for partnerships, and suggests
that any such rule be flexible enough to provide for the
typical allocations used by real estate partnerships, such as
preferred returns.
---------------------------------------------------------------------------
\6\ NAREIT supports the pension plan look-through rule contained
int the Taxpayer Refund and Relief Act of 1999.
7 As under the current ``five or fewer'' test, any new ownership
test should not apply to a REIT's first taxable year or the first half
of subsequent taxable years. See I.R.C. Sec. Sec. 542(a)(2) and
856(h)(2).
---------------------------------------------------------------------------
Third, none of the transactions identified by the
Administration have involved publicly traded REITs. Such REITs
must divulge information to the Securities and Exchange
Commission that is then available to all. This ``Sunshine''
exposure typically is antithetical to tax shelters, and there
is no reason to expect that such public attention should not
work in this case. In fact, there does not appear to be a
single example of a publicly-traded REIT serving as a tax
avoidance vehicle. Therefore, NAREIT recommends that any
closely held REIT legislation contain an exception for a REIT
the stock of which is regularly traded on an established
securities market, so long as no entity owns 80% or more of the
vote or value of its common stock. NAREIT would support certain
limits on this exception that would ensure that it would not be
used for tax avoidance purposes. This exception would allow one
entity to acquire a majority of the common stock of a public
traded REIT for business purposes, such as forcing a change in
strategy or certain types of takeover transactions.
III. BROWNFIELDS EXPENSING
Background. Under the Taxpayer Relief Act of 1997, certain
remediation costs are currently deductible if incurred with
respect to a ``qualified contaminated site'' (a ``Brownfields''
site). As part of the 1999 Act, this provision was extended for
one year to allow deductions for expenditures paid or incurred
on or before December 31, 2001.
Budget Proposal. The Budget would extend permanently the
ability to deduct remediation expenses for Brownfields sites.
NAREIT Position. NAREIT applauds the Administration for
proposing a permanent extension of current deductions for
Brownfields remediation expenses. In addition, NAREIT
encourages the Administration and other policymakers to
consider the tremendous potential remediation that could occur
at contaminated sites if the extension were expanded to
properties that do not currently fit within the exact
definition of a ``qualified contaminated site,'' but are
nevertheless in need of significant environmental remediation.
NAREIT supports the Brownfields expansion contained in S.1792,
the Senate version of the Taxpayer Refund and Relief Act of
1999, and urges Congress to enact such provision this year.
NAREIT thanks the Committee for the opportunity to comment
on these important proposals.
Statement of PricewaterhouseCoopers LLP
I. INTRODUCTION
PricewaterhouseCoopers appreciates the opportunity to
submit this statement to the Committee on Ways and Means for
the record of its February 9, 2000, hearing on the proposals in
the Administration's FY 2001 budget. This statement
specifically addresses the Administration's general proposals
regarding ``corporate tax shelters.''
PricewaterhouseCoopers, the world's largest professional
services organization, provides a full range of business
advisory services to corporations and other clients, including
audit, accounting, and tax consulting. The firm, which has more
than 6,500 tax professionals in the United States and Canada,
works closely with thousands of corporate clients worldwide,
including most of the companies comprising the Fortune 500.
These comments reflect the collective experiences of many of
our corporate clients.
We respectfully urge the Committee to reject the
Administration's general ``corporate tax shelter'' proposals.
We believe no justification has been presented that would
support enactment of such sweeping changes. Economic data does
not suggest any systemic erosion of the corporate income tax
base attributable to tax shelters. Current-law administrative
tools, if used properly, are more than adequate to detect and
penalize abuses. Further, the Administration's proposals are at
odds with sound tax policy principles and efficient tax
administration, would threaten legitimate tax-planning
activities undertaken by corporate tax professionals, and would
exacerbate the complexity of the tax code.
II. THE ADMINISTRATION'S ``CORPORATE TAX SHELTER'' PROPOSALS
The Administration's latest general proposals regarding
``corporate tax shelters,'' included in its FY 2001 budget,
reflect a number of modifications to the proposals originally
advanced in the Administration's FY 2000 budget. These
modifications, which were discussed in the Treasury
Department's ``White Paper'' \1\ released in July, generally
narrowed the scope of the original proposals. For example, the
Administration dropped proposals to eliminate the reasonable
cause exception to the accuracy-related penalty and to disallow
deductions for fees paid to tax shelter promoters and advisors.
---------------------------------------------------------------------------
\1\ The Problem of Corporate Tax Shelters, Department of the
Treasury, July 1999.
---------------------------------------------------------------------------
Surprisingly, Treasury estimates that its FY 2001 corporate
tax shelter proposals, even though narrower in scope, would
raise significantly more revenue than its previous proposals.
The prior proposals were estimated by Treasury to raise $1.5
billion over five years. The new proposals are estimated to
raise nearly five times as much--$7.3 over five years and $14.5
over ten years. It is difficult to understand this upward re-
estimate, especially given the significant victories (discussed
further below) won by the Internal Revenue Service (IRS) in the
courts over the past year, which have strengthened the hand of
the government in challenging aggressive tax positions taken by
corporations. These court decisions presumably would operate to
reduce the revenues that could be generated by further
legislative changes.
Before turning to specific concerns over the
Administration's proposals, we want to restate a general
observation. Like individual taxpayers, corporations have the
right to seek legitimate minimization of tax liabilities, i.e.,
to pay no more in taxes than the tax law demands.\2\ Indeed,
corporate executives have a fiduciary duty to preserve and
increase the value of a corporation for its shareholders. Some
commentators decry this responsibility, termed ``profit center
activity'' in current management parlance. We disagree.
Responsible minimization of taxes in conjunction with the
business activity of a corporation is an important function of
corporate executives and one that long has been viewed as
consistent with sound policy objectives.\3\
---------------------------------------------------------------------------
\2\ Individual taxpayers often undertake actions to obtain
favorable tax treatment, but this alone is not considered a reason
simply to disallow the benefits. For example, an individual holding an
appreciated security may decide to hold it for sale until a particular
date solely to obtain long-term capital gain treatment. Also, an
individual may take out a home-equity loan to pay off credit-card debt
because interest on the home loan can be tax deductible. As another
example, an individual renting a home may decide to purchase it,
viewing the tax benefits as a principal purpose for entering into the
transaction. In such cases, Congress has not been concerned that the
taxpayer acted out of tax motivations; the tax benefits still are
allowed.
\3\ Judge Learned Hand wrote: ``Over and over again courts have
said that there is nothing sinister in so arranging one's affairs as to
keep taxes as low as possible. Everybody does so, rich or poor; and all
do right, for nobody owes any public duty to pay more than the law
demands: taxes are enforced extractions, not voluntary contributions.''
Comm'r v. Newman, 159 F.2d 848, 850-851 (2d Cir. 1946) (dissenting
opinion).
---------------------------------------------------------------------------
The following are our specific comments on the
Administration's proposals.
A. Increase Disclosure with Respect to Certain Reportable Transactions
Summary
The proposal would require a corporation to disclose a
transaction that has ``significant tax benefits'' if it has
some combination of the following ``filters'': (1) a book/tax
difference in excess of a certain amount; (2) a rescission
clause, unwind clause, insurance, or similar arrangement; (3)
involvement with a tax-indifferent party; (4) contingent
advisor fees in excess of a certain amount; (5) the offering of
the transaction to multiple taxpayers; and (6) a difference
between the form of the transaction and how it is reported.
Disclosure would be made on a short form or statement filed
with the return; the form or statement would have to be signed
by a corporate officer who has, or should have, knowledge of
the transaction. Failure to disclose would subject the taxpayer
to a penalty of $100,000 per failure.
Comment
This proposal would create considerable uncertainties for
taxpayers seeking to determine whether disclosure is required.
Consider, for example, the proposed requirement to disclose
transactions that are reported differently from their form.
Does ``form'' refer to the label given to the transaction or
instrument, or does it refer to the rights and liabilities set
forth in the documentation? For example, if an instrument is
labeled debt, but has features in the documentation typically
associated with an equity interest, is the form debt or equity?
What if the taxpayer reasonably believed that it was reporting
the transaction in accordance with its ``form,'' but later
interpretations of ``form'' suggested that it had not so
reported the transaction? Furthermore, it is unclear how a
company would know whether the tax consequences of a
transaction constitute a ``significant tax benefit,'' a term
that is not defined by Treasury.
The disclosure requirement would be redundant in a number
of respects. First, companies already are required to account
for book/tax differences on Schedule M of the corporate income
tax return. Treasury has not indicated why a second level of
reporting of these differences is necessary. Second, the
disclosure requirements would overlap with tax shelter
reporting requirements enacted by Congress in 1997.\4\ More
than two years later, the Treasury Department has yet to take
the steps necessary to implement the new tax shelter reporting
rules.
---------------------------------------------------------------------------
\4\ Taxpayer Relief Act of 1997, P.L. 105-34.
---------------------------------------------------------------------------
The proposed disclosure requirement would add significantly
and unnecessarily to the burdens already shouldered by
corporate tax officials.\5\ Companies would be forced to report
thousands of transactions and arrangements in order to guard
against the $100,000 penalty for failure to report. Remarkably,
this penalty would be imposed on the taxpayer regardless of
whether the the taxpayer's treatment of the unreported
transaction is sustained. Examples of commonplace transactions
that presumably would have to be reported would include
purchases of equipment that qualifies for accelerated
depreciation, thus creating a book-tax difference, and
transactions with foreign companies--hardly a rarity in today's
global economy -and other ``tax-indifferent parties.'' It would
be patently unfair to assess a tax shelter penalty for
nondisclosure of legitimate transactions.
---------------------------------------------------------------------------
\5\ Of the $1.7 trillion in tax revenue collected by the federal
government in FY 1998, corporate tax officials were responsible for
remitting more than 50 percent.
---------------------------------------------------------------------------
The utility to the IRS of this flood of information is
questionable. By point of reference, the United Kingdom last
year dropped a proposal made by the Labor Party in 1997 that
would have imposed a ``general anti-avoidance rule'' to counter
perceived tax avoidance in the corporate sector. The proposal
was dropped, in part, because of concerns that arose over
Inland Revenue's ability to process reports that UK corporate
taxpayers would have been forced to file with respect to
transactions in order to have any certainty that the tax
treatment would be respected. Similar difficulties surely would
arise for the IRS if the Administration's proposals were
enacted.
B. Modify Substantial Understatement Penalty for Corporate Tax Shelters
Summary
The substantial understatement penalty imposed on corporate
tax shelter items generally would be increased to 40 percent
(reduced to 20 percent if the taxpayer discloses). The
reasonable cause exception would be retained, but narrowed with
respect to transactions deemed to constitute a corporate tax
shelter--for these transactions, taxpayers would have to have a
``strong'' probability of success on the merits and to make
disclosure.
For this purpose, a ``corporate tax shelter'' would be
defined as any entity, plan, or arrangement in which a
corporate participant attempts to obtain a tax benefit (other
than those clearly contemplated in the Tax Code) in a ``tax
avoidance transaction.'' A ``tax avoidance transaction'' would
be defined generally as any transaction in which the reasonably
expected pre-tax profit is insignificant relative to the
reasonably expected net tax benefits. A financing transaction
would be considered a tax avoidance transaction if the present
value of the tax benefits of the taxpayer to whom the financing
is provided significantly exceed the present value of the pre-
tax profit or return of the person providing the financing.
Comment
This proposal is inconsistent with the goals of
rationalizing penalty administration. If the proposal were
enacted, an IRS agent proposing a different treatment of a tax
shelter item than on the taxpayer's return would feel compelled
to impose a penalty even if the agent determines that (1) there
is substantial authority supporting the return position taken
by the taxpayer, and (2) the taxpayer reasonably believed
(based, for example, on the opinion or advice of a qualified
tax professional) that its tax treatment of the item was more
likely than not the proper treatment. It is doubtful that the
agent would decline to impose the penalty based on the
taxpayer's arguing that its position had had a ``strong
probability of success,'' an undefined term setting an
unrealistically high threshold. Indeed, one might question how
a return position that was challenged successfully could ever
be shown to have had a strong probability of success.
The near-automatic nature of the proposed increased penalty
would alter substantially the dynamics of the current process
by which the vast majority of disputes between the IRS and
corporate taxpayers are resolved administratively. Today, even
where a corporation and the IRS agree that there is a
substantial understatement of tax attributable to a tax shelter
item, the determination as to whether the substantial
understatement penalty should be waived for reasonable cause
continues to focus on the merits of the transaction and the
reasonableness of the taxpayer's beliefs regarding those
merits. If, however, the reasonable cause exception no longer
were effectively available, the parties necessarily would have
to focus on whether the transaction in question was a ``tax
avoidance transaction'' and other definitional issues unrelated
to the underlying merits of the transaction.
