[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]



 
 SAVINGS AND INVESTMENT PROVISIONS IN THE ADMINISTRATION'S FISCAL YEAR 
                          1998 BUDGET PROPOSAL

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED FIFTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 19, 1997

                               __________

                             Serial 105-43

                               __________

         Printed for the use of the Committee on Ways and Means




                               


                      U.S. GOVERNMENT PRINTING OFFICE
 48-616 cc                   WASHINGTON : 1998
_______________________________________________________________________
           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        BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky                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
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri

                     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 March 4, 1997, announcing the hearing................     2

                               WITNESSES

Congressional Research Service, Jane G. Gravelle, Senior 
  Specialist, Economic Policy....................................    55

                                 ______

American Council for Capital Formation, Mark Bloomfield..........    46
American Family Business Institute, Harold I. Apolinsky..........   122
American Farm Bureau Federation, Charles E. Kruse................   136
Apolinsky, Harold I., Small Business Council of America, and 
  American Family Business Institute.............................   122
Biotechnology Industry Organization, Tom Wiggans.................    74
Bloomfield, Mark, American Council for Capital Formation.........    46
Christensen, Hon. Jon, a Representative in Congress from the 
  State of Nebraska..............................................    16
Communicating for Agriculture, Wayne Nelson......................   119
Conine Residential Group, C. Kent Conine, as presented by Mark 
  Kalish.........................................................   205
Connective Therapeutics, Tom Wiggans.............................    74
Cox, Hon. Christopher, a Representative in Congress from the 
  State of California............................................    31
Danner, Dan, National Federation of International Business.......   115
Davis, J. Morton, D.H. Blair Investment Banking Corp.............   222
Dean Witter Financial, James F. Higgins..........................   149
Deutsch, Hon. Peter, a Representative in Congress from the State 
  of Florida.....................................................    27
D.H. Blair Investment Banking Corp., J. Morton Davis.............   222
DRI/McGraw-Hill, David Wyss......................................    59
Dreier, Hon. David, a Representative in Congress from the State 
  of California..................................................    24
Dunn, Hon. Jennifer, a Representative in Congress from the State 
  of Washington..................................................    12
Ettline Foods Corp., and Food Distributors International, Martin 
  J. Whelan......................................................   108
Gale, William G., Brookings Institute............................   180
Higgins, James F., Dean Witter Financial, and Securities Industry 
  Association....................................................   149
Kalish, Mark, Michael T. Rose Associates, presenting statement of 
  C. Kent Conine.................................................   205
Kruse, Charles E., Missouri Farm Burea Federation, and American 
  Farm Bureau Federation.........................................   136
McCarthy, Hon. Karen, a Representative in Congress from the State 
  of Missouri....................................................    29
McCrery, Hon. Jim, a Representative in Congress from the State of 
  Louisiana......................................................     6
Michael T. Rose Associates, Mark Kalish, presenting statement of 
  C. Kent Conine.................................................   205
Missouri Farm Bureau Federation, Charles Kruse...................   136
National Association for the Self-Employed, Bennie L. Thayer.....   144
National Association of Home Builders, C. Kent Conine, as 
  presented by Mark Kalish.......................................   205
National Association of Realtors, Richard Woodbury...............    67
National Federation of International Business, Dan Danner........   115
Neal, Hon. Richard, a Representative in Congress from the State 
  of Massachusetts...............................................     9
Nelson, Wayne, Communicating for Agriculture.....................   119
Peterson, Hon. Collin C., a Representative in Congress from the 
  State of Minnesota.............................................    34
Pomeroy, Hon. Earl, a Representative in Congress from the State 
  of North Dakota................................................    37
Regalia, Martin A., U.S. Chamber of Commerce.....................   198
Savings Coalition of America, Bennie L. Thayer...................   144
Securities Industry Association, James F. Higgins................   149
Small Business Council of America, Harold I. Apolinsky...........   122
Thayer, Bennie L., National Association for the Self-Employed, 
  and Savings Coalition of America...............................   144
U.S. Chamber of Commerce, Martin A. Regalia......................   198
Whelan, Martin J., Ettline Foods Corp., and Food Distributors 
  International..................................................   108
Wiggans, Tom, Connective Therapeutics, and Biotechnology Industry 
  Organization...................................................    74
Woodbury Corp., and National Association of Realtors, Richard 
  Woodbury.......................................................    67
Wyss, David, DRI/McGraw-Hill.....................................    59
Yakoboski, Paul J., Employee Benefit Research Institute..........   156

                       SUBMISSIONS FOR THE RECORD

American Alliance for Software Exports, and BMC Software, Inc., 
  Houston, TX, John W. Cox, joint statement......................   232
American Bankers Association, statement..........................   237
Association of Proprietary Colleges, David Rhodes, statement.....   241
Independent Bankers Association of America, statement............   243
Investment Company Institute, statement..........................   247
Miles, Craig, Thedford, NE, letter...............................   249
National Apartment Association, and National Multi Housing 
  Council, joint statement.......................................   250
R&D Credit Coalition, and Pericom Semiconductor Corp., San Jose, 
  CA, Patrick Brennan, joint statement and attachments...........   259
Thomas, Hon., Bill, a Representative in Congress from the State 
  of California, statement.......................................     5



 SAVINGS AND INVESTMENT PROVISIONS IN THE ADMINISTRATION'S FISCAL YEAR 
                          1998 BUDGET PROPOSAL

                              ----------                              


                       WEDNESDAY, MARCH 19, 1997

                          House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:04 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
FOR IMMEDIATE RELEASE                           CONTACT: (202) 225-1721
March 4, 1997

No. FC-5

                      Archer Announces Hearing on

                   Savings and Investment Provisions

                  in the Administration's Fiscal Year

                          1998 Budget Proposal

    Congressman Bill Archer (R-TX), Chairman of the Committee on Ways 
and Means, today announced that the Committee will hold a hearing on 
the savings and investment provisions in the Administration's fiscal 
year 1998 budget proposal. The hearing will take place on Wednesday, 
March 19, 1997, in the main Committee hearing room, 1100 Longworth 
House Office Building, beginning at 10:00 a.m.
      
    Oral testimony at this hearing will be heard from both invited and 
public witnesses. Also, any individual or organization not scheduled 
for an oral appearance may submit a written statement for consideration 
by the Committee or for inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    The Administration's fiscal year 1998 budget proposal includes 
three savings and investment provisions: an exclusion (up to $500,000) 
of capital gains on the sale of a principal residence, an expansion of 
Individual Retirement Accounts (IRAs), and a modification to the estate 
tax.
      
    In announcing the hearing, Chairman Archer stated: ``In his budget 
proposal, the President has recognized the need for tax incentives for 
savings and investment. I heartily concur in this need. I believe our 
country has an unacceptably low savings rate, and increased savings and 
investment will ultimately mean better employment prospects for 
Americans and a higher standard of living for our children and 
grandchildren. I also believe that reining in Federal spending and 
balancing the Federal budget will help to increase our national savings 
rate. Replacing our current tax system with a broad-based consumption 
tax remains my ultimate goal. I am convinced that this would be a more 
lasting way to encourage savings and investment and produce a stronger 
economy. But until that goal can be reached, we should enact changes to 
our tax system that reduce disincentives to save and invest. 
Accordingly, we should discuss not only the implications of the 
President's proposals but also more broad-based alternatives to the 
President's proposals.''
      

FOCUS OF THE HEARING:

      
    The focus of the hearing will be the savings and investment 
provisions (e.g., capital gains exclusion, IRA expansion, and estate 
tax relief) of the Administration's budget proposal for fiscal year 
1998 and broad-based alternatives to those proposals.
      

DETAILS FOR SUBMISSIONS OF REQUESTS TO BE HEARD:

      
    Requests to be heard at the hearing must be made by telephone to 
Traci Altman or Bradley Schreiber at (202) 225-1721 no later than the 
close of business, Tuesday, March 11, 1997. The telephone request 
should be followed by a formal written request 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. The staff 
of the Committee will notify by telephone those scheduled to appear as 
soon as possible after the filing deadline. Any questions concerning a 
scheduled appearance should be directed to the Committee on staff at 
(202) 225-1721.
      
    In view of the limited time available to hear witnesses, the 
Committee may not be able to accommodate all requests to be heard. 
Those persons and organizations not scheduled for an oral appearance 
are encouraged to submit written statements for the record of the 
hearing. All persons requesting to be heard, whether they are scheduled 
for oral testimony or not, will be notified as soon as possible after 
the filing deadline.
      
    Witnesses scheduled to present oral testimony are required to 
summarize briefly their written statements in no more than five 
minutes. THE FIVE-MINUTE RULE WILL BE STRICTLY ENFORCED. The full 
written statement of each witness will be included in the printed 
record, in accordance with House Rules.
      
    In order to assure the most productive use of the limited amount of 
time available to question witnesses, all witnesses scheduled to appear 
before the Committee are required to submit 300 copies of their 
prepared statement and a 3.5-inch diskette in WordPerfect or ASCII 
format, for review by Members prior to the hearing. Testimony should 
arrive at the Committee office, room 1102 Longworth House Office 
Building, no later than Monday, March 17, 1997. Failure to do so may 
result in the witness being denied the opportunity to testify in 
person.
      

WRITTEN STATEMENTS IN LIEU OF PERSONAL APPEARANCE:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit at least six (6) 
copies of their statement and a 3.5-inch diskette in WordPerfect or 
ASCII format, with their address and date of hearing noted, by the 
close of business, Wednesday, April 2, 1997, 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, at least one hour before the hearing 
begins.
      

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 typed in single space on legal-size paper and may not exceed a total 
of 10 pages including attachments. At the same time written statements 
are submitted to the Committee, witnesses are now requested to submit 
their statements on a 3.5-inch diskette in WordPerfect or ASCII format.
      
    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, full address, a telephone number where the witness or the 
designated representative may be reached and a topical outline or 
summary of the comments and recommendations in the full statement. 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://WWW.HOUSE.GOV/WAYS__MEANS/'.
      

    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 202-225-1904 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. The Committee will come to order. The 
Chair would invite guests, staff, and Members to take seats. We 
have a very, very important witness to lead off the hearing 
today, and we want to be able to be sure and hear him. 
Actually, we have three very important witnesses at the witness 
table. Today, the Committee continues our series of hearings on 
the tax provisions in the President's budget. Today's hearing 
will focus on incentives for savings and investment.
    In the President's budget proposal, he includes a capital 
gains exclusion for principal residences and an expansion of 
IRAs and changes to the rules for deferred payments of estate 
taxes on farms and small businesses. In this hearing, we will 
examine not only these incentives but more broad-based 
alternatives as well. In particular, I welcome the support we 
will hear today from Democrats for a broad-based capital gains 
and estate tax relief.
    The reduction in the capital gains tax and the death tax is 
not and should not be a partisan issue. All Americans will 
benefit from greater savings and investment. I look forward to 
a bipartisan effort to change our tax system to one that 
encourages, rather than deters, savings and investment.
    [The opening statement of Mr. Thomas follows:]

    [GRAPHIC] [TIFF OMITTED] T8616.022
    
      

                                

    Chairman Archer. Our first witness this morning is a 
gentleman well known to the Committee, a Member of the 
Committee, the gentleman from Louisiana, Jim McCrery.
    You may proceed, Mr. McCrery.

  STATEMENT OF HON. JIM MCCRERY, A REPRESENTATIVE IN CONGRESS 
                  FROM THE STATE OF LOUISIANA

    Mr. McCrery. Thank you, Mr. Chairman.
    Mr. Chairman, in the last Congress, I, along with a few 
others on the House side and Senator Dole on the Senate side, 
introduced the Family Business Protection Act. In the House, it 
was H.R. 2190. We had about 175 or so cosponsors and had 
bipartisan support for the bill. A version of H.R. 2190, in 
fact, a pretty close version, was included in the 
reconciliation bill that was sent to the President and vetoed 
by the President.
    Since the beginning of this Congress, I have been working 
with several Members of this Committee and others on a new 
version of the Family Business Protection Act, and we will be 
introducing this soon. Essentially, the components of the new 
bill will include a $1.5 million exclusion from the estate tax 
for closely held family businesses, family farms, and the like. 
We will index that exclusion for inflation, and any excess 
value over that exclusion will be taxed at a rate 50 percent 
less than the current rate.
    Second, the legislation will make the unified credit a real 
exemption from the estate tax. What does that mean? That means 
that we will, in effect, move the tax rates applicable to 
estates up to begin at the level of the exemption. In other 
words, in the current law, you exempt $600,000 of the estate 
from taxation, but the initial rate of tax is not 18 percent, 
which is the lowest estate tax rate; it is 37 percent. What we 
do in this bill is we move the rates up to correspond with the 
first tax dollar of the estate so that the initial rate applied 
to the estate is 18 percent above the exemption.
    And we also include an increase in the unified credit from 
the current law level of $600,000 up to $1 million over a 5-
year period, and then, we index that exemption or that unified 
credit for inflation. And finally, working with Mr. Herger and 
Mr. Houghton and others, our legislation will offer some 
additional changes dealing with the election of the special use 
valuation for family farms and ranches, conservation easements, 
and historic property.
    Mr. Chairman, the estate tax has become a burden on average 
families in this country, particularly families that have saved 
and invested and built small businesses, family farms. I do not 
think the estate tax was ever meant to be a burden on those 
families. It needs to be addressed. I am hopeful this Congress 
will do it.
    Thank you.
    [The prepared statement follows:]

Statement of Hon. Jim McCrery, a Representative in Congress from the 
State of Louisiana

    Thank you Mr. Chairman for giving me the opportunity to testify 
before the Committee today. I appreciate the time you have allotted my 
colleagues and me to talk about one of the greatest disincentives to 
lifetime savings that exists in the tax code today--the estate and gift 
tax.
    There has been a direct connection between death and taxes for 
about 200 years. In fact, the year 1797 was the first time the United 
States government imposed a death duty in the form of a stamp tax. 
Between 1797 and 1916, the year Congress first enacted a federal estate 
tax, inheritance duties were imposed twice to raise revenue during 
times of war. Both instances collected very little money, even by that 
day's standards.
    As members of this committee, we have listened to hours of 
testimony describing the dismal savings rate of the U.S. population. We 
have proposed and even passed legislation that created incentives in 
the tax code for savings. Yet by some perverse logic, our tax code 
punishes those people in death who have done exactly what we hope the 
rest of the country will do during their lifetime--save and invest.
    Mr. Chairman, conventional wisdom suggests that most people believe 
they are never going to be subject to estate taxes. In their minds, 
only the very wealthy have estates large enough. I believe, however, 
more often than not, conventional wisdom is being proven wrong and that 
we are at the beginning of a period in our history where average 
Americans who have built family businesses, operated ranches and farms, 
and saved frugally and invested wisely for most of their lives, will be 
unfairly subjected to estate taxes.
    In fact, in a letter to you dated January 21, 1997, the Joint 
Committee on Taxation said that since 1993, estate and gift receipts 
have been averaging double digit rates of growth. They laid out four 
possible reasons: first, the amount of wealth exempt from the estate 
and gift tax was not indexed to inflation; second, we have witnessed an 
unusually large increase in the value of the stock market. This means 
that the value of estates that would already be subject to tax has 
increased tremendously and more estates have been bumped into taxable 
status; third, the number of people who are 85 years old or older is 
growing at a rate of 3.5% annually, thereby increasing the mortality 
rates for this decade. And fourth, the 100% marital deduction included 
in the 1981 Economic Recovery Tax Act delayed the payment of estate tax 
until the surviving spouse died. On average, spouses tend to live 10 
years longer than their mates, and therefore this decade will see more 
estates that used the marital deduction, subject to tax.
    Since the 103rd Congress, I have introduced legislation that would 
address the estate tax burden imposed upon closely held family 
businesses and farms. According to the Small Business Administration's 
Office of Advocacy, more than 70% of all family businesses do not 
survive through the second generation and fully 87% do not make it to 
the third generation. Further, according to the Tax Foundation, high 
estate taxes looming on the horizon provide a disincentive for owners 
of family owned businesses to expand their operation and create new 
jobs. In fact, current estate tax rates produce the same disincentives 
to growth as a doubling of current income tax rates.
    In the 104th Congress, H.R. 2190, the Family Business Protection 
Act, had 175 cosponsors and enjoyed wide bipartisan support from both 
urban and rural members as well as conservative Republicans and liberal 
Democrats. A modified version of this legislation was included in the 
reconciliation bill which was vetoed by President Clinton.
    Since the beginning of this Congress I have been working with a 
group of members on this committee to expand the provisions of the 
Family Business Protection Act to incorporate sections that address 
many of the underlying reasons that, if nothing is done, many more 
average families will be subject to the estate tax.
    Essentially, the components of the ``Family Business Protection 
Act'' will include a $1.5 million exclusion, indexed for inflation, 
from estate tax for the value of a closely held family owned business. 
The excess value over the $1.5 million would be taxed at 50% of the 
current rate.
    Second, our legislation will make the unified credit a real 
exemption. You may be asking what is the difference? The difference is 
that we talk about the fact that there is a unified credit of $600,000, 
but that really is not true.
    The tax code provides for a bottom rate of 18%. In reality, no one 
ever pays that. The unified credit only gets rid of the tax liability 
on $600,000, so currently the lowest rate that anyone would ever pay is 
37%. Essentially, if today a person had an estate of $600,001, of that 
$1.00, 37 cents would go to the Treasury. What we are proposing is that 
the credit be made an exemption so that the lowest rate of 18% applies 
to the first dollar of value in a person's estate upon which they 
actually pay the tax. The rates would then be graduated, as under 
current law.
    In conjunction with this, our legislation will also include an 
increase the unified credit from the current law level of $600,000 to 
$1,000,000 over five year, indexed for inflation.
    Finally, our legislation will offer some additional changes to 
current law dealing with the election of the special use valuation for 
family farms and ranches, conservation easements, and historic 
property.
    Mr. Chairman, the estate tax was never intended to be a burden on 
average families who have wisely saved and invested over their 
lifetime. What we are finding, however, is that for families all over 
this country this tax is indeed becoming a burden. They are having to 
sell their homes, businesses, and farms to meet a tax bill that is 
imposed because someone passed away. Our bill is targeted to give 
relief to those families.
    Again, thank you for this opportunity to testify. I will be happy 
to take any questions at the appropriate time.
      