The proposal also runs directly counter to the goal of
maintaining transparency (i.e., the ability for a taxpayer to
determine the tax rules applicable to transactions) in our tax
system. The inclusion of so many subjective concepts in the
definition of ``tax-avoidance transaction'' precludes it from
being an objective test. As an initial matter, what constitutes
the ``transaction'' for purposes of this test? Next, what are
the parameters for ``reasonable expectation'' in terms of both
pre-tax economic profit and tax benefits? Further, where is the
line drawn regarding the significance of the reasonably
expected pre-tax economic profit relative to the reasonably
expected net tax benefits? Given these ambiguities, this
definition would threaten to sweep in legitimate transactions
undertaken in the ordinary course of business, such as
financing transactions, capital restructuring transactions, and
corporate reorganizations. It also could sweep in many start-up
ventures--how many ``dot coms'' can be said to have a
reasonable expectation of profit? It is safe to say that it is
highly unlikely that this definition would be applied uniformly
by IRS agents.
The difficulty of defining ``corporate tax shelter'' is
highlighted when one compares Treasury's FY 2000 and FY 2001
``Green Book'' descriptions of the Administration's revenue
proposals. Some proposals (e.g., a proposal to modify the
treatment of ``built-in losses'') that were characterized as
targeting ``corporate tax shelter'' transactions in Treasury's
FY 2000 Green Book no longer are characterized as such in
Treasury's FY 2001 Green Book. Conversely, some proposals
(e.g., a proposal to amend the ``80/20'' company rules) that
were not characterized as targeting ``corporate tax shelter''
transactions in the FY 2000 Green Book are now characterized as
such in the FY 2001 Green Book. This inconsistency illustrates
the inherent difficulties in the Administration's proposed
definition.
Finally, it should be noted that the proposed 40-percent
penalty rate is out of line with other penalty rates in the tax
code.
C. Codify the Economic Substance Doctrine
Summary
The proposal would disallow tax benefits from any ``tax
avoidance transaction,'' as defined in B., above.
Comment
While couched as merely codifying an existing common-law
doctrine, the proposal would have the plain effect of
encouraging IRS agents to challenge taxpayer positions that
meet the objective rules provided by Congress and set forth in
the tax code. Given the loose definition of ``tax avoidance
transaction,'' the proposal essentially would grant IRS agents
unfettered authority to disallow deductions, credits,
exclusions, or other allowances where they see fit. This power
could be invoked without regard to the legitimacy of the
taxpayer's business purposes for entering into the transaction.
If a transaction is viewed as too tax efficient, it could be
challenged on those grounds alone. As a result, audits would
become more protracted, and corporate tax officials would find
it impossible to rely on the statute in planning transactions.
The proposed disallowance rule strongly resembles a test
that was included in the new U.S.-Italy Income Tax Treaty and
the new U.S.-Slovenia Income Tax Treaty that drew strong
criticism last year from the staff of the Joint Committee on
Taxation (``JCT''). ``Main purpose'' tests in the treaties as
proposed would have denied treaty benefits (e.g., reduced
withholding rates on dividends) if the main purpose of a
taxpayer's transaction is to take advantage of treaty benefits.
The JCT staff correctly raised policy objections to this
proposed test:
The new main purpose tests in the proposed treaty present
several issues. The tests are subjective, vague and add
uncertainty to the treaty. It is unclear how the provisions are
to be applied. . . This uncertainty can create planning
difficulties for legitimate business transactions, and can
hinder a taxpayer's ability to rely on the treaty.. . . This is
a subjective standard, dependent on the intent of the taxpayer,
that is difficult to evaluate.. . . It is also unclear how the
rule would be administered.. . .In any event, it may be
difficult for a U.S. company to evaluate whether its
transaction may be subject to Italian main purpose
standards.\6\
---------------------------------------------------------------------------
\6\ ``Explanation of Proposed Income Tax Treaty and Proposed
Protocol between the United States and the Italian Republic,'' October
8, 1999 (JCS-9-99); see also, ``Testimony of the Staff of the Joint
Committee on Taxation before the Senate Committee on Foreign Relations
Hearing on Tax Treaties and Protocols with Eight Countries,'' October
27, 1999 (JCX-76-99).
---------------------------------------------------------------------------
These very same objections--``vague,'' ``subjective,''
``difficulties for legitimate business transactions''--apply
equally to Treasury's proposed definition of ``tax-avoidance
transaction.'' In light of concerns raised by the JCT staff and
the Senate Foreign Relations Committee, the Senate last year
approved the treaties subject to a ``reservation'' that has the
effect of eliminating the ``main purpose'' test.
It would be inappropriate for the Congress to hand the IRS
this authority to deny tax benefits at this time, less than two
years after Congress enacted significant new limitations \7\ on
the authority of IRS agents in audit situations. Congress also
should note that Treasury and the IRS could use the authority
that would be provided under this proposal to make changes
administratively that Congress has not seen fit to make
legislatively. For example, Treasury in its FY 1999 budget
proposals asked for expansive authority to ``set forth the
appropriate tax results'' and ``deny tax benefits'' in hybrid
transactions.\8\ Congress dismissed this proposal. The FY 2001
budget proposals now ask for authority of the same type but
significantly broader than the authorization that Congress
rejected. The Treasury's new proposals thus can be seen as an
attempted end run around earlier failed initiatives--this time
accompanied by the shibboleth of ``stopping tax shelters.''
---------------------------------------------------------------------------
\7\ Internal Revenue Service Restructuring and Reform Act of 1998,
P.L. 105-208.
\8\ General Explanation of the Administration's Revenue Proposals,
Department of the Treasury, February 1998, p. 144.
---------------------------------------------------------------------------
D. Impose a Penalty Excise Tax on Certain Fees Received from Corporate
Tax Shelters
Summary
The proposal would impose a 25-percent excise tax on fees
received in connection with promoting or rendering tax advice
related to corporate tax shelters.
Comment
The imprecise definition of a corporate tax shelter
transaction would make it difficult for professional tax
advisers to determine the circumstances under which this
provision would apply. The substantive burdens of interpreting
and complying with the statute and the administrative problems
that taxpayers and the IRS would face cannot be overstated.
Further aggravating the complexity and burdens that are
imbedded in this proposal is the fact that the ultimate
determination that a particular transaction was a corporate tax
shelter may not be made until several years after the fees are
paid. In that situation, issues arise as to when the excise tax
is due, whether the applicable statute of limitations has
expired, and whether and upon what date interest would be owed
on the liability.
More fundamentally, the creation of the proposed excise tax
subjects tax advisors to an entirely new and burdensome tax
regime, a regime that again shifts the focus away from the
substantive tax aspects of the transaction to unrelated
definitional and computational issues. It is also unclear who
would administer or enforce this new tax regime. For instance,
if the existence of a tax shelter is determined as a result of
an income tax examination of a corporation, would the revenue
agents conducting that examination have jurisdiction over a
resulting excise tax examination of the taxpayer's tax adviser?
Would the income tax and excise tax examinations be conducted
concurrently? How would conflicts of interest between the
taxpayer and the adviser be identified and handled? These are
only a few of the serious real-world issues that would have to
be resolved to administer an inherently vague and cumbersome
proposal.
Finally, the real possibility exists that the effect of the
proposal may be to deter certain taxpayers from seeking and
obtaining necessary advice and guidance from a qualified tax
professional in many transactions where the broad and vague
scope of the prohibition calls into question the ultimate
deductibility of fees. In many such cases, it is likely that
qualified tax advice would have either convinced the taxpayer
that it would be unwise or improper to enter into the
transaction, or resulted in the restructuring of the
transaction so as to bring it within full compliance with the
letter and spirit of the internal revenue laws.
E. Tax Income from Corporate Tax Shelters Involving Tax-Indifferent
Parties
Summary
Any income allocable to a ``tax-indifferent party'' (e.g.,
a foreign person; a foreign, State, or local government; a
Native American tribal organization; a tax-exempt organization)
with respect to a corporate tax shelter would be taxable to
that party. The corporate participants in the transaction would
be jointly and severally liable for the tax.
Comment
Treasury itself has conceded that this proposal ``may be
difficult to administer.'' \9\
---------------------------------------------------------------------------
\9\ The Problem of Corporate Tax Shelters, supra n.1, at 114.
---------------------------------------------------------------------------
This overreaching Treasury proposal cannot be justified on
any tax policy grounds. The proposal ignores the fact that many
businesses operating in the global economy are not U.S.
taxpayers, and that in the global economy it is increasingly
necessary and common for U.S. companies to enter into
transactions with such entities. The fact that a tax-exempt
person earns income that would be taxable if instead it had
been earned by a taxable entity surely cannot in and of itself
be viewed as objectionable.
Moreover, as it applies to foreign persons in particular,
the proposal is overbroad in two significant respects. First,
treating foreign persons as tax-indifferent ignores the fact
that in many circumstances they may be subject to significant
U.S. tax, either because they are subject to the withholding
tax rules, because they are engaged in a U.S. trade or
business, or because their income is taxable currently to their
U.S. shareholders. Second, limiting the collection of the tax
to parties other than treaty-protected foreign persons does not
hide the fact that the tax-indifferent party tax would
constitute a significant treaty override.
III. ARGUMENTS AGAINST SWEEPING CHANGES
A. The Myth of the Eroding Corporate Income Tax Base
The Treasury Department has cited as justification for its
proposals a possible erosion of corporate income tax revenues
attributable to ``corporate tax shelters,'' but has not
presented any evidence to support this concern. Rather,
Treasury has cited statements made Joseph Bankman of Stanford
University that ``corporate tax shelters'' are responsible for
$10 billion in lost corporate income tax revenues each year.
Bankman essentially admits he has no data supporting his $10
billion figure in his Internet tax policy chatroom,\10\ where
he answers a question from a reader as to the references for
his $10 billion figure as follows: ``The $10 billion figure
that I am quoted on is obviously just an estimate.'' This
unsubstantiated claim hardly represents the type of serious
economic analysis that should be undertaken before adopting
sweeping tax policy changes of the scope envisioned by
Treasury.
---------------------------------------------------------------------------
\10\ http://www.law.nyu.edu/bankmanj/federalincometax
---------------------------------------------------------------------------
An analysis of actual data shows no evidence of a loss of
corporate income tax revenues attributable to shelter
activities. Since 1992, corporate federal income tax payments
have grown by more than 80 percent, from $100.3 billion in
fiscal 1992 to $184.7 billion in fiscal 1999 (see Appendix 1).
By point of comparison, GDP has grown by 44 percent over this
period. Over the fiscal 1993-1999 period, corporate tax
payments averaged 2.1 percent of GDP; only once in the
preceding 1980-1992 period were corporate income tax payments
higher in percentage terms (in 1980).
Despite the high level of tax payments in the post-1992
period, some commentators have pointed to a two-percent drop in
federal corporate tax payments in fiscal 1999, as compared to
the prior year, as possibly indicating corporate tax shelter
activity.\11\ This claim has been made despite the fact that
corporate tax payments as a percentage of GDP in fiscal 1999
were higher than the average for the 1980-1999 period.
---------------------------------------------------------------------------
\11\ See, Martin A Sullivan, ``Despite September Surge, Corporate
Tax Receipts Fall Short,'' 85 Tax Notes 565 (Nov. 1, 1999).
---------------------------------------------------------------------------
A possible explanation for this drop is a relative decline
in corporate profits attributable to depreciation deductions
associated with increased equipment investment and the increase
in employee compensation relative to corporate profits.\12\ The
Congressional Budget Office in its January 2000 budget outlook
noted depreciation as among the factors putting downward
pressure on corporate profits.\13\ It also should be noted that
the slight falloff in corporate profits was not unforeseen--the
Office of Management and Budget (OMB) last year projected that
corporate income tax payments would fall in FY 1999, before
rising again in FY 2000.\14\ It should be further noted that
actual corporate income tax payments for FY 1999 ultimately
exceeded the OMB forecast by more than $2 billion.
---------------------------------------------------------------------------
\12\ See, New York Times, September 21, 1999, ``When an Expense is
Not an Expense.'' This article points to rising compensation paid in
the form of stock options as a possible explanation. An increase in
employee compensation increases personal income tax (at the employee
level) at the expense of corporate income tax, because employee
compensation generally is deductible in computing corporate income tax
and includable in computing personal income tax.
\13\ Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2001-2010, January 2000, p. 60.
\14\ The Administration's FY 2000 budget projected that corporate
income revenues would total $182.2 billion in FY 1999, or $2.5 billion
less than actual.
---------------------------------------------------------------------------
In this section, we examine whether the recent dip in
corporate income tax payments provides any evidence that
``corporate tax shelter'' activity is proliferating. After a
thorough review of the data, including data from the IRS, the
Bureau of Economic Analysis (BEA), and corporate financial
statements, we find no basis for assertions that increased
shelter activity has caused corporate tax burdens to fall.