                                

    Chairman Archer. Thank you, Mr. McCrery.
    Mr. Rangel, would you like to make any sort of a 
preliminary statement and extend your own welcome to the panel 
of witnesses?
    Mr. Rangel. That is very kind of you, Mr. Chairman. I would 
like to join with you in hoping that both the Republicans and 
the Democrats, taking suggestions and recommendations made by 
our Members, will come up with a bill that will present to the 
American people a balanced budget that we all can agree to. 
This is especially so since your leadership has suggested 
removing tax cuts from the budget discussion, temporarily, at 
least, and all my colleagues share that feeling.
    Thank you.
    [The opening statement follows:]

Statement of Hon. Charles B. Rangel, a Representative in Congress from 
the State of New York

    I am delighted to be here with my colleagues today to talk 
about the choices we will have to make if we are to balance the 
budget in the next several years.
    I am pleased to listen to today's witnesses about cuts in 
capital gains taxes, expanded IRA accounts, and estate and gift 
tax relief in the contect of reducing our deficit.
    A good case will be made for each of these tax cut ideas 
from the viewpoint of its proponents.
    We will hear about the potential that each of these 
proposals has for increasing savings and investment in this 
country. We may hear some skepticism.
    Tax cuts are popular. Somebody always benefits from a tax 
cut. And, this will be reflected in the enthusiasm that some of 
our witnesses may have for various cut ideas.
    I am, like any politician, in favor of cut cuts. In fact, I 
have said that I could even be in favor of a capital gains tax 
cut if it were in the context of a fair and balanced plan. So, 
I am here today to listen to the reasons why we should include 
them in whatever budget bill we may end up with this year.But, 
tax cuts should not come at the wrong time and they should be 
focused on those who need them most.
    And, tax cuts must be paid for . . . that is, they must be 
paid for if we are serious about reducing the deficit at the 
same time.
    Who will pay for these tax cuts? Will it be the large 
corporations who eloquent and sophisticated representatives sat 
in this room last week and opposed the President's revenue 
raisers? Or will it be the poor and the disadvantaged who have 
only begun to feel the effects of the policies enacted in the 
last 2 years to pay for other initiatives?
    In the end, it is all about choices.
    We will have to make difficult choices about how to spend 
our scarce resources. We will have to decide what is best for 
our economy and for our citizens. Not just what will make them 
feel good next April 15 when they fill out their tax returns, 
but instead what will add to their changes for prosperity year 
after year.
    I have made my choice. I have come to the conclusion that 
the best thing for our country right now is deficit reduction.
    This will help to keep interest rates down and to control 
the pressure on the future generations who will have to pay for 
the debts of our generation. And it will prevent any unfairness 
in the way any possible tax cuts are paid for.
    The ``Blue Dog'' Democrats have made their choice. They 
have put forth a plan for a balanced budget without any tax 
cuts. They have said that deficit reduction is more important 
right now. I am glad we agree on this issue.
    Apparently, Speaker Gingrich has made his choice, too. 
Yesterday's Washington Post reported that the Speaker has given 
up on his ``crown jewel.'' He has dropped the idea of including 
a tax cut in the budget bill.
    I am glad that the Speaker has come around to that 
conclusion because the task of deficit reduction ids made 
undeniably easier if there are no tax cuts in the final 
package.
    If we can first get our fiscal affairs in order, then we 
can begin to consider how best to enhance the opportunities for 
prosperity of each of our citizens.
    I prefer the idea of investing in human capital. Some of 
the proposals we will consider today will support tax relief 
for investing in physical and/or financial capital. That is not 
enough. Nor is it the correct focus, in my opinion.
    A Wall Street Journal survey of 1,500 economists indicated 
that the vast majority of them do not believe that proposals 
like the ones before us today will do much, if anything, for 
the economy. However, they gave much higher marks to the notion 
of investing in education in order to improve the abilities of 
our own workforce.
    I believe in that. I believe in making people capable 
themselves of improving their circumstances in life.
    If government is going to maintain the ability to help our 
citizens do that, then we must be cautious. We must craft our 
proposals carefully and spend our money wisely.
    We must be prepared to make the tough choices.
      

                                

    Mr. McCrery. Mr. Chairman, I beg your forgiveness. I did 
not request that my written testimony be included in the 
record. I will do so at this time.
    Chairman Archer. Without objection, as usual, the written 
testimony of every witness in the hearing today will be 
included in the record.
    Mr. McCrery. Thank you.
    Chairman Archer. And all witnesses are encouraged to keep 
their verbal testimony to within a 5-minute limit.
    Our next witness is the gentleman from Massachusetts, also 
a well-known Member of the Committee, Richard Neal.
    Mr. Neal, welcome to your own Committee.
    Mr. Neal. Thank you.
    Chairman Archer. And you may proceed.

 STATEMENT OF HON. RICHARD NEAL, A REPRESENTATIVE IN CONGRESS 
                FROM THE STATE OF MASSACHUSETTS

    Mr. Neal. Thank you, Mr. Chairman.
    I want to talk to you this morning about an issue that has 
been important to me since I arrived in the Congress, and that 
is the issue of savings for retirement. Alan Greenspan has said 
time and again--and I know it sounds trite on the surface, but 
nonetheless, it is critical, that the number one economic 
problem that faces America today is our low national savings 
rate. As the baby boomers grow older, they are faced with many 
difficult financial decisions, such as the cost of long-term 
care for elderly parents, the expense of higher education, and 
saving for retirement.
    The May issue of the Atlantic Monthly coined the phrase 
social insecurity. We are beginning to face what has commonly 
been referred to as the graying of America. Within 30 years, 
one out of every five Americans will be over 65, and in 15 
years, the baby boomers will begin turning 65. The baby boomer 
generation consists of 76 million members, and this will result 
in Social Security beneficiaries doubling by the year 2040. 
Less than half of all Americans are currently covered by 
private sector pensions, and 51 million Americans have no 
pension plan at all.
    We have an opportunity to encourage these individuals to 
begin to save. Congressman Thomas and I have introduced 
bipartisan, comprehensive individual retirement account 
legislation, commonly referred to as the Super IRA. We have 110 
cosponsors in the House, including 18 Members of this 
Committee, and Senators Roth and Breaux have companion 
legislation in the Senate, and they now have 49 sponsors. Those 
who watch tax policy have dubbed this the year of the great tax 
cut compromise. And while it is still doubtful that we are 
going to reach a total agreement this year, I do believe there 
is real consensus on the expansion of IRAs. Both the Senate 
Democratic and Republican leadership have introduced 
legislation which expands IRAs. The House Democratic bill is 
being introduced today. President Clinton has included expanded 
IRAs in the new type of IRAs in his budget.
    Most of us agree that IRAs will help to increase savings 
and make individuals more personally responsible for their 
retirement. Deputy Secretary Summers testified before the 
Senate Committee on Finance and said during his testimony that 
there are two general ways to address the effect of the low 
national savings rate on economic growth and retirement income 
security. The first way is to reduce the deficit, and the 
second is to improve current incentives to promote savings, 
especially retirement savings. President Clinton's proposal 
expands income limits, creates new backloaded IRAs, and 
eliminates the 10-percent penalty for early withdrawal under 
certain circumstances. These purposes are to pay postsecondary 
education; to purchase a first-time home, to cover the cost of 
unemployment, and also to cover medical expenses of certain 
close relatives who are not dependents.
    Under our Super IRA legislation, all Americans would be 
eligible for fully deductible IRAs by the year 2001. Taxpayers 
would be offered a new choice called the IRA-Plus Account. 
Under the IRA-Plus Account, contributions would not be tax 
deductible; however, earnings on the IRA-Plus Accounts can be 
withdrawn tax free if the account is open for at least 5 years 
and the IRA holder is 59\1/2\ years old. A 10-percent penalty 
would apply to early withdrawals unless the withdrawal meets 
one of three special purpose distributions. These special 
distributions are to buy a first-time home; to pay educational 
expenses; or to cover any expenses during the period of 
unemployment compensation for at least 12 weeks.
    These are all legitimate purposes. Otherwise, the 
contributions would be locked up for retirement. IRA and 401(k) 
contributions would not have to be coordinated. It seems to me 
this legislation is one of the best options that is available 
to all of us, and I believe it is important to enact some sort 
of incentive this year to help individuals save for retirement. 
As Professor Stephen Venti of Dartmouth testified recently 
before the Senate Finance Committee, the long-term benefits of 
the provision far outweigh the revenue costs.
    Mr. Chairman, this legislation in previous sessions was 
known, I believe, as the Bentsen proposal some years back, and 
a former Member and colleague on this Committee, Jake Pickle, 
also offered this proposal many times before. It seems to me 
that we have a unique opportunity, given the discussion that is 
occurring today about entitlement reform, and just as 
importantly, it is consistent with all discussions we have had 
about personal responsibility. This is a critical issue as we 
proceed to the new century, and I hope Members of this 
Committee, 18 of whom have already signed onto this 
legislation, will, I think, have the opportunity to promote 
this legislation as it comes before the full Congress.
    [The prepared statement follows:]

Statement of Hon. Richard Neal, a Representative in Congress from the 
State of Massachusetts

    Mr. Chairman, first of all I would like to thank you for 
allowing me to testify about an issue which is of vital 
importance to our economic security. This issue is savings for 
retirement. Chairman Alan Greenspan of the Federal Reserve has 
stated our number one economic problem is our low national 
savings rate.
    As baby boomers grow older they are faced with many 
difficult financial decisions such as the cost of long-term 
care for elderly parents, the expense of higher education, and 
saving for retirement. The May issue of Atlantic Monthly coined 
the phrase ``social insecurity.''
    We are beginning to face what has been commonly referred to 
as the graying of America. Within thirty years one out of every 
five Americans will be over sixty-five. In fifteen years, the 
baby boomers will begin turning sixty-five. The baby boomer 
generation consists of 76 million members and this will result 
in Social Security beneficiaries doubling by the year 2040. 
Less than half of all Americans are covered by private sector 
pensions. Fifty-one million American workers have no pension 
plan.
    We need to encourage individuals to save. Congressman 
Thomas and I have introduced bipartisan comprehensive 
Individual Retirement Account (IRA) legislation, commonly 
referred to as the ``Super IRA.'' We have over 110 cosponsors 
in the House, including eighteen Members of this Committee. 
Senators Roth and Breaux have introduced companion legislation 
in the Senate and they now have forty-nine cosponsors.
    Those who watch tax policy have dubbed this year as ``The 
Year of the Great Tax Cut Compromise.'' It still is doubtful if 
we will reach agreement this year, but I believe there is real 
consensus on the expansion of IRAs. Both the Senate Democratic 
and Republican leadership have introduced legislation which 
expands IRAs. The House Democratic leadership is introducing 
legislation today. President Clinton has included expanded IRAs 
and a new type of IRAs in his budget. Most of us agree IRAs 
will help increase savings and make individuals more personally 
responsible for their retirement. Recently, Deputy Secretary of 
the Treasury Lawrence Summers testified before the Senate 
Committee on Finance. During his testimony, he stated there are 
two general ways to address the effect of the low savings rate 
on economic growth and retirement income security. The first 
way is to reduce the deficit and the second is to improve 
current incentives to promote savings, especially retirement 
savings. We can accomplish both of these goals by enacting a 
budget which balances by 2002 and includes an expansion of 
IRAs.
    President Clinton's IRA proposal expand income limits, 
creates new backloaded IRAs, and eliminates the 10 percent 
early withdrawal for certain purposes. These purposes are to 
pay post-secondary education costs, to purchase a first home, 
to cover costs of unemployment, and to cover medical expenses 
of certain close relatives who are not dependents. Under the 
backloaded IRA, contributions would not be tax deductible, but 
if contributions remain in the account for at least five years, 
distributions of the earnings on the contribution would also be 
tax-free.
    Under the Super IRA legislation, all Americans would be 
eligible for fully deductible IRAs by the year 2001. Taxpayers 
would be offered a new IRA choice called the ``IRA Plus 
Account.'' Under the IRA Plus Account, contributions would not 
be tax deductible. However earnings on IRA Plus Assets can be 
withdrawn tax-free if the account is open for at least 5 years 
and the IRA holder is at least age 59 and . A 10 percent 
penalty would apply to early withdrawals unless the withdrawal 
meets one of the three special purpose distributions. The 
special purpose distributions are: to buy a first time home, to 
pay educational expenses, or to cover any expenses during 
period of unemployment compensation for at least 12 weeks. 
These are legitimate purposes. Otherwise, the contribution 
should be locked up for retirement. IRA and 401(k) 
contributions would not have to be coordinated.
    I believe the super IRA legislation is the best option 
before us. However, I believe it is important to enact some 
type of incentive to help individuals save for retirement. 
Individuals need to become more personally responsible for 
their retirement. Professor Stephen Venti of Dartmouth 
testified before the Committee on Finance that IRAs work. He 
stated: ``The long-term benefits of the provision far outweigh 
the revenue costs.''
    There is skepticism among economists about IRAs generating 
new savings. Professor Venti testified that many of those who 
contribute to IRAs are saving funds they would not otherwise be 
saving. One of our panelists will testify today that IRAs do 
not create new savings and just cause a shifting of funds. I 
believe there is enough evidence that IRAs promote savings. I 
cannot think of a better alternative. IRAs do create new 
savings and the shifting of savings usually locks up existing 
savings for retirement.
    Another import aspect of increasing savings is 
marketability. Individuals have to want to save. We need to 
offer products that they want and will make savings easy for 
them. Deputy Secretary Summers testified that IRA proposals 
must be designed to reinforce and encourage psychological 
factors that could increase the efficiency of IRAs in promoting 
savings. A 1990 Gallup survey done for Fidelity Investments 
showed 71 percent of the respondents preferred expanding the 
tax incentives for IRAs to close the gap between their 
retirement needs and their retirement checks from institutional 
sources. This same answer was given by 69 percent of the 
respondents in a 1996 Luntz-Lake survey conducted for the 
Savings Coalition.
    IRAs provide the right type of vehicle for long term 
savings for retirement. Those who invest in IRAs usually invest 
for the long term. For example, 86 percent of IRA assets at 
Fidelity are invested in equity funds, as compared to an 
average of 56 percent in non-retirement accounts. This shows 
individuals can make intelligent investments for their 
retirement. Most IRA account holders are truly thinking about 
retirement when they make their investment decisions.
    Millions of Americans do not have adequate retirement 
savings and are worried about their retirement. Even with 
Social Security, a couple earning $50,000 a year needs to have 
saved about $225,000 by retirement to maintain their standard 
of living over a 35 year retirement. A USA Today/CNN Gallup 
Poll showed four out of ten Americans sets aside less than 
$1000 a year for retirement.
    The Super IRA legislation is based on legislation crafted 
by Congressman Pickle and Senator Bentsen. This legislation is 
not a panacea for social insecurity that we will inevitable 
face, but it is a reasonable, concrete solution to make 
retirement savings easier. I encourage you to work with me on 
the passage of expanded tax incentives for IRAs. This type of 
proposal will have a drastic impact on millions of Americans. 
The bottom line is more Americans will be able to be personally 
responsible for their retirement.
    As the graying of America continues Congress will have to 
face many difficult decisions about the future of Social 
Security, but in the meanwhile, we can and must all agree on 
making retirement savings easier.
      