1. Corporate tax liability and the timing of tax payments
Corporate tax payments received by the IRS during a given
year fail to reflect that year's tax liability for several
reasons. First, large corporate taxpayers frequently have five
to ten ``open'' years for which final tax liability has not
been determined. Thus, current corporate tax payments may
include deficiencies (plus interest and penalties) for a number
of prior tax years. Similarly, current corporate tax payments
may be reduced by refunds arising from overpayments of
corporate tax in a number of prior tax years. In addition,
current tax payments may be reduced by previously unused net
operating losses and tax credits that are carried forward from
prior years. Thus, current data on corporate income tax
payments received by the IRS are not a reliable indicator of
current year tax liability; rather, current year tax receipts
reflect a blend of current and past year tax liabilities, and
are reduced by carryforwards of unused losses and credits from
prior years.
Corporate tax payments
Monthly information on receipts of corporate income taxes
by the U.S. Government is published by the Financial Management
Service of the U.S. Treasury Department.\15\
---------------------------------------------------------------------------
\15\ U.S. Dept. of the Treasury, Monthly Treasury Statement of
Receipts and Outlays of the United States Government.
---------------------------------------------------------------------------
The Treasury defines net corporate tax receipts in any
month as gross receipts less refunds. Net corporate tax
receipts were $185.0 billion in calendar year 1998 and $185.9
billion in 1999. Gross corporate tax receipts were $213.5
billion in 1998 and $217.0 billion in 1999. Net corporate tax
receipts increased by a smaller amount than gross corporate tax
receipts due to an increase in corporate tax refunds, from
$28.5 billion in 1998 to $31.1 billion in 1999. Refunds can
increase as a result of overpayments of estimated tax (which
may occur when profits turn out to be lower than expected) or
as a result of amendments to prior year tax returns (for
example, when current year losses or credits are carried back
to a prior tax year). Until the IRS tabulates tax return data
for 1998 and 1999, it is not possible to determine the reason
for the recent increase in refunds.
Corporate tax liability
For purposes of the National Income and Product Accounts,
BEA makes current estimates of corporate tax liability based on
IRS and other data. The IRS calculates annual corporate income
tax liability by tabulating corporate tax returns (before
audit). The most recent publicly available corporate income tax
return information is for IRS years 1996 (i.e., tax years
ending after June 1996 and before July 1997).\16\
---------------------------------------------------------------------------
\16\ See, IRS, Statistics of Income Bulletin, Winter 1998/1999.
---------------------------------------------------------------------------
In summary, it is important to distinguish between
corporate tax liability and corporate tax receipts. Because
corporate tax receipts are a mix of estimated tax payments for
the current year as well as adjustments (both up and down) to
taxes paid with respect to prior years, a drop in corporate tax
receipts does not imply a drop in corporate tax liability. For
example, in 1985, corporate tax receipts increased over the
prior year at the same time that corporate tax liability
decreased (see Appendix 2).
2. Effective tax rates: Commerce Department data
Corporate tax liability can be broken down into two
components: (1) a reference measure of profits arising in the
corporate sector; multiplied by (2) the effective tax rate
(which is equal to corporate tax divided by reference profits).
A decline in corporate tax liability can occur as a result of
lower profits or, alternatively, as a result of a lower
effective tax rate. A decline in corporate tax liability due to
a fall in real corporate income is not, of course, evidence of
tax shelter activity. By contrast, a decline in the effective
tax rate may warrant investigation to determine if there is tax
avoidance not intended by lawmakers.
Calculation of the effective corporate tax rate requires a
measure of corporate income tax liability as well as a
reference measure of corporate profits. Two data sources are
used in this analysis: (1) the National Income and Product
Accounts (NIPA) published by the U.S. Commerce Department; and
(2) data from audited financial statements of public companies
filed with the Securities and Exchange Commission (SEC) on Form
10K. Effective tax rate calculations based on NIPA data are
described in this section; calculations based on SEC data are
described in the following section.
One of the items used by BEA to calculate GDP is
``corporate profits before tax.'' \17\ This concept of profits
includes income earned in the United States (whether by U.S. or
foreign corporations) and excludes income earned outside the
United States. For purposes of calculating an effective tax
rate, several adjustments are made to ``corporate profits
before tax'': (1) profits of the Federal Reserve Banks are
subtracted; (2) profits of subchapter S corporations are
subtracted; (3) payments of State and local income tax are
subtracted; and (4) corporate capital gains are added. These
adjustments follow the methodology developed by CBO to estimate
``taxable corporate profits.'' \18\ BEA estimates that
corporate profits before tax, as adjusted, increased from $587
billion in calendar 1998 to $603 billion in 1999 (see Appendix
3).\19\ As a percent of GDP, pre-tax corporate profits are
estimated to have reached a post-1980 high of 7.0 percent in
1996, with a dip to 6.9 percent in 1997-1998, and a further dip
to 6.8 percent in the first half of calendar 1999 on an
annualized basis.
---------------------------------------------------------------------------
\17\ BEA makes two adjustments to this measure of corporate profits
in determining GDP: (1) BEA uses an ``economic'' measure of
depreciation rather than tax depreciation (i.e., the ``capital
consumption adjustment''); and (2) BEA removes inventory profits
attributable to changes in price (i.e., the ``inventory valuation
adjustment''). Note that the BEA data uses in this report are based on
information available as of October 1999 and do not reflect the
subsequently released comprehensive revision of the National Income and
Product Accounts (NIPA).
\18\ See, Congressional Budget Office, The Shortfall in Corporate
Tax Receipts Since the Tax Reform Act of 1986, CBO Papers, May 1992.
The first adjustment reflects the fact that the Federal Reserve system
is not subject to corporate income tax; the second adjustment is made
because S corporations generally do not pay corporate level tax (rather
the income is flowed through to the shareholders); the third adjustment
is made because state and local income taxes are deductible in
computing federal income tax; and the fourth adjustment is necessary
because corporations are taxed on capital gains while GDP excludes
capital gains.
\19\ 1999 data are annualized based on the first six months of the
year, seasonally adjusted.
---------------------------------------------------------------------------
Based on adjusted NIPA data, the effective corporate tax
rate, measured as federal corporate tax liability divided by
corporate profits before federal income tax, is projected to be
32.7 percent in 1999, higher than the 31.2 percent rate in 1998
and higher than the 32.6 percent average for the 1993-1999
period (see Appendix 3). Thus, based on the National Income and
Product Accounts, there is no evidence of a decline in the
effective rate of corporate income tax.
3. Effective tax rates: SEC data
Corporate effective tax rates also can be estimated from
the audited financial statements that publicly traded companies
are required to file with the SEC. This method was used by the
General Accounting Office in its 1992 study of corporate
effective tax rates.\20\ Following the GAO methodology, the
effective corporate tax rate is measured by dividing the
current provision for federal income tax into reported U.S.
operating income, reduced by the current provision for State
and local income tax. U.S. operating income is determined by
subtracting foreign operating income from total operating
income net of depreciation, based on geographic segment
reporting.
---------------------------------------------------------------------------
\20\ See, General Accounting Office, ``1988 and 1989 Company
Effective Tax Rates Higher Than in Prior Years,'' GAO/GGD-92-11, August
1992.
---------------------------------------------------------------------------
Standard & Poors publishes SEC 10K data in its Compustat
database, which is updated monthly.\21\ Based on the August
1999 Compustat data release, effective corporate tax rates were
calculated for the 1988-1998 period using information from
every corporation in the database that supplied all of the
necessary data items. Recognizing that the results for 1998
might not be comparable to prior years due to the limited
sample size, the effective tax rates for 1996 and 1997 were
recomputed using information from the same companies as in the
1998 sample.
---------------------------------------------------------------------------
\21\ Financial statements for companies with fiscal years ending
after May of 1998, and before June of 1999, are classified as 1998
statements in Compustat. Because there is a lag between the end of a
company's fiscal year and the time it files Form 10K, and another lag
between the time the form is filed and the time it is processed by
Standard & Poors, information for Compustat's 1998 year was incomplete
as of August 1999.
---------------------------------------------------------------------------
For purposes of this analysis we excluded publicly traded
corporations and partnerships that are not generally taxable at
the corporate level (i.e., mutual funds and real estate
investment trusts). Separate calculations were made for
companies that reported foreign activity (multinationals) and
for companies that reported no foreign activity (domestics). A
multinational's current provision for U.S. tax may include U.S.
tax on foreign source income; consequently, measured relative
to domestic income, the effective tax rate of U.S.
multinationals may be higher than for comparable domestic
firms. In theory, U.S. tax on foreign source income should be
removed from the numerator of a domestic effective tax rate
calculation; however, this adjustment cannot accurately be made
with financial statement data.
The results of this analysis are shown in Appendix 4. For
1997, the most recent year for which annual reporting is
complete, companies included in the Compustat sample report $78
billion of current federal income tax liability, accounting for
over 40 percent of federal corporate tax liability in the
National Income and Product Accounts. The Compustat sample of
firms excludes private companies and public companies that do
not report all of the items necessary to calculate the
effective tax rate. While the average firm in Compustat is much
larger than the average corporate taxpayer, the main purpose of
our analysis is to examine the trend in effective corporate tax
rates over time. We have no reason to believe that there is a
systematic difference in trend effective tax rates between
companies in Compustat and other corporate taxpayers. Indeed,
if there were a proliferation of corporate tax shelter
activity, we might expect to see indications of this first
among the largest and most sophisticated corporations, of the
type included in the Compustat sample.
In general, we find that the effective tax rates calculated
from financial statement data are lower than those calculated
from the National Income and Product Accounts. One reason for
this is that the profit definition used for the NIPA
calculations is based on tax depreciation, while the profit
definition used for the financial statement calculations is
based on book depreciation. Another reason is that the income
element of nonqualified stock options is deductible for tax
purposes when the option is excercised (and included in the
employee's income), but is not treated as an expense against
income for financial statement purposes. We also find that, on
average, over the 1988-1998 period, effective federal tax rates
are higher for multinational corporation than for domestic
corporations.
Based on financial statement data, the corporate effective
tax rate for all corporations (domestic and multinational) was
higher in 1997 (19.9 percent) than the average over the ten-
year period 1988-1997 (18.5) percent, and for the sample of
companies reporting financial results for 1998, the effective
tax rate increased between 1997 (19.4 percent) and 1998 (20.7
percent).\22\
---------------------------------------------------------------------------
\22\ These results also generally hold up when effective tax rates
are measured relative to U.S. assets or U.S. revenues. Among domestic-
only firms, however, income has grown more slowly than either assets or
revenues since 1995, with the result that the ratio of tax liability to
either assets or revenues has declined slightly for companies without
foreign operations.
---------------------------------------------------------------------------
In summary, based on audited financial statements, there is
no evidence for a decline in the effective corporate tax rate.
This is consistent with our findings using National Income and
Product Account data.
4. Corporate capital gains
One category of corporate ``tax shelter'' that has received
recent attention is the use of transactions designed to avoid
tax on capital gains. Indeed, one commentator believes these
transactions are so prevalent that the tax on corporate capital
gains has essentially been rendered ``elective.'' \23\ If this
assessment of the corporate income tax system were accurate, we
would expect to see a marked decline in corporate capital gain
realizations in recent years.
---------------------------------------------------------------------------
\23\ Michael Schler, as quoted in the September 1, 1999, Wall
Street Journal ``Tax Report,'' A1.
---------------------------------------------------------------------------
The IRS data, however, do not support the view that
corporations easily can avoid tax on capital gains. Excluding
mutual funds, net corporate gain on capital assets increased by
54 percent from $53 billion in 1992 to $82 billion in 1996 (the
most recent year for which IRS data is available)--an average
annual increase of 11.5 percent per year (see Appendix 5). In
short, notices of the death of the corporate capital gains tax
are premature.
5. Conclusion
If unusually high levels of corporate tax shelter activity
have been occurring over the last few years, we would expect to
see a drop in corporate tax liability relative to normative
measures of pre-tax corporate income. To test this hypothesis,
we measure corporate effective tax rates using data from the
National Income and Product Accounts and audited financial
statements. Neither measure shows a suspicious drop in tax
liabilities relative to corporate income; to the contrary, both
measures show flat or rising corporate effective tax rates over
the last five years. Moreover, if corporate capital gains tax
was easily avoidable using tax shelter techniques, we would
expect to see little or no growth in net capital gains reported
on corporate tax returns. Again, the data disprove this
hypothesis, showing instead a robust rate of increase over the
most recent four-year period for which data are available.
B. Efficacy of Current-Law Tools
Proponents of extensive new legislation to address
``corporate tax shelters'' overlook the formidable array of
tools currently available to the government to deter and attack
transactions considered as abusive. In our view, the tools
described below are more than sufficient to achieve compliance
with the corporate income tax. That is, these tools enable the
IRS and courts to ensure that corporations pay the corporate
income tax liability that results from application of the
Internal Revenue Code.
1. Threat of penalties
As an initial matter, the tax Code includes significant
disincentives to engage in potentially abusive behavior.
Present law imposes 20-percent accuracy-related penalties under
section 6662 in the case of negligence, substantial
understatements of tax liability, and certain other cases. In
considering a proposed transaction that may turn on a debatable
reading of the tax law, a corporate tax executive must weigh
the potential for imposition of these penalties, which could
have a negative impact on shareholder value and on the
corporation.
Furthermore, it should be noted that Congress, in the 1997
Taxpayer Relief Act, strengthened the substantial
understatement penalty as it applies to ``tax shelters.'' Under
this change, which was supported and encouraged by the Treasury
Department, an entity, plan, or arrangement is treated as a tax
shelter if it has tax avoidance or evasion as just one of its
significant purposes.\24\ The Congress believed that this
change, coupled with new reporting requirements that Treasury
has failed to activate, would ``improve compliance by
discouraging taxpayers from entering into questionable
transactions.'' \25\ Although this change is effective for
current transactions, the IRS and Treasury have not yet issued
regulations providing guidance on the term ``significant
purpose.''
---------------------------------------------------------------------------
\24\ Section 6662(d)(2)(C)(iii). Prior law defined tax shelter
activity as an entity, plan, or arrangement only if it had tax
avoidance or evasion as the principal purpose.
\25\ General Explanation of Tax Legislation Enacted in 1997, Staff
of the Joint Committee on Taxation, December 17, 1997 (JCS 23-97).
---------------------------------------------------------------------------
The 1997 Act changes have made it even more important for
chief tax executives to weigh carefully the risks of penalties
and even more difficult to determine which transactions might
trigger penalties. At this time, there is no demonstrated
justification for making these penalties even harsher.
2. Anti-abuse rules
The Code includes numerous provisions that arm Treasury and
the IRS with broad authority to prevent tax avoidance, to
reallocate income and deductions, to deny tax benefits, and to
ensure taxpayers clearly report income.
These rules long have provided powerful ammunition for
challenging tax avoidance transactions. For example, section
482 authorizes the IRS to reallocate income, deductions,
credits, or allowances between controlled taxpayers to prevent
evasion of taxes or to clearly reflect income. While much
attention has been focused in recent years on the application
of section 482 in the international context, section 482 also
applies broadly in purely domestic situations. Further, the IRS
also has the authority to disregard a taxpayer's method of
accounting if it does not clearly reflect income under section
446(b).
In the partnership context, the IRS has issued regulations
under subchapter K aimed at arrangements the IRS considers as
abusive.\26\ The IRS states that these rules authorize it to
disregard the existence of a partnership, to adjust a
partnership's methods of accounting, to reallocate items of
income, gain, loss, deduction, or credit, or otherwise to
adjust a partnership's or partner's tax treatment in situations
where a transaction meets the literal requirements of a
statutory or regulatory provision, but where the IRS believes
the results are inconsistent with the intent of the Code's
partnership tax rules.
---------------------------------------------------------------------------
\26\ Treas. Reg. Sec. 1.701-2.
---------------------------------------------------------------------------
The IRS also has issued a series of far-reaching anti-abuse
rules under its legislative grant of regulatory authority in
the consolidated return area. For example, under Treas. Reg.
Sec. 1.1502-20, a parent corporation is severely limited in its
ability to deduct any loss on the sale of a consolidated
subsidiary's stock. The consolidated return investment basis
adjustment rules also contain an anti-avoidance rule.\27\ The
rule provides that the IRS may make adjustments ``as
necessary'' if a person acts with ``a principal purpose'' of
avoiding the requirements of the consolidated return rules. The
consolidated return rules feature several other anti-abuse
rules as well.\28\
---------------------------------------------------------------------------
\27\ Treas. Reg. Sec. 1.1502-32(e).
\28\ See, e.g., Treas. Reg. Sec. 1.1502-13(h) (anti-avoidance
rules with respect to the intercompany transaction provisions) and
Treas. Reg. Sec. 1.1502-17(c) (anti-avoidance rules with respect to
the consolidated return accounting methods).
---------------------------------------------------------------------------
3. Common-law doctrines
Pursuant to several ``common-law'' tax doctrines, Treasury
and the IRS can challenge a taxpayer's treatment of a
transaction if they believe the treatment is inconsistent with
statutory rules and the underlying Congressional intent. For
example, these doctrines may be invoked where the IRS believes
that (1) the taxpayer has sought to circumvent statutory
requirements by casting the transaction in a form designed to
disguise its substance, (2) the taxpayer has divided the
transaction into separate steps that have little or no
independent life or rationale, (3) the taxpayer has engaged in
``trafficking'' in tax attributes, or (4) the taxpayer
improperly has accelerated deductions or deferred income
recognition.
These broadly applicable doctrines--known as the business
purpose doctrine, the substance over form doctrine, the step
transaction doctrine, and the sham transaction and economic
substance doctrine--give the IRS considerable leeway to recast
transactions based on economic substance, to treat apparently
separate steps as one transaction, and to disregard
transactions that lack business purpose or economic substance.
Recent applications of those doctrines have demonstrated their
effectiveness and cast doubt on Treasury's asserted need for
additional tools.
The recent decisions in ACM v. Commissioner \29\ and ASA
Investerings v. Commissioner \30\ illustrate the continuing
force of these long-standing judicial doctrines. In ACM, the
Third Circuit, affirming the Tax Court, relied on the sham
transaction and economic substance doctrines to disallow losses
generated by a partnership's purchase and resale of notes. The
Tax Court similarly invoked those doctrines in ASA Investerings
to disallow losses on the purchase and resale of private
placement notes. Both cases involved complex, highly
sophisticated transactions, yet the IRS successfully used
common-law principles to prevent the taxpayers from realizing
tax benefits from the transactions.
---------------------------------------------------------------------------
\29\ 157 F.3d 231 (3d Cir. 1998). See also Saba Partnership, T.C.M.
1999-359 (10/27/99).
\30\ T.C.M. 1998-305.
---------------------------------------------------------------------------
More recent examples of use of common-law doctrines by the
IRS are the Tax Court's decisions in United Parcel Service v.
Commissioner \31\ (8/9/99), Compaq Computer Corp. v.
Commissioner \32\ (9/21/99), and Winn-Dixie v. Commissioner
\33\ (10/19/99). In United Parcel Service, the court agreed
with the IRS's position that the arrangement at issue--
involving the taxpayer, a third-party U.S. insurance company
acting as an intermediary, and an offshore company acting as a
reinsurer--lacked business purpose and economic substance. In
Compaq, the court agreed with the IRS's contention that the
taxpayer's purchase and resale of certain financial instruments
lacked economic substance and imposed accuracy-related
penalties under section 6662(a). In Winn-Dixie, the court held
that an employer's leveraged corporate-owned life insurance
program lacked business purpose and economic substance.
---------------------------------------------------------------------------
\31\ T.C.M. 1999-268.
\32\ 113. T.C. No. 17.
\33\ 113. T.C. No. 21.
---------------------------------------------------------------------------
This recent line of cases and the IRS's increasingly
successful use of common-law doctrines in these cases argue
against any need for expanding the IRS's tools at this time or
(as the Treasury Department has suggested) for codifying the
doctrines.
4. Treasury action
Treasury on numerous occasions has issued IRS Notices
stating an intention to publish regulations that would preclude
favorable tax treatment for certain transactions. Thus, a
Notice allows the government (assuming that the particular
action is within Treasury's rulemaking authority) to move
quickly, without having to await development of the regulations
themselves--often a time-consuming process--that provide more
detailed rules concerning a particular transaction.
Examples of the use of this authority include Notice 97-21,
in which the IRS addressed multiple-party financing
transactions that used a special type of preferred stock;
Notice 95-53, in which the IRS addressed the tax consequences
of ``lease strip'' or ``stripping transactions'' separating
income from deductions; and Notices 94-46 and 94-93, addressing
so-called ``corporate inversion'' transactions viewed as
avoiding the 1986 Act's repeal of the General Utilities
doctrine.\34\
---------------------------------------------------------------------------
\34\ The General Utilities doctrine generally provided for
nonrecognition of gain or loss on a corporation's distribution of
property to its shareholders with respect to their stock. See, General
Utils. & Operating Co. v. Helvering, 296 U.S. 200 (1935). The General
Utilities doctrine was repealed in 1986 out of concern that the
doctrine tended to undermine the application of the corporate-level
income tax. H.R. Rep. No. 426, 99th Cong., 1st Sess. 282 (1985).
---------------------------------------------------------------------------
Moreover, section 7805(b) of the Code expressly gives the
IRS authority to issue regulations that have retroactive effect
``to prevent abuse.'' Although many Notices have set the date
of Notice issuance as the effective date for forthcoming
regulations,\35\ Treasury has used its authority to announce
regulations that would be effective for periods prior to the
date the Notice was issued.\36\ Alternatively, Treasury in
Notices has announced that it will rely on existing law to
challenge abusive transactions that already have occurred.\37\
---------------------------------------------------------------------------
\35\ See, e.g., Notice 95-53, 1995-2 CB 334, and Notice 89-37,
1989-1 CB 679.
\36\ See, e.g., Notice 97-21, 1997-1 CB 407.
\37\ Notice 96-39, I.R.B. 1996-32.
---------------------------------------------------------------------------
5. Targeted legislation
To the extent that Treasury and the IRS may lack rulemaking
or administrative authority to challenge a particular type of
transaction, one other highly effective avenue remains open--
that is, enactment of legislation. In this regard, over the
past 30 years dozens upon dozens of changes to the tax code
have been enacted to address perceived abuses. For example,
Congress last year enacted legislation (H.R. 435) addressing
``basis-shifting'' transactions involving transfers of assets
subject to liabilities under section 357(c).
These targeted legislative changes often have immediate, or
even retroactive, application. The section 357(c) provision,
for example, was made effective for transfers on or after
October 19, 1998--the date House Ways and Means Committee
Chairman Bill Archer introduced the proposal in the form of
legislation. Chairman Archer took this action, in part, to stop
these transactions earlier than would have been accomplished
under the effective date originally proposed by Treasury (the
date of enactment).
C. IRS National Office Activities Regarding ``Corporate Tax Shelters''
The question whether broad legislative action regarding
``corporate tax shelters'' is warranted at this time should be
considered in view of current administrative initiatives now
being undertaken at the IRS. Larry Langdon, Commissioner of the
IRS's new Large and Mid-Size Business Division, has announced
that the IRS is establishing a special office to coordinate IRS
efforts to address corporate tax shelter issues.\38\ The new
office will allow for quick communication between IRS
examiners, the IRS Chief Counsel, and the Treasury Department
in identifying and addressing abuses. These IRS efforts will
serve as a strong deterrent to abusive transactions and further
call into question the need for legislative action at this
time.
---------------------------------------------------------------------------
\38\ GNA Daily Tax Report, January 18, 2000, G-4.
---------------------------------------------------------------------------
IV. CONCLUSION
Congress should reject the broad legislative proposals
regarding ``corporate tax shelters'' that have been advanced by
the Treasury Department. The revenue and economic data indicate
no need for these radical changes. Further, the proposals are
completely unnecessary in light of the array of legislative,
regulatory, administrative, and judicial tools available to
curtail perceived abuses. Finally, these proposals would create
an unacceptably high level of uncertainty and burdens for
corporate tax officials while potentially imposing penalties on
legitimate transactions undertaken in the ordinary course of
business.
Appendix 1
Corporate Income Tax Receipts, FY 1980-1999
[Billions of current dollars]
----------------------------------------------------------------------------------------------------------------
Federal
corporate Corporate tax
Fiscal year GDP (dollars) income tax receipts as a
receipts percent of GDP
(dollars) (percent)
----------------------------------------------------------------------------------------------------------------
1980............................................................ 2,719 64.6 2.4
1981............................................................ 3,048 61.1 2.0
1982............................................................ 3,214 49.2 1.5
1983............................................................ 3,423 37.0 1.1
1984............................................................ 3,819 56.9 1.5
1985............................................................ 4,109 61.3 1.5
1986............................................................ 4,368 63.1 1.4
1987............................................................ 4,609 83.9 1.8
1988............................................................ 4,957 94.5 1.9
1989............................................................ 5,356 103.3 1.9
1990............................................................ 5,683 93.5 1.6
1991............................................................ 5,862 98.1 1.7
1992............................................................ 6,149 100.3 1.6
1993............................................................ 6,478 117.5 1.8
1994............................................................ 6,849 140.4 2.1
1995............................................................ 7,194 157.0 2.2
1996............................................................ 7,533 171.8 2.3
1997............................................................ 7,972 182.3 2.3
1998............................................................ 8,404 188.7 2.2
1999............................................................ 8,851 184.7 2.1
Period averages:
1980-99....................................................... 5,529.9 105.5 1.9
1980-82....................................................... 2,993.7 58.3 1.9
1983-85....................................................... 3,783.7 51.7 1.4
1986-89....................................................... 4,822.5 86.2 1.8
1990-92....................................................... 5,898.0 97.3 1.6
1993-99....................................................... 7,611.6 163.2 2.1
----------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office, Historical Budget Data, The Economic and Budget Outlook: Fiscal Years
2000-2009, released January 1999.