                                

    Chairman Archer. Thank you, Mr. Neal.
    Our next witness is also a Member of the Committee, the 
gentlelady from the State of Washington, Jennifer Dunn.
    You may proceed.

 STATEMENT OF HON. JENNIFER DUNN, A REPRESENTATIVE IN CONGRESS 
                  FROM THE STATE OF WASHINGTON

    Ms. Dunn. Thank you, Mr. Chairman.
    And my colleagues, I appreciate the opportunity to testify 
before you today on two matters that I believe are critical to 
the economic security of every American: The estate tax and 
capital gains relief. My message is quite clear: The 
President's budget simply does not add up in a way that is fair 
to taxpayers. First, it adds up to a tax increase over 10 
years. Second, it doesn't add up to a balanced budget. Both a 
balanced budget and meaningful tax relief are desperately 
needed.
    I have introduced legislation, the Return Capital to the 
American People Act, the ReCAP Act, which provides a capital 
gains reduction for both individuals and for corporations. This 
is legislation that is sponsored in the Senate by Senator Mack, 
and Mr. Herger has joined me in proposing this legislation. I 
won't go into the specifics of the bill since you have a 
detailed description, but I do want to briefly point out that 
the measure is broad based, and the capital gains measure 
includes a 50-percent capital gains deduction, indexation of 
assets to eliminate inflationary gains, and venture capital 
incentives to help cash-starved small and startup businesses.
    I will tell you that I believe an across-the-board cut in 
the capital gains rate for both individuals and corporations 
will do more to boost our Nation's economy, more to create 
jobs, more to enhance U.S. competitiveness worldwide, and more 
to increase savings and investment than any other single piece 
of legislation we can enact. While there are many reasons to 
support a reduction in the capital gains rate, I would like to 
highlight what I believe to be the most compelling parts of the 
ReCAP Act.
    One: A low capital gains rate benefits all Americans. My 
proposal is fair to all income groups and sectors of our 
economy. Two: Low capital gains is important for our future and 
our Nation's ability to save and to invest. Three: Lowering the 
capital gains rate unlocks investment and America's true 
economic potential. Four: Lower capital gains will increase 
Federal revenues, just as was done in the twenties, the 
sixties, and the eighties, and help us reach the goal of a 
balanced budget. Finally, with respect to capital gains, I 
would suggest that sound tax policy and economic considerations 
argue for the inclusion of a corporate capital gains rate 
reduction comparable to the percentage of the individual rates 
cut.
    Second, on the estate tax; this is also called the death 
tax, or, some of the people I represent call it the agony tax. 
One of the most compelling aspects of the American dream is to 
make life better for your children and your loved ones. Yet, 
the current tax treatment of estates is so onerous that when 
one dies, their children are many times forced to sell and turn 
over more than half their inheritance simply to pay the taxes. 
This is wrong, and I hope we can all agree that something 
should be done.
    More than 70 percent of family businesses and farms do not 
survive through the second generation. Eighty-seven percent do 
not make it through the third generation. By confiscating 
between 37 and 55 percent of a family's aftertax savings, the 
estate tax punishes lifelong habits of savings. It discourages 
entrepreneurship and capital formation. It penalizes families, 
and it has an enormous negative effect on other tax revenues. 
By today's tax system, it is easier and cheaper to sell the 
business before death rather than to try to pass it on after.
    I would like to talk briefly about solutions. I am a strong 
advocate of the elimination of all estate tax, and I have 
cosponsored two separate pieces of legislation in the 105th 
Congress to provide for that repeal. One is the Crane-Hulshof 
bill; the other is the Cox bill. Unfortunately, a complete 
repeal of the estate tax is not a viable option, considering 
the President's opposition. I am working with a number of our 
colleagues on the Committee to draft a bipartisan proposal. I 
believe such a proposal should be based on a three-pronged 
approach: One, increase in the unified credit; two, targeted 
relief for family businesses and farms; and three, to make it 
broader, some level of rate reduction.
    I had hoped we would have introduced our bipartisan 
proposal at the time of this hearing, but it could not occur. 
However, I am confident that through our continued vigilance, 
we can draft a bipartisan proposal that will be a vehicle for 
relief as the Congress moves forward.
    Thank you, Mr. Chairman, for your leadership in both of 
these areas, and thanks to the Committee for your attentiveness 
this morning.
    [The prepared statement follows:]

Statement of Hon. Jennifer Dunn, a Representative in Congress from the 
State of Washington

    Thank you, Mr. Chairman.
    My colleagues, I appreciate the opportunity to testify 
before you here today on two matters that I believe are 
critical to the economic security of every American--estate tax 
and capital gains relief.
    My message is quite clear--the President's budget simply 
does not add up in a way that's fair to taxpayers. First, it 
adds up to a tax increase over 10 years. Second, it doesn't add 
up to a balanced budget. Both a balanced budget and meaningful 
tax relief are desperately needed.

                             Capital Gains

    On March 12th, I introduced the Return Capital to the 
American People Act (ReCAP Act). This legislation provides a 
capital gains reduction for both individuals and corporations 
and will do more to boost our nation's economy, more to create 
jobs, more to enhance U.S. competitiveness worldwide, and more 
to increase savings and investment than any other single 
legislative change we can enact.
    For established, successful businesses, for struggling 
entrepreneurs, and for middle-class families across the 
country, this measure represents the most serious effort to 
unlock billions of dollars in investment providing for expanded 
growth and job creation. I will not go into many specifics of 
my bill, as a detailed description is provided for in the 
materials before you. I will, however, briefly point out that 
the measure is broad-based and includes: a 50 percent capital 
gains deduction, indexation of assets to eliminate inflationary 
gains and venture capital incentives to help cash-starved 
start-up and small businesses.
    While there are many reasons to support a reduction in the 
capital gains rate, I would like to highlight what I believe to 
be the most compelling case for enactment of the ReCAP Act.
    A low capital gains rate benefits all Americans. This bill 
is fair to all income groups and sectors of our economy. Many 
of the so-called ``rich'' who would benefit from a cut in 
capital gains taxes are only rich for one year. A family in 
Eatonville that sells its house, an owner in Issaquah who sells 
a small business, a worker in Bellevue selling stock received 
through an employee stock option, and a retiree in Auburn 
selling an asset and planning to live off the proceeds would 
all be considered wealthy on current ``tax distribution'' 
tables. For example, a review by the Joint Committee on 
Taxation on capital gains realizations for the period 1979-1983 
shows that nearly 44% of tax returns claiming a capital gain 
during that 5 year period claimed only one capital gain. Most 
of these people aren't rich, regardless of what statistics say. 
They merely have one year of inflated income because they 
realized a big capital gain.
    Furthermore, an analysis of 1993 tax returns found that 
nearly 50% of the tax returns reporting capital gains were 
filed by taxpayers with less than $40,000 in adjusted gross 
income. Of tax returns claiming a capital gain, nearly 60% of 
those returns are filed by taxpayers with less than $50,000 in 
adjusted gross income.
    Low capital gains rate is important for our future and our 
nation's ability to save and invest. Americans do not save 
enough. If you look at our tax laws, you will see why. Instead 
of encouraging people to save, the tax code often punishes 
people who save and invest. This is primarily due to the fact 
that the income tax hits savings more than once--first when 
income is earned and again when interest and dividends on the 
investment supported by the original savings are received. This 
system is inherently unfair because the individual or company 
that saves and invests pays more taxes over time than if all 
income were consumed and no savings took place. We need to 
change this. Without savings, a person cannot buy a house, a 
business cannot purchase new equipment, and our economy cannot 
create jobs. Unless we can raise our national savings rate, our 
standard of living, and our children's and grandchildren's 
standards of living will not grow.
    Lowering the capital gains rate un-locks investment and 
America's true economic potential. High capital gains taxes can 
prevent someone from selling an asset and paying the tax. This 
is the ``lock-in effect'': when a person will not sell an 
investment and reinvest the proceeds in a higher paying 
alternative if the capital gains taxes he or she would owe 
exceed the expected higher return on the original investment.
    This lock-in effect limits economic growth and job 
creation. Capital stays locked in an investment instead of 
being free to go to a person who wants to hire new employees in 
her consulting business. Lower capital gains taxes will reduce 
the lock-in effect and free up capital for small businesses, 
first-time home buyers, and entrepreneurs.
    Lower capital gains will increase federal revenues and thus 
help reach the goal of a balanced budget. History indicates 
that lower capital gains taxes have a positive impact on 
federal revenues. During the period of 1978 to 1985 the 
marginal federal tax rate on capital gains was cut from almost 
50 percent to 20 percent--but total individual capital gains 
tax receipts increased from $9.1 billion to $26.5 billion. 
After surging to $326 billion in 1986 (the year before the 1986 
rate increase took effect), capital gains realizations have 
trended down and remained at less than $130 billion per year in 
the 1990s.
    Given the increases in the stock market, inflation and 
growth of the economy since the late 1980s, realizations and 
taxes paid are certainly being depressed by the current high 
capital gains rates.
    Rather than discouraging American workers and businesses, 
the Federal government ought to simply get out of the way. 
Lower capital gains taxes--as embodied in this bill--leave more 
vital capital in the hands of businesses, investors and 
entrepreneurs. They know a lot more than the Federal government 
ever can or will about creating jobs and products in a 
competitive marketplace.
    I would also point out that sound tax policy and economic 
considerations argue for inclusion of a corporate capital gains 
rate reduction comparable to the percentage as individual rates 
are cut.
    History proves that capital gains tax reduction is the 
right course to take. In the past, reductions always have 
boosted the nation's economy and increased tax revenues to the 
federal government. If a goal of this Congress is to pass 
legislation promoting economic opportunity and growth in 
America, then common sense suggests that we enact the ReCAP 
Act.

Estate Tax Relief

    One of the most compelling aspects of the American dream is 
to make life better for your children and loved ones. Yet, the 
current tax treatment of estates is so onerous that when one 
dies, their children are many times forced to sell and turn 
over more than half of their inheritance to just pay the taxes. 
This is wrong and I would hope that we all can agree upon that 
and that something must be done.
    More than 70% of family business and farms do not survive 
through the second generation. 87% do not make it through the 
third generation. By confiscating between 37% and 55% of a 
family's after tax savings, the estate tax punishes life-long 
habits of savings, discourages entrepreneurship and capital 
formation, penalizes families, and has an enormous negative 
effect on other tax revenues. By today's tax system, it is 
easier and cheaper to sell the business before death rather 
than try to pass it on after.
    I would like to talk briefly about solutions. I am a strong 
advocate of elimination of all estate taxes and have 
cosponsored two separate pieces of legislation in the 105th to 
provide for that repeal. Unfortunately, a complete repeal of 
estate taxes is not a viable option considering the President's 
position.
    I am working with a number of our colleagues on the 
Committee to draft a bi-partisan proposal. I believe that such 
a proposal should be based upon a three-pronged approach: 1) 
increase in the unified credit, 2) targeted relief for family 
businesses and farms, and 3) some level of rate reduction.
    I had hoped that we would have introduced our bi-partisan 
proposal by the time of this hearing. Unfortunately, this could 
not occur. However, I am confident that through our continued 
vigilance we can draft a bi-partisan proposal that will be a 
vehicle for relief as the Congress moves forward.
    Thank you, Mr. Chairman for your leadership in both these 
areas. And thank you to the Committee colleagues for your 
attentiveness this morning.
      

                                

    Chairman Archer. Thank you, Ms. Dunn.
    Our final witness in this panel is another well-known 
Member of our Committee, Congressman Jon Christensen from 
Nebraska.
    Mr. Christensen. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Christensen, you may proceed.

STATEMENT OF HON. JON CHRISTENSEN, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF NEBRASKA

    Mr. Christensen. Thank you.
    This past week, I had the opportunity to convene a death 
tax roundtable in my district, in Omaha, Nebraska, and we had 
people from all sectors: From the accounting field; from the 
small business area; from the estate tax area; and financial 
planning. We listened to a lot of the stories they had 
experienced personally, and we had one individual who shared a 
good comment. Doug Kulak from Omaha said: ``Jon, I can prove 
two things to you. I can prove that Uncle Sam is not a blood 
relative; and second, I can prove that Uncle Sam squanders his 
inheritance.'' And I thought that that comment rang true in 
terms of what we are looking at today, a truly bipartisan group 
of people. You have never seen as many witnesses from both 
sides want to testify about an issue that is onerous; that is 
taking capital formation away; taking away the thriving 
opportunity to start and to continue a business.
    So, Mr. Chairman, I really believe we have an issue here 
that cuts across young, old, rich, poor, black, white, and that 
we can work together in a bipartisan fashion. More than 70 
percent of family farms do not make it to the second generation 
because of the death tax. As a matter of fact, 87 percent do 
not make it to the third generation. By confiscating between 37 
and 55 percent of a family's aftertax savings, the estate tax, 
which I like to call the death tax, punishes life-long habits 
of thrift, discourages entrepreneurship and capital formation, 
penalizes hard-working families, and has an enormous negative 
effect on other tax revenues.
    This past year, 1 year ago last week, I lost my father, who 
died unexpectedly of cancer. I have seen what my mother has 
gone through in terms of preparing the estate, going through 
all of the various tax and accounting and legal situations, and 
she spent upward in the neighborhood of $40,000 to $50,000 in 
just preparation and getting ready to go through the whole 
process. I have seen a lady who was not used to this whole 
process, who spent her life being a housewife, a farm wife, and 
all of this has gone on for the Federal Government to bring in 
1 percent. One percent of the Federal Treasury comes in from 
death taxes. Out of a $1.5 trillion budget, we are talking 
about $12 to $15 billion. And I have seen some studies where it 
showed that if you took the amount of money that was spent in 
second-to-die life insurance policies, which I made a living 
in, and attorney's fees, accountants fees, if you took all of 
the fees and added them up and allowed the individual to save 
that money and to invest it, to put it back into their 
business, to create jobs and opportunities, you would see more 
money generated from the income taxes and from Social Security 
taxes and the other areas for the Federal Government that would 
far outweigh the amount of money that was collected from the 
death tax alone.
    So, we have an issue here that I believe we can work 
together in a bipartisan fashion and achieve some kind of 
incremental reform. Now, I support the Hulshof-Crane bill; I 
support the Cox bill. But I also realize that the President 
isn't willing to go as far as we would all like to go. Now, we 
have had an opportunity to work with Erskine Bowles on the 
issue, and I applaud his leadership in starting to make some 
incremental reform in this area. But we need to go a lot 
further than the President has started. I believe an 
incremental form of raising the unified credit, from $600,000 
upward in the neighborhood of $1 million; indexing it to 
inflation. As a matter of fact, if it had been indexed to 
inflation, currently, it would be at $830,000 today.
    Second, I would agree with Ms. Dunn that we need to create 
an exemption for the family owned business. We also need to 
give some meaningful relief to family farms, ranches, and 
family owned businesses. Last, I believe we need to begin a 
reduction, a slight reduction, over the 55 percent, bring it 
down gradually over time: 55 to 54 to 53. Make some small steps 
in this area if we cannot go with a full repeal this year.
    I have a family friend out in western Nebraska, in Max, 
Nebraska, in Congressman Barrett's district. They were telling 
me about an issue where they had three siblings, four siblings 
in the family. Only one of them farmed. And so, therefore, they 
did not buy a large enough life insurance policy to be able to 
keep the one individual farming. They are struggling. They do 
not want to sell the farm. Yet, that happens every day in 
America, whether it is a small business or whether it is a 
family farm.
    Mr. Chairman, this is an issue we can agree on; we can work 
together on, and I applaud your leadership, and hopefully, we 
can get something passed in the 105th Congress.
    [The prepared statement follows:]