Congressional Budget Office, The Economic and Budget Outlook: An Update, July 1999. U.S. Treasury Department,
Monthly Treasury Statement, October 1999 and earlier issues.
US Treasury Department, Monthly Treasury Statement, October 1999 and earlier issues.
Appendix 2
Federal Corporate Tax Liability and Receipts, 1980-1999
[Billions of dollars]
----------------------------------------------------------------------------------------------------------------
Federal corp. Federal corp. income tax receipts
Calendar year tax liability -----------------------------------------------
\1\ Gross Refunds Net
----------------------------------------------------------------------------------------------------------------
1980............................................ 58.6 72.0 8.6 63.4
1981............................................ 51.7 75.1 13.4 61.7
1982............................................ 33.9 63.5 19.5 44.0
1983............................................ 47.1 64.6 22.7 41.9
1984............................................ 59.1 75.5 16.9 58.6
1985............................................ 58.5 78.7 16.1 62.6
1986............................................ 66.0 84.1 17.8 66.3
1987............................................ 85.5 105.2 18.0 87.2
1988............................................ 93.6 114.4 16.0 98.5
1989............................................ 95.5 113.9 14.1 99.8
1990............................................ 94.4 112.9 15.9 96.9
1991............................................ 89.0 112.9 16.6 96.4
1992............................................ 101.8 119.7 16.6 103.1
1993............................................ 122.3 137.3 13.7 123.6
1994............................................ 136.2 158.9 14.7 144.2
1995............................................ 155.9 180.4 17.9 162.5
1996............................................ 172.9 191.8 19.8 172.1
1997............................................ 189.5 211.1 19.8 191.3
1998............................................ 183.2 213.5 28.5 185.0
1999............................................ 197.0 \2\ 217.0 31.1 185.9
----------------------------------------------------------------------------------------------------------------
\1\ Determined from the National Income and Product Accounts as profits before tax (domestic basis) minus
profits of the Federal Reserve Banks minus state and local income taxes. See text for details.
\2\ Federal corp. tax liability is seasonally adjusted at an annual rate based on first six months of the year.
Sources:
1. U.S. Commerce Department, Bureau of Economic Analysis, Survey of Current, October 1999. Note that the data do
not reflect changes in the most recent comprehensive revision of the National Income and Product Accounts
(NIPA), which came out after our study was completed.
U.S. Treasury Department, Monthly Treasury Summary, January 2000 and earlier issues.
PwC calculations.
Appendix 3
Effective Corporate Tax Rate, NIPA, 1980-1999
[Billions of dollars]
----------------------------------------------------------------------------------------------------------------
Federal
corp. tax Corp.
Corp. liability profits
profits Federal (BEA adj.) before tax
GDP before tax corp. tax as a (BEA adj.)
Calendar year (dollars) (BEA liability percent of as a
adj.\1\ (BEA adj.) corp. percent of
(dollars) (dollars) profits GDP
before tax (percent)
(percent)
----------------------------------------------------------------------------------------------------------------
1980........................................... 2,784.2 200.8 58.6 29.2 7.2
1981........................................... 3,115.9 193.6 51.7 26.7 6.2
1982........................................... 3,242.1 142.9 33.9 23.7 4.4
1983........................................... 3,514.5 181.1 47.1 26.0 5.2
1984........................................... 3,902.4 212.3 59.1 27.8 5.4
1985........................................... 4,180.7 215.4 58.5 27.2 5.2
1986........................................... 4,422.2 238.0 66.0 27.7 5.4
1987........................................... 4,692.3 255.9 85.5 33.4 5.5
1988........................................... 5,049.6 305.2 93.6 30.7 6.0
1989........................................... 5,438.7 290.0 95.5 32.9 5.3
1990........................................... 5,743.8 281.1 94.4 33.6 4.9
1991........................................... 5,916.7 287.3 89.0 31.0 4.9
1992........................................... 6,244.4 317.8 101.8 32.0 5.1
1993........................................... 6,558.1 369.5 122.3 33.1 5.6
1994........................................... 6,947.0 399.5 136.2 34.1 5.8
1995........................................... 7,269.6 499.9 155.9 31.2 6.9
1996........................................... 7,661.6 537.6 172.9 32.2 7.0
1997........................................... 8,110.9 559.7 189.5 33.9 6.9
1998........................................... 8,511.0 587.3 183.2 31.2 6.9
1999 \2\....................................... 8,873.4 603.4 197.5 32.7 6.8
Period averages:
1980-99...................................... 5,609.0 333.9 104.6 31.3 6.0
1980-82...................................... 3,047.4 179.1 48.1 26.8 5.9
1983-85...................................... 3,865.9 203.0 54.9 27.1 5.2
1986-86...................................... 4,900.7 272.3 85.1 31.3 5.6
1990-92...................................... 5,968.3 295.4 95.1 32.2 4.9
1993-99...................................... 7,704.5 508.1 165.4 32.5 6.6
----------------------------------------------------------------------------------------------------------------
\1\ Figures for 1997-1999 are based on CBO fiscal year projections. Because actual corporate capital gains data
were not available for 1980-82, imputations were used.
\2\ Figures for 1999 are annualized based on first six months, seasonally adjusted.
Sources:
1. U.S. Commerce Department, Bureau of Economic Analysis, Survey of Current Business, October 1999. Note that
the data are based on information available as of October 1999 and do not reflect the subsequently released
comprehensive revision of the National Income and Product Accounts (NIPA).
2 U.S. Treasury Department, Monthly Treasury Summary, October 1999.
3. PwC Calculations
Appendix 4
U.S. Corporate Income Tax Liability per Audited Financial Statements, 1988-1998
[Dollar amounts in billions; Tax years ending after May of indicated year, and before July of following year]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Avg '88-
Item 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 96Aug 97Aug 98Aug 97
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
A. Companies with foreign operations
U.S. fed. inc. tax liability \1\...... $25 $24 $25 $23 $23 $27 $34 $41 $42 $48 $19 $22 $24 $31
U.S. oper. inc. after state inc. tax.. $127 $144 $138 $123 $128 $149 $181 $222 $231 $234 $89 $103 $105 $168
U.S. assets........................... $1,408 $1,587 $1,753 $1,904 $1,996 $1,988 $2,310 $2,433 $2,595 $2,494 $905 $1,050 $1,071 $2,047
U.S. revenues......................... $1,063 $1,212 $1,313 $1,371 $1,423 $1,373 $1,529 $1,745 $1,794 $1,770 $736 $817 $841 $1,459
U.S. fed. inc. tax liability as % of:
U.S. oper. inc. after state inc. tax 19.9% 16.6% 18.2% 19.1% 18.3% 18.2% 19.0% 18.3% 18.4% 20.7% 21.7% 21.4% 22.6% 18.7%
U.S. assets......................... 1.8% 1.5% 1.4% 1.2% 1.2% 1.4% 1.5% 1.7% 1.6% 1.9% 2.1% 2.1% 2.2% 1.5%
U.S. revenues....................... 2.4% 2.0% 1.9% 1.7% 1.6% 2.0% 2.2% 2.3% 2.4% 2.7% 2.6% 2.7% 2.8% 2.2%
Number of corps....................... 700 746 806 886 963 820 934 1,057 1,159 1,178 633 633 633 925
B. Companies without foreign operations
U.S. fed. inc. tax liability \1\...... $17 $19 $20 $23 $24 $22 $25 $27 $29 $29 $24 $26 $29 $24
U.S. oper. inc. after state inc. tax.. $106 $116 $118 $123 $136 $115 $130 $149 $157 $157 $131 $144 $150 $131
U.S. assets........................... $1,332 $1,488 $1,570 $1,658 $1,825 $1,627 $2,061 $2,295 $2,526 $2,676 $2,124 $2,493 $2,907 $1,906
U.S. revenues......................... $913 $1,016 $1,117 $1,182 $1,286 $1,079 $1,252 $1,398 $1,509 $1,564 $1,214 $1,403 $1,593 $1,232
U.S. fed. inc. tax liability as % of:
U.S. oper. inc. after state inc. tax.. 15.7% 16.3% 17.3% 18.4% 18.0% 19.2% 19.6% 18.2% 18.7% 18.6% 18.1% 18.0% 19.4% 18.1%
U.S. assets......................... 1.2% 1.3% 1.3% 1.4% 1.3% 1.4% 1.2% 1.2% 1.2% 1.1% 1.1% 1.0% 1.0% 1.2%
U.S. revenues....................... 1.8% 1.9% 1.8% 1.9% 1.9% 2.1% 2.0% 1.9% 1.9% 1.9% 2.0% 1.9% 1.8% 1.9%
Number of corps....................... 3,681% 3,573% 3,646% 3,731% 3,945% 3,696% 3,847% 4,209% 4,249% 4,052% 3,357% 3,357% 3,357% 3,863
C. Companies with and without foreign operations
U.S. fed. inc. tax liability \1\...... $42 $43 $45 $46 $48 $49 $60 $68 $72 $78 $43 $48 $53 $55
U.S. oper. inc. after state inc. tax.. $233 $261 $256 $246 $264 $264 $310 $372 $387 $391 $220 $247 $256 $298
U.S. assets........................... $2,740 $3,075 $3,323 $3,562 $3,821 $3,615 $4,371 $4,727 $5,120 $5,171 $3,030 $3,543 $3,978 $3,952
U.S. revenues......................... $1,976 $2,228 $2,430 $2,553 $2,709 $2,452 $2,781 $3,143 $3,302 $3,333 $1,950 $2,220 $2,434 $2,691
U.S. fed. inc. tax liability as % of:
U.S. oper. inc. after state inc. tax 18.0 16.5% 17.8% 18.8% 18.2% 18.7% 19.2% 18.3% 18.5% 19.9% 19.6% 19.4% 20.7% 18.5%
U.S. assets......................... 1.5% 1.4% 1.4% 1.3% 1.3% 1.4% 1.4% 1.4% 1.4% 1.5% 1.4% 1.4% 1.3% 1.4%
U.S. revenues....................... 2.1% 1.9% 1.9% 1.8% 1.8% 2.0% 2.1% 2.2% 2.2% 2.3% 2.2% 2.2% 2.2% 2.0%
Number of corps....................... 4,381 4,319 4,452 4,617 4,908 4,516 4,781 5,266 5,408 5,230 3,990 3,990 3,990 4,788
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1. Current provision for tax.
Source: Standard and Poors, Compustat, September 1999; PwC calculations.
Appendix 5
Net Capital Gains for All Active Corporations, 1980-1996
[Excluding RICs in Billions of dollars]
----------------------------------------------------------------------------------------------------------------
Net gain on capital assets
-----------------------------------------------
Net long-term
Year Net short-term gain less net
gain less net short-term Subtotal
long-term loss loss
----------------------------------------------------------------------------------------------------------------
1980............................................................ 11.4 22.1 23.5
1981............................................................ 1.7 25.6 27.3
1982............................................................ 1.9 24.1 26.0
1983............................................................ 2.7 28.4 31.1
1984............................................................ 2.4 35.1 37.6
1985............................................................ 4.3 45.9 50.2
1986............................................................ 8.2 74.2 82.4
1987............................................................ 4.4 54.5 58.9
1988............................................................ 4.0 56.7 60.7
1989............................................................ 6.0 62.5 68.5
1990............................................................ 2.9 43.4 46.3
1991............................................................ 7.1 41.1 48.2
1992............................................................ 7.9 45.1 53.0
1993............................................................ 10.8 53.3 64.1
1994............................................................ 2.4 47.9 50.3
1995............................................................ 10.0 60.9 70.8
1996............................................................ 6.6 75.2 81.8
----------------------------------------------------------------------------------------------------------------
Source: IRS. Corporate Source Book, various issues.
Statement of the Real Estate Roundtable
The Real Estate Roundtable \1\ appreciates the opportunity
to submit comments for the record of the February 9, 2000
hearing of the House Committee on Ways and Means regarding the
revenue provisions of the Administration's fiscal year 2001
budget proposal.
---------------------------------------------------------------------------
\1\ The Real Estate Roundtable is a Washington based policy
organization comprised of America's leading public and private real
estate owners, investors, lenders and managers as well as the leaders
of major national real estate trade associations actively involved in
shaping federal policies affecting income producing real estate. The
Real Estate Roundtable is engaged in a range of important policy issues
in the areas of tax, capital and credit, telecommunications and
technology and the environment.
---------------------------------------------------------------------------
Background
The Administration's budget contains proposals that could
significantly affect the real estate industry, both positively
and negatively, and we look forward to working with the
Committee as it deliberates on these proposals. We welcome
those proposals in the Administration's budget intended to be
favorable to real estate, however, we oppose a number of
proposals that are detrimental. Furthermore, we favor a
comprehensive and related approach to real estate tax policy.
In this testimony we will comment briefly on some of the real
estate tax policies we believe the Committee should consider.
If these tax policies were enacted, current tax impediments
that otherwise discourage sound economic real estate decisions
would be removed from the Internal Revenue Code and bring about
fairer tax treatment and a more productive flow of real estate
capital and credit.
Overall State of the Commercial Real Estate Industry
Real estate represents about 12 percent of America's gross
domestic product and accounts for nearly 9 million jobs. About
$293 billion in tax revenues is generated annually by real
estate and almost 70 percent of all tax revenues raised by
local governments come from real property taxes.
Unquestionably, real estate is a direct, vital and major
contributor to the nation's economy.
Today's real estate markets, as a whole, are in overall
good health. Interest rates, although rising are relatively
low, inflation is in check, availability of capital and credit
is good; and demand for work and shopping space, in most
regions, is relatively strong. Nevertheless, the financial
markets on which real estate depends are quite sensitive and
volatile. The financial crisis that erupted during the summer
of 1998 in Japan and Russia demonstrated how quickly things can
change in the credit markets. This crisis seriously impacted
the real estate industry despite the underlying fundamentals of
real estate investment being strong.
Real estate is similarly sensitive to changes in tax
treatment. The turmoil in the industry created by the whipsaw
effect of the tax changes of the Economic Recovery Tax Act of
1981 and the Tax Reform Act of 1986 is evidence of this. Real
estate tax policy changes should be implemented through a
carefully thought through and deliberative course of action
that brings about a rational relationship between the economics
of a transaction and its taxation.
The Real Estate Roundtable Tax Agenda
The Real Estate Roundtable recommends the Committee adopt,
(in addition to those provisions in the President's budget we
support) the following tax proposals:
10 year depreciation recovery period for leasehold
improvements. Today's depreciation rules do not differentiate
between the economic useful life of building improvements,
(i.e. internal walls, ceilings, partitions, plumbing, lighting,
floor coverings, electrical and communication outlets and
computer data ports), and the life of the overall building
structure. The result is that current tax law dictates a
depreciable life for leasehold improvement of 39 years--the
depreciable life of the entire building--even though most
commercial lease terms average between 7-10 years.
As a result, the after-tax cost of reconfiguring or
building out space to accommodate new tenants, modernize the
space or upgrade technology is artificially high and out of
step with the economics of the transaction. The tax implication
of this could negatively impact decisions relating to leasehold
improvements--particularly when extensive improvements are
involved. Providing a depreciation life for leasehold
improvements that more closely matches the lease terms,
(typically about ten years), would more closely align the tax
treatment for these assets and better reflect economic reality.
Current law provides a tax obstacle to reinvesting in
existing properties. Without proper reinvestment, tenants will
leave older buildings for more modern buildings that offer
desired amenities and efficiencies. This would enhance new
development demand and contribute to a deterioration of
existing property. H.R. 844 (Shaw) provides a 10-year
depreciation period for leasehold improvements and currently
has 122 bipartisan cosponsors. Its companion bill S. 879
(Conrad, Nickles) has 15 bipartisan cosponsors.
Expensing or Rapid Amortization of Environmental
Cleanup Costs. Costs to cleanup land purchased in a
contaminated state must be capitalized and added to the basis
of the non-depreciable land. These contaminated sites are known
as ``brownfields'' and are less toxic than Superfund sites but
still must be remediated prior to redevelopment. The U.S.
Conference of Mayors estimates that there are approximately
400,000 brownfield properties across the country.
The 1997 Taxpayer Relief Act provided immediate expensing
of brownfield cleanup costs in empowerment zones and other high
poverty targeted areas (Section 198). The President's budget
proposes to make this provision permanent. Section 198 should
be extended to brownfields located in non-targeted areas as
well and the definition of ``hazardous substance'' expanded to
include common contaminants such as petroleum and pesticides.
Also, if not immediate deductibility, then a rapid amortization
period such as 60 months would be appropriate. The expansion of
Section 198 beyond targeted areas, (H.R. 2264-Johnson, R-CT),
was included in the Taxpayer Refund and Relief Act of 1999 and
should be included in the community renewal legislation the
Committee intends to mark up this year.
At-Risk Rules: The definition of qualified
nonrecourse financing in the at-risk rules needs to be modified
to allow for the inclusion of publicly traded real estate debt
(general obligation bonds issued by public real estate
companies). Qualified nonrecourse financing is nonrecourse
financing provided by a person in the business of lending (i.e.
banks, insurance companies, pension funds) that is secured by
the real property. This exception was adequate for the type of
real estate lending that existed in 1986 -property specific
financing from traditional lending institutions. Since 1986,
however, real estate financing has undergone significant
changes. The most significant being the use of publicly traded
debt to finance real estate.
Currently, publicly traded debt does not meet the technical
requirements of the qualified nonrecourse financing because the
lender--in this case the public--is not in the business of
lending. Furthermore, the debt is a general obligation of the
company and is not secured by a specific property interest as
is a typical mortgage loan. The failure of the at-risk rules to
be updated as real estate financing has evolved is creating
unfair potential tax liabilities for many real estate owners
and serious compliance headaches. The Real Estate Roundtable
worked closely with the Joint Committee On Taxation to develop
an modification was included in the Taxpayer Refund and Relief
Act.
Amortization of Demolition Costs. Current law
(Code Section 280B) requires that demolition expense and the
unrecovered basis of the demolished structure must be
capitalized and added to the basis of the land rather than
deducted. This tends to discourage redevelopment of land that
includes a structure which must be demolished, because the
costs of demolition are not recovered until the underlying land
is sold. A more appropriate tax result would permit these
expenses to be added to the tax basis of the replacement
structure and depreciated.
Update the Placed in Service Date for Properties
Eligible for the Rehabilitation Tax Credit. The 1986 Tax Reform
Act provided that the only properties eligible for the
rehabilitation tax credit are those placed in service before
1936. Prior to 1986, a 10% tax credit was allowed for
rehabilitation of properties placed in service at least 20
years prior to the rehabilitation activity. Qualifying a
building for the rehabilitation credit based on its age, rather
than a fixed placed in service date, is a preferable approach
because it continually adds buildings to the credit eligibility
pool as they reached the required age. The pre-1936 placed in
service requirement excludes all buildings placed in service
from 1936 on--regardless of age. Allowing buildings of a
minimum age to be eligible for the credit would update the pool
of eligible buildings and help achieve the social, economic and
aesthetic goals brought about by rehabilitating and preserving
older structures.
We believe the above-proposed policies, (with the exception
of the at-risk rules), comprise a related package of tax
changes aimed at promoting smart growth through redevelopment.
In communities across the nation, rapid land development -often
called ``sprawl'' -is having unwanted side effects such as
traffic congestion, higher taxes, loss of open spaces and parks
and overcrowded schools. Although the problems and solutions
are primarily at the state and local level, the Federal
government can help provide solutions, particularly through tax
policy.
Current federal tax law discourages redevelopment of
existing property through its uneconomic tax treatment of
leasehold improvement depreciation, demolition costs and
brownfield cleanup expenses. Enacting the changes proposed
above would mitigate these tax impediments and level the tax
implications associated with new versus re development
decisions, thus making redevelopment more viable. Renewing the
viability of the rehabilitation tax credit by allowing more
buildings to be eligible also would promote redevelopment and,
in turn, ease pressure to develop new space. We look forward to
working with the Committee to shape and implement these real
estate tax policies.
REAL ESTATE RELATED REVENUE INCREASES IN PRESIDENT'S BUDGET PROPOSAL
Modify the treatment of closely held REITs. The
Administration proposal would impose an additional requirement
for REIT qualification that no person can own stock of a REIT
possessing 50 percent or more of the total combined voting
power of all classes of voting stock or 50 percent or more of
the total value of all shares of all classes of stock. The
stated reason supporting this proposal is that ``[a] number of
tax avoidance transactions involve the use of closely held
REITs.''
Recommendation: We believe the Administration's proposed
prohibition on almost all closely held REITs is overly broad
and unnecessary. We are concerned with the impact the
Administration's closely held proposal could have on capital
flows to real estate and the potential resulting negative
effect on asset values and jobs. The capitalization of real
estate through REITs that has occurred in the 1990s has been an
important factor in the recovery of the real estate industry
which itself is making a significant contribution to the
strength of the overall economy.
We are pleased that the Administration has revised this
proposal over the last three years to provide look through
rules for certain entities owning interests in REITs in
determining whether the REIT is closely held. These rules
include a look through for a REIT or a domestic pension fund
owning another REIT. A limited look through rule for
partnerships is included in this year's budget. We believe,
however, that these exceptions need to be broadened as follows:
Pass-through entities. Allow an unlimited look-through of
all pass through entities -domestic and foreign. The lack of
such a look-through would undercut the recently negotiated
treaty with the Netherlands that is designed to improve foreign
investment in REITs. The treaty allows up to 80 percent
ownership of a U.S. REIT by a Dutch pension fund without
dividend withholding. In the absence of the treaty, foreign
pension funds and investors are also subject to 30 percent
withholding tax. The Netherlands treaty has facilitated a
significant amount of capital to flow to U.S. real estate.
Similarly, the treaty allows U.S. pension funds to own up to 80
percent of a Dutch venture without dividend withholding. This
is a significant benefit to outbound international investment.
The failure to allow the closely held private REIT structure
for foreign investors would dampen foreign investment interest
cause a significant amount of capital that is presently flowing
into U.S. real estate to dry up.
Incubator REITs. Any closely held proposal must provide for
the use of ``incubator REITs.'' Incubator REITs sometimes have
a majority shareholder corporation for a transition period in
order to prepare the REIT for going public by allowing it to
develop a track record. Corporate majority shareholders of
private REITs are also used for legitimate state and local
income and real property tax planning purposes and as a vehicle
for legitimate foreign investment in real estate.
Joint Ventures with Publicly traded REITs. Public REITs
benefit from being able to joint venture with third parties
that often take the form of closely held private REITs. In
present market conditions, depressed stock prices can hamper
the ability of some public REITs to go back to the stock market
to raise equity capital. Many of these same REITs want to limit
borrowings under their lines of credit to maintain, or improve,
their investment grade ratings. They, therefore, are relying on
privately structured joint ventures with closely held REITs to
raise equity in order to complete new transactions and to grow.
In many cases, a third party investor owns a majority share
of the closely held REIT. Although the Administration's
proposal would allow a REIT to own another REIT, such ownership
effectively would be limited to REITs that meet the ownership
requirements of the proposal. This would have a material
adverse impact on the ability of public REITs to tap into the
much needed alternative source of capital provided by joint
ventures with closely held private REITs.
Eliminate non-business valuation discounts (for
family limited partnerships). The budget proposal asserts that
family limited partnerships are being used to take ``illusory''
valuation discounts on marketable assets. The proposal contends
that taxpayers are making contributions of these assets to
limited partnerships, gifting minority interests in the
partnerships to family members, and then claiming valuation
discounts based on the interest being a minority interest of a
non-publicly traded business. The proposal would eliminate such
valuation discounts except as they apply to ``active''
businesses.
Recommendation: The Real Estate Roundtable opposes this
proposal in concept because it increases the estate tax burden
and specifically because it defines non-business assets as
including ``real property.'' The reference to real property,
which lacks any elaboration, could be interpreted broadly to
include much of the nation's directly or indirectly family-
owned real estate. In all events, further clarification by the
Administration is needed to determine the definition of ``real
property'' and whether it is considered part of an active
business.
Nevertheless, The Real Estate Roundtable does not believe
that real property or interests in real property should be
included in a proposal targeted at truly passive investments,
such as publicly traded stocks and bonds. We applaud the
Committee for its continuing effort to reduce the estate and
gift tax burden. This proposal would take a number of steps
backward and increase the estate tax burden. As a result,
successors in family-owned real estate businesses could be
faced with the troubling scenario of having to sell real
property in the estate (often at distressed value prices) in
order to pay death taxes.
Disallow interest on debt allocable to tax-exempt
investments. The President's proposal would expand the
definition of ``financial institution'' in Section 265(b) of
the Code to include ``any person engaged in the active conduct
of banking, financing, or similar business, such as securities
dealers and other financial intermediaries.'' As a result, a
``financial institution'' that invests in tax-exempt
obligations would not be allowed to deduct a portion of its
interest expense in proportion to its tax-exempt investments.
Under current law, (Revenue Procedure 72-18) taxpayers, other
than financial institutions, are not subject to such
limitations provided the average amount of the tax exempt
obligations does not exceed 2 percent of the average total
assets of the taxpayer.