Statement of Hon. Jon Christensen, a Representative in Congress from 
the State of Nebraska

    Mr. Chairman, I want to thank you and my other colleagues 
of the Ways and Means Committee for this opportunity to testify 
on the savings and investment provisions in the 
Administration's budget. I want to focus in particular on the 
estate tax.
    The estate or death tax is killing family farms and small 
businesses. Today, more than 70 percent of all family farms and 
businesses do not survive through the second generation and 87 
percent don't make it to a third generation. How sad. According 
to the National Federation of Independent Business (NFIB), 90 
percent of small businesses which fail after the death of their 
founder are literally torn apart because the inheritance tax 
burden falls at a difficult time of transition. By confiscating 
between 37 percent and 55 percent of a family's after-tax 
savings, the estate tax punishes lifelong habits of thrift, 
discourages entrepreneurship and capital formation, penalizes 
hard-working families, and has an enormous negative effect on 
other tax revenues. Since the $600,000 unified credit, enacted 
in 1981, is not indexed for inflation, it is worth only about 
$377,000 in 1981 dollars. Every year the death tax brings more 
and more family farms and small businesses under its death 
sentence.
    I have witnessed how the estate tax can kill a family farm. 
In Max, Nebraska, a strong community in Congressman Bill 
Barrett's district, the Gardner family lives on a modest plot 
of land. They raise some cattle and grow wheat, corn and 
alfalfa. The land that the Gardners live on once belonged to 
Mr. Gardner's father who passed away two years ago. Before the 
elder Gardner passed away, he planned for his death. The 
Gardner family employed an attorney, an accountant, and a 
financial planner to assist them in their estate tax planning. 
They did everything that the lawyers and accountants told them 
to do and yet they still might lose their farm.
    Since the elder Gardner deeded his farm to his four 
children, and only one child and his family work on the farm, 
it has placed the other three siblings in an awkward situation. 
The Gardners did not purchase enough life insurance on their 
father, and when he died, there was not enough money to pay off 
the three siblings. If the siblings sell their land to the 
brother and his family, who work on the farm, they will pay 
exorbitant amounts in capital gains taxes. The son and his 
family who work on the farm are forced to lease the land from 
the other three siblings who do not work on the farm, making it 
nearly impossible to even keep up with the bills.
    The Gardners would be better off if they sold their whole 
farm to the highest bidder. They have land, cattle, and 
machinery worth about $1.8 million. But, the Gardner family is 
having a tough time making ends meet. I have asked Phyllis 
Gardner why they don't sell the farm. She, like almost every 
farmer and rancher I have ever known, is committed to keeping 
her family farm going--even if that means barely staying 
afloat. The federal government is destroying American family 
farms, ranches and small businesses. What the Gardner family 
has spent a lifetime working for, the federal government wants 
to take away.
    Many people assume that the estate tax, unlike the income 
tax, will affect them only if they have large estates. In a 
way, they are right. The estate tax won't directly hit you 
unless you have an estate with a taxable value of $600,000 or 
more (including any taxable gifts you've made during your 
lifetime). But, these days owning a home, a modest investment 
portfolio, life insurance, retirement benefits, a family farm 
or business can easily knock you into the estate tax realm. In 
1993, estates from $10 million to $20 million paid 18 percent 
in that year; those over $20 million paid just 12.6 percent. 
However, more than half the government's total estate tax 
revenue came from estates of $5 million or less.
    Others believe that the estate tax law won't affect them 
because they are leaving all of their property to their 
spouses. The tax law provides an unlimited marital deduction 
that allows you to leave all of your property to your surviving 
spouse free of federal estate tax. However, many people die 
without a surviving spouse. What happens if your surviving 
spouse dies, or if your spouse dies before you? The use of the 
marital deduction does not eliminate estate tax, it simply 
defers it until the surviving spouse dies.
    The estate tax accounts for roughly 1 percent of the 
federal government's tax receipts a year, but eats up 8 percent 
of Americans' savings each year. That's $15 billion that could 
be invested in expanding the economy. It the estate tax had 
been abolished in 1971, our national stock of savings would 
have been $399 billion larger in 1991, the gross domestic 
product would have be $46 billion higher and we would have 
262,000 more jobs.
    I support a full repeal of the federal estate tax and am a 
cosponsor of bills introduced by my good friends Rep. Crane, 
Hulshof, and Cox. However, I understand that not everyone 
agrees with me. To get meaningful tax relief passed by Congress 
and signed by President Clinton, we need to make incremental 
reforms. I believe that we need to do three fundamental things 
in reforming the estate tax. First, I believe we need to 
increase the unified credit and tie it to inflation. Currently, 
the estate tax credit is at $600,000. Had it been indexed in 
1981, it would be worth around $830,000 today. Second, I 
believe we need to create a family-owned business exclusion to 
the federal estate tax. Last, I think we need to look at an 
across-the-board reduction in the statutory estate and gift tax 
rate--a rate that reaches as high as 55 percent.
    Although the Administration's budget proposal provides 
estate tax relief, we need to take an ax to the estate tax and 
the Administration has handed us a butter knife. Under current 
law, estate tax attributable to certain interests in closely 
held businesses may be paid in installments over a 14-year 
period. A special four-percent interest rate is provided for 
the tax deferred on the first $1 million. The regular IRS rate 
on tax underpayments applies to values over $1 million. A 
special estate tax lien applies to property on which the tax is 
deferred during the installment payment period. Interest paid 
on the deferred estate tax is allowed as a deduction against 
either the estate tax or the estate's income tax deduction. The 
administration's proposal would increase the cap on interest 
rates so that it applies to the tax deferred on the first $2.5 
million of value of the closely held business. The current 4 
percent rate would be reduced to 2 percent, and the rate on 
values over $2.5 million would be reduced to 45 percent of the 
usual IRS rate on tax underpayments. The interest paid on 
deferred estate tax would not be deductible for estate or 
income tax purposes. While I applaud the Administration's first 
step, I believe that we can go much, much further in providing 
meaningful estate tax relief.
    In closing, I want to again thank you, Chairman Archer, and 
my colleagues on the Ways and Means Committee for the 
opportunity to testify before you today. The death tax is a 
disincentive for owners of family businesses and farms to 
expand their operation and create jobs. Repealing it would 
eliminate 82 pages of the tax code and 300 pages of regulations 
that American taxpayers are forced to follow. I believe as a 
society we are already taxed too much. We pay property taxes, 
sales taxes, gasoline taxes, and income taxes, just to name a 
few. The federal death tax is a tax on money that has been 
taxed at least once, if not more. Repealing or modifying the 
death tax will help ensure economic fairness for all American 
families and businesses, as well as provide economic growth and 
prosperity for the nation as whole.
    Thank you.
      

                                

    Chairman Archer. Thank you, Mr. Christensen.
    My compliments to each of you for, I think, excellent 
presentations.
    Does any Member of the Committee wish to inquire?
    Mr. Rangel. I guess my question to Ms. Dunn will be a very 
general question that everyone does not have to answer: What 
estimate do you have of the capital gains tax cuts that would 
please you--over a long period of time.
    Ms. Dunn. We do not have an estimate yet on our bill, but 
our bill includes some facets of other bills, and it could be 
as high as $60 billion over 10 years.
    Mr. Rangel. In estimates of many capital gains proposals, 
there is an increase in revenues in the early years and then, a 
large decrease in revenue in the later years. Proponents of 
cutting capital gains taxes complain about the method of 
calculating revenue losses. They claim you do not actually lose 
revenue. Notwithstanding that point of view, we must use the 
methods of CBO and the White House. So, how do you explain when 
people say that is a great idea, how you are going to pay for 
it? How do you respond to that? Since I have been here, the 
biggest argument against capital gains tax cuts that have been 
demanded has been the shortfall in revenue.
    Ms. Dunn. Mr. Rangel, I do believe that static scoring is 
not an interpretation of behavior, and I think that is a 
shortfall in our scoring system. I would like to see our bill 
scored under dynamic scoring, but that is not an opportunity 
for us right now, and that is why I gave you the number I did, 
because that is under static scoring, as close as we can come 
together with the facets of our bill, which, as I said, has not 
been scored since we introduced it just a week or so ago.
    My belief is based on history. In the twenties and the 
sixties and the eighties, consistently, we saw that when people 
were allowed to have some kind of rate reduction in capital 
gains, this unlocked assets. It caused and will cause a larger 
degree of trading of these assets. Somebody sells a home; that 
commission is given to a realtor. The realtor takes it to a 
local hardware store; the hardware buyer buys groceries and so 
forth, and that creates an increase in revenue.
    Mr. Rangel. I do not want to debate the merits. If you and 
I agree that dynamic scoring is not available to you and it is 
not available to me, then we put that issue aside. I would not 
want to discuss the merits regarding what positive impact it 
would have on the economy because you can line up the 
economists and get no concensus on that subject.
    But when it reaches the point that we have got to make 
certain that we come up with a revenue-neutral bill, that is 
when we look around and wonder, Who ``behind the tree'' are we 
going to tax in order to pay for a capital gains tax cut? Every 
time we talk this way, some program designed to give assistance 
to the poor not only comes up on the radar screen but stays 
there. Other ways of paying for it come and go. The President 
has a whole lot of revenue raisers that will not stand the 
light of day in this Committee. But he has proposed them as 
revenue raisers.
    So, I guess we do not have an answer today. Although I want 
so badly to work with both sides, it just seems to me that we 
cannot even consider the merits seriously until we find a way 
to raise the money so we end up with a revenue-neutral bill.
    Ms. Dunn. Mr. Rangel, I appreciate your point of view, and 
I agree with you. We do need to come up with the revenues. And 
in a broad context, I would say that that is where spending 
cuts come from. But in addition to that, as I say, there is 
revenue that is actually produced from the particular tax 
relief package that is contained entitled ``capital gains.''
    Chairman Archer. Does any other Member of the Committee 
wish to inquire?
    Mr. Becerra.
    Mr. Becerra. Mr. Chairman, thank you; I will be brief. I 
just have one question, and I offer it up to anyone on the 
panel. If we get into the discussion of dynamic scoring and 
what we consider investments that pay off more than they will 
cost us, I was wondering if any of you would be willing to 
comment on the whole issue of programs such as Head Start and 
prenatal care. We have been told in the past that if we invest 
$1 in Head Start, we can prevent a child from becoming an at-
risk youth and ultimately an adult offender; that individual 
who may go on to college and be more productive than just a 
high school graduate.
    We know that a $1 spent on prenatal care probably saves you 
$3 in after-birth costs of infants who are born with some 
abnormality or problem that could be prevented. I know we just 
had a debate last week on the whole issue of drugs and Mexico 
certification, and I saw some studies that showed that for 
every $1 we invest in preventing drug use and providing for 
drug rehab, we save $11 necessary to do drug interdiction and 
$23 to do drug eradication in foreign countries.
    Your thoughts on if we were to ever go toward some form of 
dynamic scoring, how we should score programs like Head Start 
or prenatal care.
    Mr. Christensen. Mr. Becerra, I think what you have touched 
on is a much deeper issue, and the issue goes to the 
fundamental question of what is the proper role of the Federal 
Government rather than the dynamic scoring issue.
    Mr. Becerra. But, then, no comment in terms of the dollars 
or the investments?
    Mr. Neal. I agree with you, Mr. Becerra, and believe that 
having children who can read and write is real national defense 
as well as what we do around here every day in providing for 
what we commonly refer to as the national defense.
    Mr. McCrery. I do not disagree with Mr. Neal entirely. 
There are all kinds of investments that we make as individuals 
and that we make as a government. I think, though, to be able 
to predict a return on the investment gets more difficult as 
you get into the programs such as those you mentioned. But 
certainly, some of those could be considered investments. But 
when you have to score it, it gets very difficult.
    Ms. Dunn. Mr. Becerra, I would just say that I know there 
are groups right now who are putting together plans for dynamic 
scoring. I think it would be very interesting for all of us to 
hear from them. I do not know the answer to your question. I 
would like to know the answer. When I think about what could 
pay for programs like what we have advocated today, though, 
there are certainly areas that do not have to do with Head 
Start or other areas that many of us do support that could be 
cut, and I would offer up one, the Government Printing Office, 
as an example of something that we have barely touched, and 
privatization, securing for the Government and the GPO the 
ability to contract out, that there is a cut just minimally at 
$1.5 billion over the next 5 years is how that has been scored.
    But certainly, when you come to dynamic scoring, you have 
to look at the change in behavior, and so, what you asked about 
Head Start as an example is going to depend on the welfare 
system and how well our changes are enacted and accepted there. 
But I simply say that behavioral scoring is very important. I 
realize we have to have a mix of the two, because you do not 
want to get out there too far, but people are putting together 
a plan, and it would be interesting at least for me to hear 
from those folks.
    Mr. Becerra. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Portman.
    Mr. Portman. A brief question for the panel on the estate 
tax issue. I appreciate the testimony from all my colleagues 
and sympathize with your position on the estate tax. I think, 
as Mr. Christensen said, it is more likely that we can reform 
it this year than repeal it, and I think some of these 
proposals make a lot of sense.
    My concern is simply on the issue of complexity and how you 
go about defining in particular family businesses and family 
farms. I have always believed that that would not only cause 
the IRS a lot of problems, and we are all finding out about the 
IRS' inability to administer our current code, but also our 
taxpayers. And it would, perhaps, Mr. Christensen, put a lot 
more money in the pockets of those tax planners you talked 
about and the lawyers and accountants and so on trying to 
figure out how to define your business in that way and to meet 
those criteria.
    Mr. McCrery, you had a thoughtful statement this morning, 
and I know you have thought a lot about this issue, so I will 
ask you: Why not--and perhaps this is simply a revenue issue--
why not simply raise the exemption, as you have suggested, to 
$1 million or even $1.5 million, change the provisions of the 
exemption to a real exemption so that the tax rate that applies 
is the lowest rate after that amount, and index it to inflation 
to be able to catch up to what would now be about an $830,000 
exemption had it been indexed for all Americans and not to try 
to define and to carve out these special categories within the 
tax law?
    Mr. McCrery. Well, I think the families that are being hurt 
the most by this are the ones that have invested in businesses, 
that have built their family businesses over generations, and 
some of the data we have seen recently talked about by Ms. Dunn 
and Mr. Christensen indicate that it is very, very difficult 
these days for those small businesses to survive generational 
transfer because of the estate tax. In a recent survey, the 
number one reason for small businesses and family farms ceasing 
to exist was the estate tax. That is why I have chosen to 
target those family businesses, family farms for relief. I 
think as Ms. Dunn and Mr. Christensen said, I, too, am for the 
abolition of the estate tax, but that is just not a realistic 
goal, I think, in the short term.
    So, when we start talking about limited revenue that we 
have for tax cuts, I wanted to target a proposal that would 
have minimal loss of revenue and do the most good: Get the most 
bang for the buck. And I think we do that when we target family 
businesses, family farms, family ranches for relief.
    Mr. Portman. And how do you respond to the concern that we 
may have difficulty defining those entities and that there may 
be the ability for taxpayers to shift assets around or even 
change forms of business to be able to qualify? And how can we 
avoid those problems?
    Mr. McCrery. You cannot avoid them.
    Mr. Portman. Is there a simple way to define what is a 
closely held or family business?
    Mr. McCrery. We have chosen the simplest way, which is not 
simple, and it is subject to interpretation. However, in the 
legislation that we are writing for introduction soon, we do 
expand the definition to bring in the greatest number of 
entities that one would normally think of as a family business. 
So, you are never going to be able to have a definition that is 
not subject to interpretation by the IRS or by us. But that is 
no reason not to endeavor to give relief to those folks.
    Mr. Portman. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Jefferson.
    Mr. Jefferson. I have an ever-so-brief question. I am 
trying to see--Jim, is it fair to say, if you have read 
Jennifer's proposal on estate tax relief, that yours is less 
broad than her proposal? Or are they more similar than I read 
them? She talks about unified credit, targeted relief for 
family farms. It is a level of rate reduction. You are talking 
about raising the exclusion to $1.5 million; you talk about a 
real unified rate. The first dollar over $600,000 you would tax 
at 18 percent. And I think another provision--I have kind of 
forgotten what it was.
    Mr. McCrery. Perhaps you would be interested in the 
historic property provision, Mr. Jefferson.
    Mr. Jefferson. I'm sorry?
    Mr. McCrery. Perhaps you would be interested in the 
historic property provision.
    Mr. Jefferson. Yes, sir; that would be appealing to me, 
sir.
    But what is the difference, sir, between what you are 
proposing and what Jennifer is proposing on estate tax relief?
    Mr. McCrery. Actually, Ms. Dunn and I worked together for a 
long time developing a new bill, and we ended up deciding to 
introduce two different bills. The primary difference is the 
approach on estate tax relief. She chooses to reduce rates from 
the top down, basically; I choose to reduce rates from the 
bottom up. So, I target more relief to the smaller businesses, 
the smaller estates than she has chosen to in her bill. I do 
not disagree with her approach. I would love to do that. I just 
think the people in this country who are getting hurt most by 
the estate tax are your smaller businesses, smaller farms, and 
I want to target relief as much as I can to those folks with 
the limited revenue that we are going to have available to use 
in any tax cut portion of reconciliation.
    Mr. Jefferson. Consequently, yours is less expensive in 
that area than hers is. It is more targeted and less expensive.
    Mr. McCrery. Yes.
    Ms. Dunn. Mr. Jefferson, let me just add that mine is 
similar to Mr. McCrery's, but we have a broader approach in 
that we also do the rate reduction. And my thought, even though 
we haven't filed the bill yet, is that we would, at some point 
in the near future, begin a rate reduction of 1, 2, or 3 
percent a year on the top rate. But responding to Mr. Portman, 
too, I would just say there are lots of ways to go about this, 
and one would make estate taxes comparable to regular income 
taxes. I think that could simplify the system, if you took away 
the entire rate that is currently in place on estates and make 
estates, inheritance, subject to regular income tax rates.
    Chairman Archer. Mr. Jefferson, have you concluded your 
inquiry?
    Are there any other Members who wish to inquire?
    If not, the Chair would just conclude by making a couple of 
small requests: Mr. McCrery, do you have a revenue estimate on 
your proposal?
    Mr. McCrery. Not yet, Mr. Chairman. We are having 
legislation written as we speak.
    Chairman Archer. OK.
    Mr. McCrery. We will get that to the Joint Committee on 
Printing as soon as possible.
    Chairman Archer. Mr. Neal, do you have----
    Mr. Neal. We do not have a final one.
    Chairman Archer. You do not either.
    Ms. Dunn mentioned her revenue----
    Mr. Christensen. No, Mr. Chairman, we are waiting.
    Mr. McCrery. Mr. Chairman.
    Chairman Archer. Yes.
    Mr. McCrery. The bill we had introduced last year was $6 
billion over the 5-year budget window. We expect this year's 
bill to be very close to that.
    Chairman Archer. OK; thank you very much and thank you 
again for your testimony.
    Our next panel is a number of our own colleagues from other 
Committees, and if you will take your seat at the witness 
table: Hon. David Dreier, Christopher Cox, Collin Peterson, 
Peter Deutsch, Earl Pomeroy, and Karen McCarthy.
    Gentlemen and Ms. McCarthy, a warm welcome to each of you. 
Mr. Dreier, if you would be our leadoff witness for this panel, 
we would welcome you, and you may proceed.