Recommendation: The Real Estate Roundtable opposed a
similar proposal last year and opposes this proposal because it
would reduce corporate demand for tax-exempt securities, such
as industrial development and housing bonds. Reducing corporate
demand for these important investment vehicles would increase
the borrowing costs of municipalities throughout the country--
thus, hindering urban reinvestment activity--and it would
discourage corporate investment in state and local housing
bonds issued to finance housing for low and middle income
families.
Limit Inappropriate Tax Benefits For Lessors of
Tax Exempt Use Property. Under current law, certain property
leased to governments, tax-exempt organizations, or foreign
persons is considered to be ``tax-exempt use property.'' There
are a number of restrictions on the ability of lessors of tax-
exempt use property to claim tax benefits from transactions
related to the property. For example, such property must be
depreciated using the straight-line method over a period equal
to the greater of the property's class life (40 years for non-
residential real property) or 125 percent of the lease term.
The Administration contends that certain leasing transactions
involving tax-exempt use property are being structured using a
short-term lease and optional service contracts to avoid the
special depreciation rules for tax-exempt use property.
Therefore, the budget proposes to require lessors of tax-exempt
property to include the term of optional service contracts and
other similar arrangements in the lease term for purposes of
determining the recovery period.
Recommendation: We stand ready to work with the Committee
and the Administration on this proposal to determine the extent
and nature of any potential tax abuse in lease arrangements for
tax-exempt use property. Until that time, we must oppose the
proposal due to a concern that it may be overly broad. Should
the transactions prove to be without economic justification and
solely tax motivated, we would be pleased to work with the
Committee and the Administration on an appropriate and targeted
remedy.
RIC excise tax application to undistributed REIT
profits. The Administration is proposing that REIT distribution
rules conform to the Regulated Investment Company (RIC)
distribution rules. Therefore, it is proposing that a REIT
distribute 98 percent of its ordinary income and capital gain
net income for a calendar year in that year in order to avoid
the four percent excise tax that applies to insufficient RIC
distributions. Currently REITs are only required to distribute
85 percent of the REITs ordinary income for the calendar year
and 95 percent of its capital gain income.
Recommendation. The current differentiation between the RIC
and REIT distribution rules exists for a reason. RICs are
mutual funds that own stocks and bonds. This allows them to
determine relatively easily by the end of a calendar year the
amount of ordinary and capital gain income for that year. As a
consequence, RICs are able to distribute in such year a very
high percentage (98%) of its income. REITs derive their income
primarily from rents -in the retail sector the rents are based
on a percentage of sales. Year-end holiday shopping accounts
for a significant amount of these sales. As a result, it is
more difficult for REITs to determine their income for a
calendar year and distribute it in such year. Current law
requires a lower distribution level for that reason. This is
logical and relates to the economics of leases. Therefore, we
oppose the Administration's conforming proposal since it does
not take into the account that the assets of RICs and REITs are
different and this difference affects their respective ability
to determine and distribute income in a calendar year.
Start-up Cost Amortization. Currently, start-up
and organizational expenditures for a new trade or business can
be amortized over 60 months. Acquired intangible assets, such
as goodwill and trademarks, may be amortized over 15 years. The
Administration proposes to allow a taxpayer to elect to deduct
up to $5,000 of start-up expenditures and up to $5,000 of
organizational expenditures. However, these amounts would be
reduced by the amount cumulative costs exceed $50,000. Any
amount of expenditures that is not deductible must be amortized
over 15 years.
Recommendation. Real Estate Roundtable opposes this
proposal. Start-up and organizational costs are a significant
cost for real estate--particularly because many real estate
assets are now held in single purpose entities. Single purpose
limited liability companies (LLCs) are widely used because they
allow for the pass-through tax advantages of a partnership and
the limited liability of a corporation. In fact, lenders often
require their use. Real estate companies can hold dozens, even
hundreds, of properties in separate LLCs. This results in
significant amounts of start -up expenses. For many real estate
companies, the Administration's proposal would result in most
start-up expenses being amortized over 15 years as opposed to
the current 60 months. We do not believe such a tax increase is
warranted or justified and we strongly oppose the proposal.
REAL ESTATE RELATED TAX INCENTIVES IN THE BUDGET PROPOSAL
Energy-efficient building equipment tax credit.
The Administration's budget proposes a 20 percent tax credit
for the purchase of certain highly-efficient building
equipment, including fuel cells, electric heat pump water
heaters, advanced natural gas and residential size electric
heat pumps, and advanced central air conditioners. Specific
technology criteria would have to be met to be eligible for the
credit. The credit would apply to purchases made after December
31, 2000 and before January 1, 2005.
Recommendation: The Real Estate Roundtable believes the
immediate objective of this proposal--encouraging energy
efficiency in buildings--is appropriate. In preparing for the
21st century, the real estate industry, like other major
industries, is looking for ways to improve its overall
performance from an economic and environmental perspective. The
Real Estate Roundtable has taken notice of statistics from the
Department of Energy identifying office buildings as consuming
about 27% of the nation's electrical supply. If this is an
accurate assessment, we are surprised that, of the six specific
tax credit proposals for energy efficient building equipment,
only one (fuel cells) has any practical application to
commercial office buildings. More specifically on the matter of
the fuel cell credit, while the amount of the incentive is not
insignificant, it is not yet sufficient to encourage the use of
this technology except in limited circumstances.
Furthermore, because of the December 31, 2000 effective
date, the credit provides no incentive to taxpayers considering
making energy efficient building equipment decisions this year.
Optimally, the credit should be available for purchases made in
2000. Postponing the credit until 2001 could affect negatively
decisions to purchase certain energy efficient building
equipment this year resulting in a missed opportunity for the
new building stock coming on line.
Expensing of brownfield remediation costs. The
Administration proposes to make permanent the deduction for
brownfield remediation costs. This sunset date for this
provision was extended to December 31, 2001 as part of last
year's tax bill.
Recommendation: The Real Estate Roundtable has supported
making section 198 permanent since its enactment in 1997 and is
pleased the Administration is seeking to take this important
step. However, further broadening of the provision's scope is
warranted and necessary.
The deductibility of clean-up expenses applies only to
brownfields in specifically targeted areas, such as empowerment
zones. We understand the need to revitalize these acutely
distressed communities. However, there are almost 400,000
brownfields across the nation, most of which are outside of
these targeted areas. Many brownfields are located in prime
business locations near critical infrastructure, including
transportation, and close to a productive workforce. These
sites need to be put back into productive use, contributing to
the economy and producing good paying jobs where they are need
most. Allowing the expensing or amortization of clean-up costs
for all of these brownfields would help restore brownfields
across America to viable and productive use.
Fifteen year depreciable life for distributed
power property. The budget proposes to assign a 15 year
depreciation recovery period and a 22-year class life for
distributed power property. Distributed power property is
property used to generate electricity and/or heat and can be
more energy efficient and generate fewer greenhouse gases than
convention generation methods. Typically, it is used in an
industrial manufacturing setting and is depreciated using the
150 percent declining balance method over 15 years.
Technological advancements have made it possible to place
electrical generation assets in or adjacent to commercial and
residential rental properties as well as industrial sites.
Distributed power property used in commercial or rental
residential buildings, however, is likely to be classified as a
building component and currently depreciated over 39 years.
Recommendation: The Real Estate Roundtable supports this
proposal because it would simplify current law by clarifying
and rationalizing the assignment of recovery periods to
distributed power property. It would reduce taxpayer
uncertainty and controversy and promote the use of more
efficient technologies. Further, this provision is consistent
with our position that certain building components should be
treated separately from the structure for depreciation
purposes.
Increase limit on charitable donations of
appreciated property. This proposal would repeal the special
lower contribution limits for gifts to charity of capital gain
property. As a result, both cash and non-cash contributions
would be subject to the general 50 percent deductibility limit
for gifts to public charities and the 30 percent deductibility
limit for gifts to private foundations. It would be effective
for contributions made after December 31, 2000.
Recommendation. The Real Estate Roundtable supports this
provision as philanthropists often contribute appreciated real
property to charities. The special lower contribution limits
that apply to contributions of capital gain property create
added complexity and could discourage gifts of valuable real
property to charitable organizations. Contributions of
conservation easements and open spaces are often gifted to
charitable organizations with the intent of promoting more
livable communities. This provision would facilitate such
contributions.
Low-income housing tax credit expansion. The
budget proposes a major expansion of the low-income housing tax
credit, which could facilitate the construction of 150,000-
180,000 new affordable housing units over five years. Under the
Administration's proposal, the annual state low-income housing
credit limitation would be raised from $1.25 per capita to
$1.75 per capita for calendar year 2001and indexed for
inflation for each year thereafter.
Recommendation: The Real Estate Roundtable supports this
proposal. We also support related legislation, H.R. 175
introduced by Representative Nancy Johnson (CT) and cosponsored
by several other Members of the Committee on a bipartisan
basis. We are encouraged by the consensus developing between
the Administration and Members of Congress on the need for
increasing the amount of low income housing tax credits
allocated to the states.
Tax credits for holders of Better America Bonds.
The Administration is proposing a tax credit for holders of
certain bonds issued by state and local governments for the
purpose of protecting open spaces; creating forest preserves
near urban areas; rehabilitating brownfields; improving parks
and reestablishing wetlands.
Recommendation: Although we have no specific comment on how
the Better America Bonds would, or should, function from a tax
perspective, we believe the Committee should consider tax
policies that would improve the livability of our communities
by encouraging redevelopment, protection of open spaces and
clean up of contaminated sites. The Real Estate Roundtable tax
agenda described in this testimony is intended to achieve a
similar goal and we welcome the opportunity to work with the
Committee on these proposals.
Conclusion
Again, we thank Chairman Archer and the Committee for the
opportunity to comment regarding the revenue proposals in the
President's fiscal 2001 budget. We are encouraged by the
proposals to make permanent the deductibility of brownfield
clean-up costs and implement credits for energy-efficient
improvements for buildings. We are also pleased that the
Administration is again seeking an increase in the low-income
housing tax credit and simplifying the charitable contribution
limits for appreciated property.
We are concerned, however, about the proposals for closely
held REITs ownership and the application of the RIC excise tax
to undistributed profits by REITs. We also object to the
proposals to amortize start-up costs over 15 years, eliminate
valuation discounts for non-business, family limited
partnerships and disallow interest on debt allocable to tax
exempt investments.
Finally, we encourage you to adopt the tax agenda we
outlined in the beginning of our comments. A 10 year
depreciation life for leasehold improvements is our top
priority and is strongly justified by the economics of typical
leases. Allowing the expensing of brownfield clean up costs for
any brownfield site would remove a significant tax impediment
to community revitalization. Modification of the ``at-risk''
rules to incorporate publicly traded real estate debt within
the definition of qualified nonrecourse financing is an
important updating of these rules that would free real estate
owners from an unintended and unfair tax liability.
Vanguard Charitable Endowment
Southeastern, PA 19398-9917
February 22, 2000
A.L. Singleton, Chief of Staff
Committee on Ways and Means
1102 Longworth Building
Washington, D.C. 20515
Dear Mr. Singleton:
The purpose of this letter is to comment on a provision contained
in the Administration's Fiscal Year 2001 Revenue Proposals, to
``clarify public charity status of donor advised funds.'' In this
regard, we note that one commentator has characterized the recent surge
in the creation of donor-advised funds as a form of ``democratization
of endowment giving,'' with ``exciting prospects for the future of
philanthropy.'' \1\
---------------------------------------------------------------------------
\1\ Steuerle, ``Charitable Endowments, Advised Funds & the Mutual
Fund Industry,'' The Exempt Organization Tax Review, Vol. 23, No. 2
(February 1999) at 299.
---------------------------------------------------------------------------
By way of background, the Vanguard Charitable Endowment Program
(the ``Endowment Program'') was founded by The Vanguard Group, Inc. It
is an independent public charity that was recognized by the Internal
Revenue Service as exempt from federal income tax under Section
501(c)(3), and as a public charity under Sections 509(a)(1) and
170(b)(1)(A)(vi), on December 8, 1997.
We are writing to observe that the Administration's proposal
concerning donor-advised funds is generally consistent with the
Endowment Program's current operations, and in our view would codify
some ``best practices'' for charitable organizations maintaining donor-
advised funds. For example, the Endowment Program has adopted a policy
of making minimum annual distributions of at least 5% of the aggregate
average net asset value on a five year rolling basis. We believe this
requirement, which is included in the Administration's proposal,
provides an important assurance that there will be an immediate
charitable benefit for the beneficiaries of donor-advised fund
organizations. Similarly, the Endowment Program maintains a prohibition
against the use of funds in donor-advised accounts for the personal
benefit of the donors and/or advisors of those accounts. This is an
important safeguard to ensure that funds are used for the proper and
intended charitable purposes, and the Administration's proposal would
further this objective by imposing a penalty on donors and/or advisors
who violate this prohibition.
Our only question about the Administration's proposal relates to
its reliance on the ``no material restriction'' test under Section 507.