 STATEMENT OF HON. DAVID DREIER, A REPRESENTATIVE IN CONGRESS 
                  FROM THE STATE OF CALIFORNIA

    Mr. Dreier. Thank you very much, Mr. Chairman, and let me 
say I am somewhat embarrassed to be here before you advocating 
any tax on capital whatsoever. The fact of the matter is that 
you and I share a view that there should not be a tax on 
capital, and I think it is very important to recognize that 
what we are proposing is, I believe, a very good compromise 
position.
    I have talked at length with you, with Charlie Rangel, with 
Mr. Crane, other Members of this Committee, Mr. Jefferson just 
yesterday, on this issue, and I think it is a very, very 
important one. On the opening day of the 105th Congress, your 
Committee Member Phil English and I joined with my colleague, 
the former Chairman of the Ways and Means Committee of the 
Missouri State Legislature, Congresswoman Karen McCarthy, Jim 
Moran of Virginia, and Ralph Hall of Texas--more Democrats than 
Republicans on the opening day--and we are joined today by 
Peter Deutsch from Florida, another Democrat, who has joined 
along with 90 Democrats and Republicans in cosponsoring the 
bill we introduced on the opening day, which takes the top rate 
on capital gains from 28 percent to 14 percent and indexes.
    Now, I have been listening to the testimony of the other 
panel, and I think that some important things have been said 
which I believe need to be underscored, and I would like to try 
and maybe answer some of the questions that were posed by 
Members of the Committee as we proceed.
    I agree with Jennifer Dunn that the reduction of that rate 
on capital gains would do more than almost anything to boost 
the economy. There are three things we have been focusing on in 
a bipartisan way in this Congress. They include trying to 
balance the budget, increasing the take-home pay of working 
Americans, and spurring economic growth. And as we look at 
halving the capital gains tax rate, it seems to me we can 
successfully address every single one of them.
    This argument that has been made by so many, and I think 
Charlie Rangel very appropriately asked about the cost factor, 
is one that needs to come forward, but we also have to look at 
the benefit that is going to be accrued to the economy. We are 
at a point where I think we should recognize that the economic 
growth we are enjoying today is not going to continue ad 
infinitum, and I think a capital gains tax rate reduction is 
going to be pivotal to our attempt to ensure that we do not 
move into recession.
    We all know the chairman of the Federal Reserve has made a 
very strong statement on the issue of capital gains, and so, I 
think a capital gains tax rate reduction would be a federally 
friendly reduction, which I think is something that also needs 
to be addressed.
    And also, I am gratified by the fact that we very rarely 
hear the argument that was so prevalent during the last several 
years, that being that reducing the top rate on capital gains 
would be nothing but a tax cut for the rich. The arguments that 
were made by the last panel, I think, very appropriately put 
forward the fact that 40 percent of capital gains taxes are 
realized by people who earn less than $50,000 a year. Peter 
Deutsch, I suspect, might mention something that he said to me 
the other day: 63 million American families have mutual funds 
today. So, this is something that I believe is very important 
for us.
    To specifically get into Charlie's question on the cost 
factor, we have scored with CBO and Joint Tax a $44 billion 
cost over that 5-year period, although, as I just said, I think 
it is important to recognize that we should look at the 
benefits. This ``cost'' would be less than half of the proposal 
in the President's cost, and I think if you look at more 
realistic scoring, we several years ago formed what I call the 
Zero Capital Gains Tax Caucus, bipartisan, bicameral, and I 
think that over a 7-year period, if we look at this, we could 
have a gain of $211 billion in revenues to the Treasury.
    Mr. Rangel, you and I have often talked with our mutual 
friend Jude Wanninski on this--yes, well--[Laughter.]
    Mr. Dreier. The fact is that we do both talk to him, and I 
think that it is no secret that we do, and there is going to be 
a real benefit. Frankly, Bill Jefferson, I know, has raised 
this. Xavier Becerra has raised this; you have raised this, the 
need to address the challenges that exist in the inner city and 
other areas. I believe that what we are proposing would go a 
long way toward getting the needed capital into the areas where 
you and I are very, very concerned, and I hope very much that 
the Committee will proceed with this and, again, recognizing 
that we have broad, bipartisan support.
    The President is great in focusing on the issue of capital 
gains reduction in the area of human capital, his education 
area. But we also have to look at the other half of the 
equation, and that is physical capital that goes along with it, 
and that is why an across-the-board proposal, I think, would be 
very beneficial.
    Thank you very much for inviting me to be here, Mr. 
Chairman. I am used to looking at you in the Rules Committee, 
and so, it is nice to have a chance to come before you and all 
of the other distinguished members of this panel.
    [The prepared statement follows:]

Statement of Hon. David Dreier, A Representative in Congress from the 
State of California

    Mr. Chairman, Members of the Committee, thank you for 
holding this important hearing on the tax proposals in 
President Clinton's fiscal year 1998 budget submission. I am 
grateful for the opportunity to take a few minutes to discuss 
the President's proposal for a very limited modification in the 
capital gains tax, and my support for a major reduction in this 
anti-investment, anti-growth and anti-savings tax.
    I believe that we must judge any tax proposal on its 
ability to address two of our most pressing economic needs--
increasing real economic growth and raising the wages of 
working Americans. Cutting the capital gains tax rate in half 
offers one of the most reliable, fair and fiscally responsible 
methods of achieving those two goals.
    On the first day of the 105th Congress I joined with a 
bipartisan group of our colleagues to introduce H.R. 14, 
legislation to cut the maximum tax rate on capital gains to 14 
percent, reduce the lower tax rate from 15 percent to 7.5 
percent, and end the taxation of capital gains due solely to 
inflation. Today, over 90 of our colleagues have sponsored this 
bipartisan bill.
    A capital gains tax cut should not be a partisan issue. 
Reducing the tax on investment puts good public policy ahead of 
politics. Promoting investment in new factories, equipment, 
machine tools and technologies will benefit working people of 
every income level. Cutting the capital gains tax rewards 
homeowners, farmers, small business people, entrepreneurs and 
mutual fund holders, not Democrats or Republicans.
    Mr. Chairman, balancing the federal budget by 2002 is a 
goal I share, and I know you share, with President Clinton and 
the majority in Congress. This is clearly a top fiscal 
priority. At the same time, the balanced budget passed by 
Congress the past two years, as well as the President's FY 1998 
budget proposal, illustrates the clear fact that tax cuts and a 
balanced budget are not incompatible. The President's budget 
includes nearly $100 billion in tax cuts. Although I prefer a 
more aggressive tax cutting agenda, I believe that we can do 
much to improve our economy, raise living standards, and help 
balance the budget with tax reductions totaling $100 billion 
over five years.
    A broad-based capital gains tax cut such as that embodied 
in H.R. 14 would account for less than half of the President's 
$100 billion tax cut target. Most important, it is a tax cut 
that is likely to help us attain a balanced budget by 2002. 
Even if Congress and the President agree on a bipartisan 
balanced budget this year, a recession between now and 2002 
will derail the process. A capital gains tax cut is the best 
antidote to a balanced budget-killing recession.
    Mr. Chairman, fiscal policy, budget policy, and tax cuts do 
not occur in a vacuum. There is no question that the Federal 
Reserve Board's interest rate policy can make or break the 
success of any balanced budget plan that cuts taxes. If the Fed 
believes that a given tax policy raises the prospect of 
inflation or fails to increase real economic productivity, it 
is possible that monetary policy will not be supportive. 
Therefore, I was very encouraged by the comments of Federal 
Reserve Board Chairman Alan Greenspan before the Senate Banking 
Committee last month. He said:
    I think while all taxes impede economic growth to one 
extent or another, the capital gains tax, in my judgment, is at 
the far end of the scale. And so, I argued that the appropriate 
capital gains tax rate was zero. And short of that, any cuts 
and especially indexing would, in my judgment, be an act that 
would be appropriate policy for this Congress.
    Mr. Chairman, I know you share the view of Chairman 
Greenspan that the best capital gains tax rate for the overall 
health of the economy would be zero. I share that view, and I 
organized the bipartisan, bicameral Zero Capital Gains Tax 
Caucus in the 103rd Congress to raise that issue. However, 
given that the President has not proposed reducing the current 
tax rate, I believe that totally eliminating this anti-
entrepreneur tax is not politically feasible. However, we can 
split the difference. Cut the 28 percent rate in half, to 14 
percent.
    The capital gains tax has become a political football 
because of charges that it is a tax cut for the rich. While I 
don't think punitive, politically motivated, class-warfare 
goals ought to determine our tax policy, I would argue that the 
charge is simply incorrect. As The New York Times detailed in a 
major report in December, the capital gains tax ``is becoming 
largely academic to the nation's wealthiest taxpayers.'' That 
report quoted David Bradford, an economist at Princeton 
University, expressing a view too many families on Main Street 
USA share. ``The Government can adopt rule after rule after 
rule--but the people who will get stuck paying capital gains 
taxes will be the ordinary investors,'' said Bradford.
    Mr. Chairman, forty percent of annual capital gains are 
realized by people with incomes of less than $50,000. Regular 
people--farmers, small businessmen, families with some savings 
in mutual funds, small investors with rental property--are the 
ones who face the bite of the capital gains tax. They are left 
out in the cold by the President's very narrow capital gains 
tax proposal that places good politics over sound economic 
policy by selectively targeting one type of investment.
    Even though many middle income Americans will directly 
benefit from a broad-based reduction in the capital gains tax, 
we must move beyond looking at who gets the tax cut and focus 
of the economic benefits of any tax change. At the very top of 
our priority list must be ensuring that we, as a nation, make 
the investments needed to help working families raise their 
living standards.
    While I am not convinced that President Clinton's education 
tax credits will work, I cannot argue with his goal of using 
the tax code to promote investments to raise the skill-level of 
new workers and help current workers learn new skills. 
Economists would call that investment in human capital. His 
proposals deserve a serious look.
    At the same time, investment in the skills of working 
people only addresses half the equation. It is also critical 
that we encourage the private sector to invest in the machines, 
technology and tools that will raise the productivity of 
American workers, and thus their wages. Cutting the capital 
gains tax rate in half will do just that. Economists call this 
pro-worker tax reform investment in physical capital.
    Cutting the tax rate on capital gains will lower the cost 
of investing in the kind of tools and technology that makes 
American workers the most productive in the world--and that 
means higher pay. A 1993 study by the Institute for Policy 
Innovation predicted that cutting the capital gains tax rate to 
15 percent and indexing the rate to inflation would boost the 
wages of the average American worker by $1,500 over seven 
years. Those are gains that don't expire at some future date 
like some self-advertised pro-family tax cuts. Of course, the 
tax cut will also bring immediate relief to small investors, 
small business owners, family farmers, homeowners, and the 
elderly.
    Mr. Chairman, there is much to be done to get our economic 
house in order. We must balance the budget because mounting 
debt saps life from the productive sectors of our economy and 
strangles resources needed for important government programs. 
We must also help the working families that have seen their 
incomes stagnate as they try to prepare their children to get 
good 21st century jobs. While the President is proposing tax 
credits to help with college costs--a commendable goal--we also 
owe those working families a broad-based capital gains tax cut 
to ensure that plentiful technology, tools and high-wage jobs 
are available in coming years.
    Thank you again for giving me the opportunity to testify 
this morning.
      

                                

    Chairman Archer. Thank you, Mr. Dreier.
    Mr. Deutsch, since your name has been mentioned in Mr. 
Drier's testimony, we would be pleased to recognize you. 
Welcome to the Ways and Means Committee. You may proceed.