We believe that test is complicated and subjective, and that it could
be replaced by a simple and explicit requirement that donors and/or
their advisors have only the right to recommend grants and no legal
right to direct the use of funds in the donor-advised accounts.
The Endowment Program is proud to be at the forefront of the
movement to expand the accessibility of philanthropy, and we believe
that legislation along the lines described in the Administration's
proposals will help to ensure that the intended philanthropic
objectives are achieved.
Sincerely,
Benjamin R. Pierce
Executive Director
cc: Timothy L. Hanford
Susan D. Brown
Statement of LaBrenda Garrett-Nelson, Gary Gasper, Nicholas Giordano,
and Mark Weinberger, Wahsington Counsel, P.C.
Washington Counsel, P.C. is a law firm based in the
District of Columbia that represents a variety of clients on
tax legislative and policy matters.
THE ADMINISTRATION'S BUDGET PROPOSAL TO TAX SHAREHOLDERS ON THE RECEIPT
OF TRACKING STOCK SHOULD BE REJECTED
Introduction
Although 28 of the 39 members of the Committee on Ways and
Means opposed the Administration's proposal to tax the issuance
of tracking stock in the President's Budget for FY2000, and the
Congress did not enact that proposal, Treasury has proposed yet
another attack on tracking stock in the form of a proposal to
tax shareholders on the receipt of ``tracking stock.'' In
effect, this proposal would increase the cost of capital to
corporations by inhibiting the use of ``tracking stock'' as a
financing option. Apart from proposing a new tax and granting
broad regulatory authority to Treasury, the Administration's
proposal represents an arbitrary departure from established tax
principles and fails to offer any tax policy reason for the
change. Moreover, it is not at all clear that the issuance of
tracking stock is an appropriate time to impose a tax, because
there is no bail out of corporate earnings. For these and other
reasons set forth below, the ``tracking stock'' proposal should
be rejected.
Summary Of The Administration's ``Tracking Stock'' Proposal
The Administration's proposal would impose a new tax on a
shareholder's receipt of tracking stock as a distribution or in
a recapitalization or similar exchange of stock or securities
for tracking stock. Under the proposal, tracking stock would be
treated as ``property'' other than stock in the issuing
corporation. As a result, a shareholder who receives a
distribution of tracking stock would be subject to tax on the
entire value of the tracking stock received. Similarly, a
shareholder who exchanges stock in the issuing corporation for
tracking stock would be treated as having engaged in a taxable
disposition of the stock surrendered in the exchange (and
subject to tax on any gain, determined by reference to the
excess of the fair market value of the tracking stock over the
tax basis of the stock surrendered). ``Tracking stock'' would
be defined generally as ``stock that relates to, and tracks the
economic performance of, less than all of the assets of the
issuing corporation (including the stock of a subsidiary).''
Two characteristics are identified as factors to be taken into
account in applying this definition: (1) whether dividends are
``directly or indirectly determined by reference to the value
or performance of the tracked entity or assets,'' and (2)
whether liquidation rights are ``directly or indirectly
determined by reference to the value of the tracked entity or
assets.'' Treasury would be authorized to prescribe regulations
treating ``tracking stock as nonstock (e.g., debt, a notional
principal contract, etc.) or as stock of another entity as
appropriate to prevent tax avoidance. The provision would be
effective for ``tracking stock'' issued on or after the date of
enactment.
I. The Administration's Proposal Would Inhibit The Use Of A
Valuable Corporate Financing Tool
Over the last 16 years, corporations have utilized
``tracking stock'' as a vehicle for raising capital and to meet
a variety of non-tax, business needs. By limiting the financing
options of U.S. corporations, the Administration's ``tracking
stock'' proposal would impinge on the ability of corporations
to raise low-cost capital in an efficient manner, and thereby
have an adverse impact on economic growth, job creation, and
the international competitiveness of U.S. businesses. The
``tracking stock'' proposal would also inhibit the ability of
businesses to use ``tracking stock'' in several other
beneficial situations, such as issuing the stock to better
align management and shareholders interests.
A. Corporations Have Issued Tracking Stock For a Variety of Business
Reasons
``Tracking stock'' is issued by corporations that have
multiple lines of business that the marketplace would value at
different prices if each line of business were held by a
separate corporation. By issuing ``tracking stock,'' a
corporation can raise capital in a manner that improves the
attractiveness of the issuer's stock to the public. The
valuation of the entire enterprise increases, because
``tracking stock'' provides a mechanism for ``tracking'' the
performance of individual businesses. There is, however, no
actual separation of a tracked subsidiary or other asset. The
corporate issuer continues to benefit from operating
efficiencies that would be lost if different lines of business
became independent. These efficiencies include economies of
scale, sharing of administrative costs, and reduced borrowing
rates based on the issuing corporation's overall credit rating.
Thus, it is clear that corporations issue ``tracking stock''
for the business purpose of obtaining the highest values for
the separate tracked businesses, while maintaining legal
ownership and other operating synergies.
B. The Essential Elements of ``Tracking Stock'' Are Consistent With the
Form of the Transaction as A Class of Common Stock of The Issuer
Typically, ``tracking stock'' is issued as a class of common stock,
the return on which is determined by reference to less than all of the
issuer's assets. The ``tracked'' asset can take a variety of forms
(e.g., a line of business, a separate subsidiary, or a specified
percentage of a separable business). There is no legal separation of
corporate assets, and thus an investor's return remains subject to the
economic risks of the issuer's entire operation: (1) the holder of
tracking stock retains voting rights in the issuer (not, for example, a
``tracked'' subsidiary); (2) dividend rights, although based on the
earnings of a tracked subsidiary or other asset, are subject to whether
the parent/issuer's board of directors declares a dividend, as well as
state law limitations on the parent/issuer's ability to pay (without
regard to a ``tracked'' subsidiary's ability to pay); and (3)
liquidation rights might be determined by reference to the value of
tracked assets, but investors in tracking stock have no special right
to those assets; rather they are entitled to share in all of the
issuer's assets on a pro rata basis.
II. The Administration's Tracking Stock Proposal Presents Serious Tax
Policy Concerns, in Addition to Technical Issues
A. Unjustified and Radical Departure From the Normal Treatment of the
Receipt of Common Stock
Sections 305 \1\ provides tax-free treatment to a
shareholder who receives a proportional distribution of common
stock on common stock. This treatment is based on the fact that
a common shareholder already owns all the corporate assets that
are not devoted to preferred shareholders, and they do not
receive anything more by a common stock dividend that re-
divides the same ``pie.'' Similarly, tax-free treatment is
provided to a shareholder who surrenders common stock for
common stock by either Section 1036 or Section 354 (where the
exchange is a reorganization in the form of a
recapitalization). In the case of an exchange, tax-free
treatment is justified on the ground that the transaction
represents a mere reshuffling of an existing corporation's
capital structure. The Administration's proposal represents a
radical departure from these established tax principles, and
inappropriately relies on the typical features of tracking
stock to justify the result.
---------------------------------------------------------------------------
\1\ Except as provided, references to ``Sections'' are to the
Internal Revenue Code of 1986, as amended (referred to herein as the
``Code'').
---------------------------------------------------------------------------
Consistent with the theory that underlies the tax-free
treatment of stock dividends and recapitalizations, the
issuance of tracking stock is not an appropriate time to impose
a tax on a shareholder, to the extent that a taxpayer's
investment remains in corporate solution, and the stock
represents merely a new form of participation in a continuing
enterprise.\2\
---------------------------------------------------------------------------
\2\ See generally Bittker and Eustice, Federal Income Taxation of
Corporations and Shareholders, par. 12.01[3] regarding the theory
underlying tax-free treatment.
---------------------------------------------------------------------------
Nevertheless, the Administration's proposal would trigger a
tax on receipt of tracking stock, even in a case where a
distribution of the tracked subsidiary would satisfy the strict
requirements for tax-free distribution.
B. Technical Issues
Circular Definition Of Tracking Stock. The proposed
definition of ``tracking stock'' could include stock that has
no tracking-stock features. For example, consider a corporation
with one class of common stock outstanding, which then issues a
new class of tracking stock, dividends on which are based on
the operating results of one of the corporation's two
subsidiaries. In such a case, by definition, the pre-existing
common will constitute ``stock that relates to--less than all
of the assets of the issuing corporation;'' similarly,
dividends on the pre-existing common will (effectively) track
the results of only one of the two subsidiaries. (Note that
last year's Treasury proposal included a specific statement
that the ``issuance of tracking stock will not result in
another class of the stock becoming tracking stock if the a--
rights of such other class are determined by reference to the
corporation's general asset. . .'')
Failure To Provide Any Substantive Guidance. Apart from the
imposition of a new tax, the Administration's proposal fails to
provide any substantive guidance on the treatment of tracking
stock under the Code. Rather than providing operating rules to
deal with identified issues, the Administration proposes to
grant new and exceedingly broad regulatory authority for
Treasury to prescribe rules treating tracking stock as
nonstock, etc. Note that the effect of the Budget proposal is
to treat tracking stock as nonstock for purposes of the rules
regarding stock dividends and recapitalizations. Thus, it is
unclear what other circumstances Treasury might identify as
candidates for an exercise of this regulatory authority.
Presumably, regulatory guidance would be applied prospectively;
however, it is not at all clear whether Treasury contemplates a
grant of authority to recast a transaction on a retroactive
basis.
III. The Administration Has Failed To Establish A Reason To
Single Out Tracking Stock for Congressional Action
The Administration has failed to set forth a basis for
either legislative action or the delegation of additional
regulatory authority to Treasury. Tracking stock is not a new
concept in the tax law. Moreover, the enactment of the proposal
would effectively put an end to the market for tracking stock,
and thus little if any revenue would be raised.
A. Over Fifty Years of Tax Law Contradicts the Administration's
Statement that ``Tracking Stock is. . .Outside the Contemplation of
Subchapter C and Other Sections of the. . .Code.''
The stated rationale for the Administration's proposal includes the
statement that the ``use of tracking stock is clearly outside the
contemplation of subchapter C and others sections of the. . .Code.'' It
is quite clear, however, that present law is adequate to the task,
particularly in view of the existence of case law that pre-dates the
Internal Revenue Code of 1954,\3\ as well as numerous grants of
specific regulatory authority relating to tracking stock.\4\
---------------------------------------------------------------------------
\3\ As early as 1947, the U.S. Tax Court had occasion to consider
the federal income tax consequences of the issuance of tracking stock
in the case of Union Trusteed Funds, Inc. v. Commissioner. Similarly,
the Congress has taken account of the existence of tracking stock, as
appropriate for purposes of particular tax provisions. For example, in
1986 the Congress reversed the result in the Union Trusteed Funds case;
as another example, in the original enactment of the Passive Foreign
Investment Company (``PFIC'') regime, the Congress included regulatory
authority to treat ``separate classes of stock. . .in a corporation. .
.as interests in separate corporations.'' Interestingly, the Congress
did not suggest that all tracking stock should be so treated, thus
allowing for circumstances in which the form of an issuance of tracking
stock should be respected.
\4\ For example, in 1990, the Congress specifically addressed a
tracking stock issue in the legislative history of Section 355(d), a
provision added to deny tax-free treatment to a ``disguised sale'' of a
subsidiary. Very generally, section 355(d) triggers a tax on the
distributing corporation in a divisive reorganization where 50 percent
or more of the corporation's stock was acquired by purchase during the
preceding five years. In measuring the five-year window, section
355(d)(6) reduces the holding period for stock for any period during
which the holder's risk of loss is substantially diminished by any
device or transaction. In this regard, the Conference Report on the
1990 legislation specifically cites the use of ``so-called 'tracking
stock' that grants particular rights to the holder or the issuer with
respect to the earnings, assets, or other attributes of less than all
the activities of a corporation or any of its subsidiaries.'' H.R.
Conf. Rep. No. 5835 p. 87.
---------------------------------------------------------------------------
B. It is Questionable Whether the Administration's Proposal Would
Increase Tax Revenues
It is arguable that the use of tracking stock increases tax
revenues. This view is based on the availability of financing options
such as the issuance of debt, an alternative that would generate
interest deductions and thereby eliminate tax on corporate earnings. By
comparison, the issuance of tracking stock does not reduce a
corporation's tax liability because dividends are paid out of after-tax
income. In any case, one likely consequence of the Administration's
proposal is that few (if any) corporations will issue tracking stock.
IV. A Similar Proposal Was Rejected By The Congress Last Year
The tracking stock proposal in this year's Budget is a reiteration
of a proposal that was considered but not acted upon by Congress last
session. Last year, the Administration's budget contained a ``tracking
stock'' proposal that taxed the issuing corporation on the issuance of
tracking stock, or a recapitalization of stock or securities into
tracking stock. This year's proposal changes the point of taxation from
a tax on the issuing corporation to a tax on a shareholder who receives
tracking stock in a distribution or in exchange for other stock. While
the point of taxation has changed the underlying tax policy concerns
presented by the proposal (described above) remain the same.