 STATEMENT OF PETER DEUTSCH, A REPRESENTATIVE IN CONGRESS FROM 
                      THE STATE OF FLORIDA

    Mr. Deutsch. Thank you, Mr. Chairman. I appreciate it. I'm 
glad you remembered what we talked about, which is a good sign.
    We are clearly living through an incredible age in American 
history and in world history, in a sense, a blessed age to be 
living through, a renaissance of the American economy. The 
American economy has leapfrogged other economies in the world, 
and we literally, whether we acknowledge it or not, are in a 
new age in terms of economics. We are an economic powerhouse. 
We have transcended the age, and we are in an information age, 
and where it is going to end, we do not know.
    And access to capital is critical in this age. We have the 
ability, as the U.S. Congress, to grow the economy more, and we 
have the ability on the capital gains issue to do that 
specifically.
    I am going to focus a little bit, though, on the fact, and 
I think it is appropriate to talk a little bit about how this 
issue has come to us today in the present form that it is, that 
capital gains cuts too often have been viewed, I think, in a 
demagog way really by my own party, that a capital gains cut is 
a cut that just benefits the wealthy, and that's why some 
people, on occasion, have spoken against it.
    I think that that attitude is changing and is also just 
flat wrong. Obviously, growth in the economy affects everyone 
directly, but there are just some fascinating things that have 
happened in the economy. First, just the statistics themselves, 
I think, are important. Another number, even below the $50,000 
threshold, in 1993, 37 percent of U.S. taxpayers reporting 
capital gains and income of $30,000 or less. But the phenomenon 
of mutual funds and the fact of the investments of middle-class 
Americans in mutual funds is a phenomenon that really did not 
exist 10 years ago. Sixty-three million American households 
have investments in mutual funds. It is an incredible 
statistic, an absolutely incredible statistic. A majority of 
these households have incomes ranging from $35,000 to $75,000.
    The growth has been unbelievable: 20 percent growth since 
1994, 800 percent growth since 1990. It is a phenomenon that if 
we do not acknowledge as policymakers, I think we are missing 
something very important. Again, I am going to speak to my own 
party and really to the President: I think not to support 
across-the-board capital gains cuts misses this entire group of 
people; essentially misses the middle class of America. If we 
are looking for a middle-class tax break in the United States 
of America in 1997, what we really ought to be talking about is 
capital gains cuts. If you tie it into the phenomenon of mutual 
funds, there are literally hundreds of billions of dollars, in 
a sense, of phantom income that people are paying tax on, and 
the phantom income I am describing, because the typical 
situation, where it is a mutual fund that is a retirement fund, 
but mostly middle-class people, and you can look to yourself 
and your friends whom you know and your constituents. What are 
they doing with their capital? For most Americans, where are 
they putting their capital that they are earning on a daily 
basis, a monthly basis? An incredible percentage, 90 percent of 
capital, in the last several years has been going into this 
phenomenon.
    And the phantom income, in a sense, is people are getting 
taxed on the appreciated gains, but generally, they are not 
selling the mutual fund in terms of paying that tax. That is 
coming out of their disposable income. And it is a phenomenon 
that people are seeing. And I think as an institution, this 
Congress is missing the boat. It is missing a phenomenon in the 
American economy not to be changing the capital gains tax for 
the broad-based economic reasons that we are talking about, to 
grow the economy.
    But also, if we are talking about middle-class tax cuts, 
for 63 million American households, the numbers speak for 
themselves. If we want to give people more money back in their 
pockets; if we want to help the hard-working people who are the 
core of our economy and the core of our society, then, that is 
what we need to do, and I urge this Committee to take that 
action, and I urge my colleagues in the Congress in general to 
support an across-the-board capital gains cut.
    Thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Representative Peter Deutsch, a Representative in Congress 
from the State of Florida

    Mr. Chairman, Members of the Committee, thank you for this 
opportunity to discuss with you what I see as perhaps the most 
important issue in U.S. tax policy--the capital gains tax. 
President Clinton's budget calls for a targeted modification to 
the capital gains tax. I would argue that our economy would be 
served better by a comprehensive capital gains reduction. This 
reform would be good for the American people, good for the 
national economy, and can be accomplished in the context of a 
balanced budget.
    I have worked in Congress to eliminate the federal deficit, 
balance the budget, and promote an equitable economic package 
for my constituents in South Florida and the American people. 
While we have made great strides in reducing the deficit and 
committing in principle to balance the budget by 2002, we have 
failed to address capital gains reform. Reducing the tax can 
only benefit the economy and the public. Such a move will 
encourage savings and investment and is necessary if we as a 
nation are going to compete globally and have a healthy 
economy.
    What many fail to see is that a capital gains tax reduction 
would benefit all Americans. In fact, 40 percent of capital 
gains are realized by individuals with incomes less than 
$50,000. Now more than ever, capital gains is an issue that 
crosses socioeconomic borders. Consider the massive movement 
toward mutual funds which has become the preferred savings and 
investment vehicle for more and more Americans. Today, an 
estimated 63 million Americans and 37 million households are 
invested in mutual funds. That figure represents a 20 percent 
growth since 1994 and an 800 percent jump since 1980. The 
majority of these households have incomes ranging from $35,000-
$75,000--a true example of how middle income America is now 
affected by the capital gains tax. Eighty-four percent of 
mutual fund investors are primarily investing for retirement. 
Middle aged Americans comprise the largest bloc of mutual fund 
investors as 35-64 year olds own 77 percent of the mutuals. 
With the explosion of mutual funds among middle class families, 
Congress should encourage more savings and investment by 
reforming the capital gains tax.
    The appropriate way to meet the needs of a growing market 
and the public's changing attitude towards investment is to 
incorporate real capital gains relief into any economic package 
that we support. I am a cosponsor of H.R. 14--The Capital Gains 
Tax Reduction Act of 1997--a bipartisan bill which is 
cosponsored by over 90 of my colleagues. H.R. 14 would cut the 
maximum tax rate on capital gains to 14 percent, reduce the 
lower rate to 7.5 percent, and index for inflation. This 
legislation represents a strong, comprehensive effort to attack 
an issue that threatens to hinder the potential growth of the 
U.S. economy.
    It is time that members of Congress get serious about 
capital gains tax reform--Republicans and Democrats alike. 
Reducing the tax on capital gains should not be a partisan 
issue or used as a political tool. As a Democrat who supports a 
reduction in the capital gains tax, I am working with my 
Democrat colleagues to forge a consensus on this issue. Some of 
my colleagues believe that a capital gains tax reduction would 
solely benefit the rich. It is apparent that is simply not the 
case. I am currently spearheading an effort to form a consensus 
within the Democratic Caucus by openly calling for my Democrat 
colleagues and President Clinton to address capital gains 
relief within the context of a balanced budget.
    Mr. Chairman, thank you again for this opportunity. I look 
forward to continuing our efforts to encourage more savings and 
investment for more Americans.
      

                                

    Chairman Archer. Thank you, Mr. Deutsch.
    The Chair next recognizes Congresswoman Karen McCarthy, who 
is also a cosponsor of H.R. 14.
    Ms. McCarthy, welcome to the Ways and Means Committee.

STATEMENT OF HON. KAREN MCCARTHY, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF MISSOURI

    Ms. McCarthy. Mr. Chairman, I thank you. I am very honored 
to be here on behalf of H.R. 14 to express my support in this 
bipartisan effort. It is critical, as you have heard from the 
numerous Members who have already testified, that we in the 
105th Congress address tax relief. This particular legislation 
will help homeowners, working families, and will also help the 
private sector promote job growth.
    I wanted to speak very briefly about what that will mean 
for the small businesses in my district and around the Nation, 
because they are very concerned about their businesses as it 
relates to capital gains. A survey of the 3,000-plus members of 
the Greater Kansas City Chamber of Commerce reflects that a 
primary concern of businessowners is the reduction of the 
capital gains tax rate. Under the status quo, financial 
resources are trapped and precluded from benefiting our economy 
as a whole.
    In the metropolitan Kansas City area, which I represent, we 
know that a majority of the job growth will come from existing 
firms. So, with the relief that is provided in H.R. 14, job 
growth will be enhanced, not prohibited. Mr. Chairman, whether 
the legislative vehicle is H.R. 14 or one designed by your 
Committee in its wisdom, I believe we must address this issue, 
build on the bipartisan agreement we have in place through our 
President and our legislative leaders on both sides of the 
rotunda, and pass a capital gains tax reduction in the 105th 
Congress. Working men and women in my district and around the 
country would benefit from a meaningful capital gains tax 
reduction, because the investments, savings, and the economy 
would all gain from unleashing these captured resources.
    You have my written testimony, Mr. Chairman. I very much 
appreciate the responsibility you have in moving this issue 
along, and I, therefore, would refer you to that and would be 
happy to answer any questions when time permits.
    [The prepared statement follows:]

Statement of Hon. Karen McCarthy, a Representative in Congress from the 
State of Missouri

    Mr. Chairman, Members of the Committee, thank you for 
holding this hearing on the President's tax proposals, and for 
allowing me to address the committee on this important subject. 
As many of my colleagues have testified, I also believe we 
should pass middle-class tax relief during the 105th Congress, 
especially for homeowners and working Americans. As an original 
cosponsor of HR 14, the Capital Gains Tax Reduction Act of 
1997, I would like to note the bipartisan support that is 
building for this legislation. Our proposal will bring 
immediate relief to working families, small business owners, 
individual investors and seniors.
    As we work to develop a balanced budget that is reasonable 
and fair to all Americans, we must ensure that we, as a nation, 
make the investments needed in human capital to help working 
families raise their standards of living. President Clinton 
proposed a capital gains exclusion on the sale of a principal 
residence, which will help homeowners, in addition to proposing 
much needed investments in education to grow the skill level of 
new workers while helping enhance the abilities of the current 
workforce.
    These investments are an important step, but only address 
part of the equation. It is also critical that we encourage the 
private sector to invest in the physical capital of machines, 
technology and tools that will increase the productivity of 
American workers and our economy. H.R. 14, the Capital Gains 
Tax Reduction Act of 1997, cuts the top tax rate on capital 
gains from 28% to 14%, the lower tax rate from 15% to 7.5% and 
indexes assets to inflation. This will help homeowners and 
working families, but also help the private sector promote job 
growth. Many of the small business owners in my district and 
around the Nation are very concerned about their businesses as 
it relates to the capital gains tax rate. A survey of the 3,000 
plus members of the Greater Kansas City Chamber of Commerce 
reflects that a primary concern of business owners is the 
reduction of the capital gains rate. Under the status quo, 
financial resources are trapped and precluded from benefitting 
our economy as a whole. In the metropolitan Kansas City area, 
we know that a majority of the job growth will come from 
existing firms. With the relief provided in H.R. 14, job growth 
will be enhanced and not inhibited.
    The overall benefit of a capital gains rate reduction will 
be felt in each and every household which we are privileged to 
represent. An increasing number of Americans have become 
investors in mutual funds, stocks, bonds, and other securities. 
These individuals are trying to provide for a better future for 
themselves and their families. Even without extraordinary gain 
in the capital markets, they are trapped in their investments 
with the current tax structure. Looking a step further, one 
finds that our citizens are participating in pension plans 
which could benefit from the passage of H.R. 14.
    It is time to move beyond politics and make the investments 
needed to raise the incomes of working families and ensure a 
growing economy. This year's important bipartisan agreement on 
priorities for the 105th Congress between President Clinton and 
congressional leaders included both education initiatives and 
tax relief. Whether the legislative vehicle is HR 14, or Mr. 
Matsui's HR 420, the Enterprise Capital Formation Act of 1997, 
of which I am also a cosponsor, we should build on that 
bipartisan agreement and pass a capital gains tax reduction in 
the 105th Congress. Working men and women in my district and 
around the country would benefit from meaningful capital gains 
rate reduction because the investments, savings, and the 
economy would all gain from the unleashing of these captured 
resources.
      

                                

    Chairman Archer. Thank you very much, and I understand that 
you were Chairman of the Ways and Means Committee in the 
Missouri Legislature, so you can understand the 
responsibilities that go along with this.
    Ms. McCarthy. I am very respectful and mindful of those 
responsibilities, Mr. Chairman, and I appreciate the task that 
you are about.
    Chairman Archer. Thank you for your testimony.
    Our next witness is Hon. Chris Cox of California. Welcome 
to the Committee. We are delighted to have you, and we will be 
pleased to receive your testimony.

STATEMENT OF HON. CHRISTOPHER COX, A REPRESENTATIVE IN CONGRESS 
                  FROM THE STATE OF CALIFORNIA

    Mr. Cox. Thank you, Mr. Chairman, and I, too, am a sponsor 
of H.R. 14 and any other legislation to the same effect. Often, 
and this morning is no exception, when we talk about reducing 
tax rates, we confuse the discussion with reducing tax 
revenues, and the question arises: How are you going to pay for 
it?
    There are two problems with this. One is that the 
presumption that an adjustment in tax rates is going to cost 
revenue to the Treasury is often false, and second, the use of 
the personal pronoun ``you'' is ambiguous. When we ask the 
question, How are you going to pay for it, it is not clear who 
you is. I would suggest that we would be just as well advised 
to have the antecedent of you be the American people as the 
Government of the United States, because the Government will 
never be fiscally sound over the long term if the economy which 
supports it is not.
    And so, if we have not figured out how the American people 
are going to pay for this, we have an even bigger problem than 
if we have not figured out how the government is going to pay 
for it. On the first point, on the false premise that reducing 
tax rates is going to lead inexorably to lower revenues to the 
Treasury, I would cite only our own experience with the Joint 
Committee on Taxation and with the estimates of past revenue 
legislation. We are talking this morning about capital gains, 
and it is a perfect example, probably the best example. You all 
know--and some of you served on this Committee in 1978 when 
this happened--that when STIGR was proposed, Joint Tax told us 
it was going to cost a bundle. It was going to cost a lot of 
money to reduce the capital gains tax rate by almost half, as 
we did in 1978.
    But Joint Tax was wrong. It did not cost a bundle. In 1979 
and 1980, revenues went up. Then, we heard testimony before 
this Committee that this was a one-time phenomenon; there was 
sort of a fire sale effect. Well, of course, with all of this 
pent-up, locked-up capital, you would get an immediate effect 
from reducing the rate of tax on capital gains, but it could 
not last. And yet, in 1981, when this Committee passed the 
Economic Recovery Tax Act, and Joint Tax told us that surely, 
reducing the rate further, from 28 percent down to 20 percent, 
phased in between 1981 and January 1, 1983, surely, that would 
really cost a bundle. And they were wrong again; it did not 
cost a bundle. It, in fact, raised a bundle. From the base year 
of 1978, when we started reducing the rate of tax on capital 
gains to 1986, the last year of sound tax policy on capital 
gains in this country, revenues to the Treasury did not go down 
as Joint Tax told us and as it was scored for budget purposes 
in this Congress. They went up over 500 percent. And just in 
case you wanted empirical data the other way, Congress tried 
the experiment in the opposite direction, and we jacked up the 
rate of tax on capital gains to its present level in 1986, and 
in the following year, revenues fell from $50 to $33 billion.
    So, we ought not listen to a debate about static or dynamic 
modeling; we ought to stop the fraud. We ought to get accurate 
numbers. We are not using them. We live in a fantasy world 
here. And I raise the same point with respect to the estate 
tax, the death tax. It raises less than 1 percent of Federal 
revenues. And I make an impassioned plea: Please do not raise 
the exemption if you are interested in simplifying taxes 
because it does nothing to simplify taxes. In one fell swoop, 
with something that accounts presently for less than 1 percent 
of Federal revenues, you can eliminate over 80 pages of the 
Internal Revenue Code and over 200 pages of regulations.
    You know that rich people do not pay this tax, or rarely do 
they pay it, because, like Jacqueline Kennedy Onassis, they can 
form a state-of-the-art trust to avoid it or avoid most of it. 
It is not even the small businesses and the family farms and 
the family ranches that we should be concerned most about. It 
is the low-wage workers at these businesses who pay a 100-
percent tax rate when their jobs are destroyed, when the 
property, because this is essentially a property tax, must be 
liquidated in order to pay the death taxes.
    It has been estimated that our capital stock in this 
country will increase by two-thirds of $1 trillion over 8 years 
if we repeal this tax. Let's grow the economy and help the 
Government in that way rather than destroying the economy in 
order to help the government.
    I thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Rep. Christopher Cox, a Representative in Congress from 
the State of California

            On Balancing the Budget in a Low-Tax Environment

    Chairman Archer, I want to commend you for your leadership 
in holding these hearings today, and I welcome the opportunity 
to talk about the urgent need for tax cuts. I know most of my 
colleagues on this Committee agree with me that it is 
absolutely essential that the budget be balanced in a low-tax 
environment.
    We are all working in this Congress to achieve a balanced 
budget, but to do this without tax cuts would be a grave 
mistake. A balanced budget in and of itself will do little to 
encourage economic growth in this country if it is based upon 
high rates of taxation and government spending.
    Taxes which directly tax savings and investment are even 
more detrimental to our economy--by increasing the cost of 
capital they slow the rate at which the economy can expand and 
they make it more difficult for all Americans to save.
    The key to an effective balanced budget is the level of 
taxation we can tolerate, not the amount of spending we want. 
It is imperative that we determine the appropriate amount of 
spending from the amount of tax disruption that spending 
causes, not by how many programs we like here in Washington 
D.C.
    I'd like to focus my testimony today on the capital gains 
tax and the estate tax--the source of much of our tax code's 
bias against savings and investment. The current capital gains 
tax and estate tax dramatically increase the cost of capital, 
penalize savings, disproportionately damage small businesses--
slowing economic growth and hurting federal payroll and income 
tax collections that would otherwise take in more under a 
healthier economy.
    Specifically, I'm here to call for a 50% cut in the capital 
gains rate and complete repeal of the federal estate tax. These 
two elements should be a crucial part of our goal of balancing 
the budget in a low-tax environment. I hope that this Committee 
will make it a priority to approve cuts in both of these anti-
growth, unfair taxes, so that we can send legislation to 
President Clinton this year.
    These two tax cuts complement each other in a number of 
ways, aside from their inherent damage to our nation's growth. 
The effect on revenue from cutting these taxes will, far from 
hurting federal tax collections, in fact lead to increased 
revenues, especially in the short term from increased capital 
gains realizations, and in the long term through increased 
payroll, income taxes, and corporate tax collections that will 
arise from more vigorous economic growth.
    The historical evidence is irrefutable--carefully-crafted 
capital gains rate cuts can increase tax revenues:
     In 1982, the capital gains tax rate was cut to 
20%. The Joint Committee on Taxation predicted a massive loss 
in government revenue. Yet, over the next five years, capital 
gains realizations increased by 362%; federal revenue from the 
capital gains tax grew 385%, from $12.9 billion in 1982 to 
$49.7 in 1986.
    Precisely the opposite phenomenon occurred in 1986, when 
Congress decided to increase the capital gains tax rate.
     In 1986, the capital gains tax rate was hiked from 
20% to 28%--an increase of almost 40%. The Joint Committee on 
Taxation told us that this would be a great way to raise more 
funds for the U.S. Treasury. Yet, in the first year alone, both 
realizations and revenues plummeted, falling 56% and 34% 
respectively. This was hardly a one-time phenomenon: even in 
1996, the 28% tax rate was still producing revenues 
significantly less than the 20% rate that had been in effect in 
1986.
    Cutting the current capital gains tax rate in half, as 
Republicans proposed last year, could generate $20 billion in 
additional revenues over the next six years, according to 
testimony presented to the House Small Business Committee.
    Repeal of the federal estate tax, by contrast, would have 
its greatest effect on the economy and on federal tax 
collections just as the initial effects of reducing the capital 
gains tax rate are beginning to stabilize. Repeal of the estate 
tax will allow vast reserves of capital to be put to their most 
productive use--not hidden away, diverted from business 
operations for estate planning, or not driven into less 
efficient uses as estates are liquidated to pay the tax man. 
These burdens--compliance and enforcement costs, and 
litigation--consume 65 cents for every dollar collected by the 
estate tax.
    Repeal of the estate tax will lead to dramatically 
increased federal tax collections from income and payroll taxes 
after a few years:
     Repealing the estate tax this year would boost 
annual economic growth by $11 billion, create 145,000 new jobs, 
and raise annual personal income by $8 billion, according to 
the Heritage Foundation.
     As a result of this additional economic growth, 
federal payroll and income taxes will be more than enough to 
offset any short-term revenue loss from estate tax repeal.
     A retrospective study of the economy over the last 
20 years showed that net annual federal revenues would have 
been $21 billion higher if the estate tax had been repealed 20 
years ago.
    Mr. Chairman, too many people inside the beltway seem to 
think that they know what is best for the American people 
better than the American people do. This kind of thinking 
results in dangerous concepts such as paying for tax cuts, as 
though the money belongs to the government rather than to the 
people.
    Our tax code today punishes savings, rewards spending, and 
double (and sometimes triple) taxes income, making it virtually 
impossible for parents to provide for their children and save 
for the future. It is basic human nature that after we have 
taken care of our immediate needs--food, clothing, shelter and 
the like--we want to make life better for our children and 
loved ones. I work, you work, and every American in this 
country works not just for himself or herself, but for his or 
her family, for those we care about.
    Rather than seek to reverse human nature, which the death 
tax and the capital gains tax do, our tax code should tap this 
force as a powerful engine for wealth creation.
    Again, Mr. Chairman, thank you for giving me the 
opportunity to testify before you today.
      

                                

    Chairman Archer. Thank you, Mr. Cox.
    Our next witness is Hon. Collin Peterson from Minnesota, 
one of our colleagues familiar to us.
    Welcome to the Committee, and you may proceed.

   STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE IN 
              CONGRESS FROM THE STATE OF MINNESOTA

    Mr. Peterson. Thank you very much, Mr. Chairman, and I 
appreciate the opportunity to appear here today and testify, 
and we appreciated your coming over and visiting with our Blue 
Dog group the other day. A lot of us are interested in your 
idea of reforming the overall tax system and look forward to 
working with you on that.
    As you are aware, we have spent a lot of time within our 
group trying to put together a budget that we think gets us to 
balance, and we have put off, as you know, tax cuts until after 
we get the budget balanced for a number of different reasons, 
most of which it is very hard to get this accomplished and make 
all of the numbers work, given the way we have to score things. 
We are not against tax cuts, however. We just think we ought to 
put them off until after we get the budget balanced.
    And so, we have been advocating for a long time that we 
should split this process up, and we should take the budget. As 
one vote and one bill and take the tax cuts as another bill. We 
are very gratified to see that there appears to be some 
interest and some movement in that direction, and we think that 
would be very useful. We think that that would be a way we 
could maybe get through this whole situation and actually get a 
balanced budget put in place.
    Obviously, we think we have the best budget out there. We 
have a CPI, consumer price index, change in our budget which 
allows us to do some things that we think are very positive, 
some of which have not gotten a whole lot of notoriety. We are 
proposing taking the Social Security Trust Fund offbudget in 
the year 2005 and putting it back in its own fund like it used 
to be and taking the other trust funds offbudget by the year 
2007. One of the reasons we are able to do that is because we 
have the 0.08 change in the CPI in our budget.
    So, having said all of that, we have a task force we have 
set up to work with you and your Committee and also to work 
with the administration, and we are ready to do that. However, 
what I am going to say now is going to be my own views, because 
we have not come to any conclusion on where we are at within 
the Blue Dog group. I have looked at the President's tax 
proposals. I think some of the education things maybe make some 
sense, but in my mind, the most important thing we need to do 
is if we are going to look at tax cuts, we need to focus on the 
things that are going to do the best for the economy, and I 
think those things are capital gains changes, estate tax 
changes, and I would add to that some changes in the 
alternative minimum tax.
    I can go into a lot of reasons why I think the capital 
gains change makes a lot of sense, but in my district, the most 
important thing is most farmers are 58 years old, and they are 
having a hard time turning over their operations to their kids 
or to the neighbors. It is this capital gains structure that we 
have now which is locking up a lot of assets that would be 
better off if they were turned over. We have got a lot of 
apartment buildings out there that have owners who really do 
not want to own them any more, who bought them for tax 
shelters, and that was screwed up in the 1986 Tax Reform Act. 
They are not being turned over because of the capital gains 
situation. There are just a lot of reasons, in my view, why we 
need to change the capital gains provisions.
    And the one thing I would say that I personally would 
prefer that we look at, not at an across-the-board capital 
gains change, but I think we ought to phase it in based on the 
length of time that you own an asset. Maybe a simple way to do 
it would be that you get a 10-percent exclusion from income for 
every year that you own the asset, so, you would get the 50 
percent if you owned the asset 5 years. I think that that would 
be a more equitable way to put a capital gains provision in 
place, and there are a number of folks within the Blue Dog 
group who agree with me on that. We are asking Joint Tax to 
score that and see what that looks like.
    There are also a number of us, myself included, who think 
we need to make changes in the estate tax, that we need to 
raise the unified credit; we need to look at the rates; we need 
to look at, potentially, some targeted relief for small 
businesses and for family farms who are having the same kinds 
of problems they are having with capital gains in the estate 
tax area. And I also think we need to look at the alternative 
minimum tax. I am a former tax preparer and personally get 
involved with this AMT, alternative minimum tax, every year, 
and there are just a lot of problems in that area. I think we 
need to look at taking depreciation out of there or, if not 
taking it out, making some changes, and I think that is an area 
that needs to be looked at.
    And I also think, from my perspective, that we need to take 
a look at section 1245 gains. That is something you do not hear 
a lot about, but I think that is something that could be a lot 
of benefit for people in my district. Farmers, especially, get 
all tangled up with that provision.
    So, there is a lot of support within our group, and I think 
on the Democratic side, for changes in the estate tax, changes 
in the capital gains rate. We think it would be good for the 
economy; we think it would be good for the country. But, having 
said that, I think most of us are going to say if we are going 
to do these things, they need to be paid for. We would like to 
see them done in a separate bill and done in a way that they 
are scored so they are not going to cost the Treasury any 
money. And if we can split these two things up, and if we can 
figure out how to pay for them, I think you will find quite a 
bit of support on the Democratic side for that.
    Thank you.
    [The prepared statement follows:]

Statement of Hon. Collin C. Peterson, a Representative in Congress from 
the State of Minnesota

    First of all, I want to thank the Chairman and the 
Committee for giving me the opportunity to present this 
testimony today. The Blue Dog Coalition, of which I am a 
member, met with Chairman Archer recently to discuss our 
commitment to overall reform and our willingness to work with 
the Chairman and the Committee on these issues. To that end, 
the Blue Dog Coalition has formed a Tax Reform Task Force to 
work with this Committee and with the Administration. The 
Coalition position which we have been advocating for a long 
time is that tax cuts should be split from the rest of the 
budget and the two issues should be voted on separately; in our 
view, any tax cuts must be paid for by cuts in spending or by 
changes in entitlements. Although we are not in favor of 
cutting taxes until we balance the budget, we are not opposed 
to tax cuts as long as they can be paid for with spending cuts 
or entitlement changes, and we can balance the budget in an 
honest way.
    I am Co-Chairman for the Tax Reform Task Force for the 
Coalition. However, the testimony that I am giving today is my 
own position. I strongly believe that if we are going to have a 
tax cut, and if we can pay for it, that it makes sense to have 
a tax cut which will be beneficial to the productivity of our 
economy. If there is to be a tax cut which we can pay for, the 
top priority should be to make capital gains changes, estate 
tax changes, and some modification of the alternative minimum 
tax.

                             Capital Gains

    I think it was a mistake to eliminate the capital gains 
preference in the 1986 Tax Reform Act. I know that in my 
district, the 7th District of Minnesota, there are a lot of 
long-term capital assets that need to be turned over. We have 
family farms where parents want to turn over the farm to their 
children. Small family-run businesses and apartment owners also 
want to turn over their assets to their families; however, 
these changes are not occurring because of the current capital 
gains structure. If we create an incentive for families to turn 
over their assets, the turnovers will result in increased 
productivity of the assets and increased vitality for the 
economy. The new owners will upgrade the assets by putting more 
money into them, improving their value, and making them more 
productive.
    However, we should not return to the capital gains 
provisions that were in place prior to 1986. Instead, we need a 
program which rewards long-term investments in capital assets 
and capital markets. To that end, I believe that it makes sense 
to structure a capital gains reduction based on the length of 
the owner's holding of their asset. This would not make Wall 
Street happy, but they have not had a problem in attracting 
capital in the last few years. The reduction could be simply 
structured so that the exclusion from income increases along 
with each successive year that the owner holds the asset. The 
structure would involve a 10% exclusion from income for the 
first year. This reduction would increase to 20% in the second 
year and so on until reaching 50% after five years. This 
structure would not only be less expensive to maintain, but 
would also reward capital invested over a long period of time 
from those people who build up small family businesses or farms 
for over a period of years.
    In addition, we could better target our capital resources 
by eliminating depreciation in the calculation of alternative 
minimum tax. We also should take a look at how we treat section 
1245 gains. The current provisions are having a negative impact 
on capital formation and the long-term viability of certain 
businesses.

                              Estate Taxes

    Along with the changes in capital gains, we need to also 
consider increasing the present-law unified estate and gift tax 
credit amount. We are open to suggestions on what the amounts 
of increase should be, and how they should be implemented; 
however, the bottom line is that these increases in exemptions 
and credits must be paid for. We also should consider making 
additional exemptions for small family-owned businesses and 
family farms when these assets are transferred within the 
family unit.

                               Conclusion

    In making these changes, I believe that we will generate 
positive economic activity. By unlocking assets through changes 
in the capital gains structure, increasing the estate tax 
exemption, and making changes to the alternative minimum tax, 
we can increase the value and productivity of these assets, and 
raise considerable revenue for the Treasury. I believe that 
these changes would be good for the economy of the country, and 
good for the people of my District. also think we need to look 
at the alternative minimum tax. I am a former tax preparer and 
personally get involved with this AMT, alternative minimum tax, 
every year, and there are just a lot of problems in that area. 
I think we need to look at taking depreciation out of there or, 
if not taking it out, making some changes, and I think that is 
an area that needs to be looked at.
      

                                

    Chairman Archer. Thank you, Mr. Peterson.
    Our last witness in this panel is Hon. Earl Pomeroy. We are 
happy to have you with us, and we will be pleased to receive 
your testimony.

 STATEMENT OF HON. EARL POMEROY, A REPRESENTATIVE IN CONGRESS 
                 FROM THE STATE OF NORTH DAKOTA

    Mr. Pomeroy. Thank you, Mr. Chairman. I will summarize my 
testimony as briefly as I can.
    For the last year, I have focused on the growing concern 
about whether Americans are saving enough for retirement. There 
is some frightening data out there that suggests that our 
savings rates are falling far short of what Americans will need 
for their retirement. In fact, the savings rate in this country 
has fallen by about half of what it was in the years between 
World War II and 1980 to now dipping under 4 percent in 1994.
    One in three baby boomers, as estimated by Merrill Lynch, 
is on track with their private savings to augment their 
retirement needs, and the use of the individual retirement 
accounts has mirrored these trends. Since the 1986 Tax Reform 
Act, rates of taxpayers contributing to IRAs has fallen by 75 
percent. In my testimony this morning, the component of the 
President's tax relief proposals I am talking about, obviously, 
relates to his proposals to expand the individual retirement 
account, which I believe is a critical strategy in terms of 
helping step up the rate of private retirement savings for 
people in this country.
    Social Security was never intended to be the sole source of 
people's retirement income, and it certainly is not going to be 
able to meet that as baby boomers move into retirement. The 
tax-preferred individual retirement accounts are an excellent 
way to encourage such savings, and I think, really, the only 
discussion we have relative to that is how much IRA expansion 
can we afford? I suggest we apply two priorities to expanding 
the IRA: First, expanding access for middle-class Americans so 
they can step up their retirement savings rates and do so by 
enjoying the tax savings of a tax-deductible IRA; second, we 
need to reach those who are not able to save for retirement and 
devise new strategies that encourage savings among these 
taxpayers.
    The President's plan with respect to expanding access to 
the IRA, I think, does an excellent job. Doubling the income 
limits of households and individuals able to contribute to an 
IRA and deduct the amount from their taxable obligation would 
take it to $100,000 per household, $70,000 per individual. You 
would make 20 million more Americans able to have a tax benefit 
from contributing to an IRA under this recommendation, and that 
is an excellent start. I am convinced it will step up IRA 
participation and retirement savings.
    In the area of what else we do, you have to look, I think, 
at how much you can afford. There is a proposal introduced in 
the Senate and House relative to open-ended IRAs, no limit on 
the top-end deduction. The scoring, at least to date, is that 
that would cost you about $25 billion, compared to the 
President's package, costing about $5.5 billion. I think you 
need to look at the area where you do not have people 
contributing to savings, and, of course, common sense tells us 
just what the data shows us: Those who cannot afford to save 
for retirement are those who are struggling to meet the needs 
of normal living expenses.
    In fact, of workers with incomes of less than $25,000, 
fully 42 percent report no retirement savings; 18 percent no 
retirement savings in income ranges between $25,000 and 
$40,000; 9 percent with incomes over $40,000. Now, I believe we 
need to devise a strategy to incent those at lower earning 
levels to also do something for their own retirement savings 
needs, and a feature of legislation that I have introduced, 
H.R. 17, would do just that. It would allow for individuals 
earning less than $35,000 and households earning less than 
$50,000 a 20-percent, nonrefundable tax credit for whatever 
they contributed to the IRA. In other words, if they 
contributed $1,000 to an IRA, they would actually have their 
final tax liability reduced by $200. I think you could market 
this as a $1-in-$5 match by the Federal Government, very 
analogous to an employer match in a 401(k) situation that has 
proven so very successful at incenting additional participation 
in private retirement savings.
    A final note, Mr. Chairman: If the purpose of IRA expansion 
is to incent retirement savings, the more early access you 
allow to the IRA accounts, the less retirement savings you are 
going to have at the end of the day. Therefore, I am concerned 
the President has proposed a number of exceptions that allow 
early access to the funds that you are actually undercutting 
what you are trying to achieve, and that is accelerate private 
retirement savings so that people have their own assets to help 
with retirement income.
    I thank you, Mr. Chairman, for hearing me and wish the 
Committee well in its difficult deliberations.
    [The prepared statement follows:]

Statement of Hon. Earl Pomeroy, a Representative in Congress from the 
State of North Dakota

    Chairman Archer, members of the Committee, thank you for 
the opportunity to appear before you this morning. As we all 
recognize, the topic we discuss today--how to stimulate savings 
and investment while maintaining progress toward a balanced 
budget--is one of critical importance to the economic health of 
our people and our nation.
    While this morning's hearing touches on three different 
components of President Clinton's fiscal year 1998 budget 
proposal--the expansion of individual retirement accounts 
(IRAs), the broadened exclusion for capital gains and the 
modification of the estate tax, I wish to focus my remarks 
exclusively on IRA expansion.
    Americans are not saving adequately for retirement. For 
most of the post-World War II period, personal savings as a 
percent of disposable income in this country averaged nearly 
8%. Yet in recent years, personal savings rates have fallen 
dramatically, even dipping below 4% in 1994. Use of individual 
retirement accounts by the American people has mirrored these 
trends. While 16.2 million individuals made IRA contributions 
in 1986, this number dropped--by nearly 75%--to 4.3 million in 
1994. Much of this reduction was attributable to the Tax Reform 
Act of 1986, which substantially curtailed the number of 
individuals who could claim the tax benefits of IRAs.
    Mr. Chairman, I have devoted much of my time in Congress to 
the issue of retirement security, and I firmly believe that we 
must pursue a national strategy to reverse these trends and 
encourage greater savings for retirement. While we wrestle with 
the difficult question of how to reform the Social Security 
system to ensure its long-term solvency, we must remember that 
Social Security was never intended to be the sole source of 
retirement income. Rather, it was intended to augment personal 
savings and an employer pension. Given this critical role that 
personal savings plays in assuring financial security in 
retirement, and given the inadequacy of Americans' savings 
efforts, we must make encouraging private retirement savings a 
top priority.
    Tax-preferred individual retirement accounts are an 
excellent means to encourage such savings, and we must take 
steps to expand access to these accounts. The only question is 
how much IRA expansion we can afford given the need to balance 
the federal budget by 2002. As we grapple with these questions 
of affordability, I suggest that our priority for IRA expansion 
must be two-fold. First, we must expand the number of middle 
income households who have access to this important incentive 
to save for retirement. And second, we must find ways to 
encourage use of IRAs by those working families who are 
presently unable to save.
    The data demonstrates that middle income families are 
simply not saving enough for retirement. In fact, only one in 
three baby-boomers is on track for a financially secure 
retirement according to a recent study by Merrill Lynch. And 
with the first of the baby-boomers turning 50 this past year, 
their window to save for retirement is rapidly closing. To help 
these and other middle income Americans reach financial 
independence in retirement, we must take steps now to 
accelerate the rate of private retirement savings.
    With respect to this first priority--expanding IRA access 
for middle income families--I believe the President's FY98 
budget proposal achieves this goal in a responsible way. I have 
long advocated for and fully support the President's proposal 
to double the amount that individuals with workplace retirement 
plans may earn--to $70,000 for individuals and $100,000 for 
households--and still qualify for tax-deductible IRA 
contributions. In fact, my own IRA legislation, the IRA Savings 
Opportunity Act of 1997--H.R. 17, would make this same reform. 
With this single step of doubling income eligibility levels, we 
can restore the tax benefits of IRAs to as many as 20 million 
middle income families.
    Whether to raise the income eligibility levels further than 
this is really a question of what we can afford in the current 
budget climate. While the doubling of the income caps has been 
scored at a cost of $5.5 billion over five years, the outright 
removal of the income caps--as authorized in the Super IRA 
legislation introduced in the House and Senate--has been scored 
at a five-year cost of nearly $25 billion. My belief is that it 
would be better to devote some of these funds to achieving the 
second priority of encouraging IRA use by working families who 
are presently unable to save.
    When it comes to this second priority, I believe the 
President's budget could do more. Statistics confirm what 
common sense tells us--that savings correlates with disposable 
income and that low-wage workers have great difficulty saving 
for retirement. According to a recent study by the Public 
Agenda Foundation, among workers with incomes of less than 
$25,000, fully 42% reported no retirement savings whatsoever. 
In contrast, only 18% of those with incomes between $25,000 and 
$40,000 and 9% of those with incomes over $40,000 reported 
being unable to accumulate retirement savings. IRA 
participation rates tell the same story. In 1982 when the IRA 
tax deduction was available to all taxpayers, 56% of households 
with earnings greater than $50,000 contributed to an IRA 
compared to only 19% of households with earnings between 
$20,000 and $25,000. These IRA participation disparities have 
continued even as eligibility for the IRA deduction has been 
curtailed for those at higher income levels.
    Mr. Chairman, what these statistics tell us is that 
families at the lower end of the wage scale must be given a 
little extra help if they are to be able to save for their own 
retirement. Providing such help is in all of our interests. It 
will not only create new savers who will help spur the economy 
but it will also reduce the number of individuals who must 
later turn to the government for assistance when Social 
Security alone proves insufficient to meet their basic needs.
    My IRA legislation, H.R. 17, attempts to provide this help 
by giving an added tax incentive for low-wage workers to 
contribute to an IRA. Under my bill, individuals earning less 
than $35,000 and households earning less than $50,000 would be 
entitled to a non-refundable tax credit equal to 20% of the 
amount contributed to an IRA. For example, a taxpayer in this 
income range who contributes $1,000 to an IRA would see his or 
her final tax liability reduced by $200. This tax credit 
component of my bill resembles the employer match feature of 
401(k) plans, which has proven so effective in encouraging low 
and moderate income workers to contribute to retirement plans 
in the workplace. The effect of the tax credit is that for 
every $5 the taxpayer puts toward retirement savings, the 
federal government kicks in an additional dollar. I believe 
this tax credit approach will prove effective at achieving the 
second priority of IRA expansion--creating new savers among 
those who are not saving today.
    Addressing these two key priorities--expanding access to 
IRAs for middle income families and encouraging IRA use by 
those not presently able to save--will require substantial 
resources. If we are able, however, to devote additional funds 
to IRA expansion after reaching these goals, there are 
certainly additional reforms that would help working and middle 
income families accumulate adequate retirement savings. One 
measure I have included in my IRA Savings Opportunity Act would 
allow middle income individuals without access to a workplace 
retirement plan--a group for whom personal retirement savings 
is especially important--to double their annual IRA 
contribution to a total of $4,000. Another measure I have 
included in my legislation would remedy a glaring inequity in 
current IRA law by allowing an individual to take an IRA 
deduction irrespective of whether his or her spouse is covered 
by a workplace retirement plan. For the first time, this reform 
would allow working women whose husbands are covered by a 
workplace retirement plan to deduct contributions to their own 
IRA. Another helpful reform, which is contained in the 
President's FY98 budget proposal, would be to index both the 
income eligibility levels for IRA deductions and the $2,000 
annual IRA contribution amount so that inflation will not eat 
away at the IRA benefits we restore to middle income Americans.
    The President's IRA proposal and a number of others include 
authorization of a limited number of penalty-free withdrawals. 
I believe these proposals require us to reevaluate the basic 
purpose of the IRA tax incentive. If the purpose of the 
incentive is to encourage savings for retirement--as I believe 
it is--then I am concerned that by providing access to the 
accounts for non-retirement purposes we will undercut the 
ability of the IRA to achieve its policy objective.
    Mr. Chairman, members of the committee, as you move forward 
to consider the various IRA expansion proposals put forth by 
the President and others, I encourage you to focus your efforts 
on addressing the two key priorities of expanding access to 
IRAs for middle income families and encouraging IRA use by 
those not presently able to save. I thank you for your time 
this morning, and I look forward to working with you in the 
coming weeks and months to craft a budget plan which contains 
targeted and meaningful savings incentives.
      

                                

    Chairman Archer. Thank you, Mr. Pomeroy, and the Chair 
compliments each of the witnesses for their presentation, and I 
think each of them has been exceedingly constructive in moving 
us to what I hope will be the ultimate goal, which is a zero 
tax on savings in the United States of America. But every 
movement that we can get in that direction is a very 
constructive one.
    Do any Members wish to inquire?
     Mr. Christensen.
    Mr. Christensen. Mr. Chairman, I just wanted to applaud Mr. 
Deutsch, even though he is not here, on his testimony. I have 
never heard it quite so eloquently put by a Member of the other 
side on the confiscatory nature of capital gains and how 
punishing a tax it really is on savings and investment. I 
really want to applaud his leadership, and I really look 
forward to working with him on this issue.
    Congressman Cox, I wanted to ask you a quick question: 
Obviously, I applaud your efforts both on capital gains and on 
the death tax issue. If you were to have to choose between the 
two, and hopefully, we would never have to do that, but if you 
were to focus your efforts on one or the other, which would be 
the better of the two to work on to try to get this country 
going, and in terms of a confiscatory task, what would be your 
comments on that?
    Mr. Cox. Well, to put it the other way, I think it is the 
same question answered from either angle: Which of these taxes 
would you most like to keep? I would say that that question is 
logically equivalent to asking me whether I would prefer to be 
hit by a truck or a bus. Neither of these taxes has any place 
in a rational system where tax policy animates the Code. But 
let me explain from the premise of tax policy why the death tax 
is even worse than the capital gains. I like to call the 
capital gains tax a penalty tax on savings and investment. That 
is a more apt description than capital gains, which is some 
Internal Revenue Code jargon. Capital gains really does 
penalize savings, and it penalizes investment, and it is a 
penalty tax.
    And since our savings rate is so abysmally low, I was just 
mentioning to Congressman Dreier here that Alan Greenspan has 
told us the average financial assets owned by an American 
between the ages of 45 and 53 is--anybody want to guess? David 
and I are the same age; we are 44; we will turn 45 next year. 
So, next year, we will graduate into this class of 45- to 53-
year-olds. And according to Greenspan, the average financial 
assets held by Americans between the age of 45 to 53--and guess 
yourself what that number was.
    Mr. Dreier. Tell them what my guess was.
    Mr. Cox. My guess was $10,000. It is $2,300, and when you 
hear this aggregate statistic of America's low savings rate 
compared to everybody in the world, this is a great way to 
personalize it: $2,300 in financial assets for Americans 
between 45 and 53. So, a tax that penalizes savings and 
investment is doing grave damage to our economy.
    But the estate tax goes beyond being a penalty tax on 
savings and investment. It is certainly that, but it has been 
called a virtue tax. Sometimes, in Ways and Means, you talk 
about sin taxes. Let's tax alcohol, tobacco, what have you. If 
you have got to tax something, why not tax sin? But the estate 
tax is a virtue tax, because not only is it a penalty tax on 
savings and investment, but it also penalizes work. The Code 
calls capital gains passive income, but if you continue to work 
beyond what is required to put clothes on your back, a roof 
over your head, food on the table so that you can take care of 
your loved ones, which is a human urge, you are penalized by 
the estate tax. You are penalized for doing what we want you to 
do, which is to continue to work, continue to provide for other 
people, continue to pay taxes, quite frankly. And, at the same 
time, you are rewarded for sin: You are rewarded for 
conspicuous consumption; you are rewarded for early retirement. 
None of these things should be incented by our Tax Code.
    And so, while I go back to my original analogy, which is 
that this is like getting hit by a truck or a bus, if you ask 
me which is worse, capital gains or the death tax, I would get 
rid of the death tax.
    The red light is on. I just want to share with you one very 
poignant story. A city council member in my district--it is a 
part-time city council--in his real life is an estate tax 
lawyer, and he came to see me the other day about city 
business, but he said I really am glad that the Congress is 
looking to repeal the death tax, because while I do this for a 
living, I have to tell you: I hate what I do for a living in 
many ways. Just the other day, I spent several hours at the 
bedside of one of my clients who passed away that day, and this 
happens not infrequently, because this is what I do for a 
living. And he said what I was doing with this man, and it took 
me the better part of 1 hour, was getting him to sign documents 
to create nothing in economic reality but tax avoidance so that 
he would not pay the estate tax. And the consequence of my 
being there was that if he signed the documents, he would not 
have to pay these taxes, but if he did not sign the documents, 
he would. Otherwise, there is no economic reality.
    He signed the papers, and I went home, and he died, and I 
talked to his wife and his kids on the way out, and I thought 
how sad that our government creates a situation in which this 
dying man is spending his last hours on Earth with me, the tax 
lawyer, instead of with his wife and his kids. This is an 
awful, immoral, grotesque tax, and I would repeal it.
    Mr. Christensen. Well, thank you, and I applaud Congressman 
Dreier and H.R. 14, and I equally echo your sentiments that I 
would like to see them both repealed.
    Thank you, Mr. Chairman.
    Chairman Archer. Thank you, Mr. Christensen.
    Mr. English.
    Mr. English. Thank you, Mr. Chairman.
    This has been an extremely impressive panel. I must say it 
has been one of the best discussions we have had before this 
Committee since I have been on it on a variety of tax issues 
that really affect the dynamics of the economy. I appreciate 
all three of you who are still here for staying here, and 
particularly, I appreciate Representative Peterson bringing up 
the alternative minimum tax, which I think is a terribly 
antigrowth provision in our Tax Code, a dead drag on our 
economy, and one that frequently gets dropped out of the 
discussion, so I am most grateful.
    Representative Dreier, it has been a privilege to work with 
you to push for broad-based capital gains relief. There is a 
discussion as we move toward tax cuts as to whether it is 
better to have broad-based capital gains relief or try to carve 
out some areas where the capital gains tax is particularly 
punitive. And so, there have been a number of proposals for 
targeted capital gains relief. I wonder if you could briefly 
generalize on how strongly you feel about broad-based relief 
and why it is essential that it be in any tax package we do.
    Mr. Dreier. Well, thank you very much, and as I said in my 
statement, I appreciate the fact that you responded to my call 
last fall when we looked to put this whole package together, 
and I appreciate your leadership on it. I mentioned in my 
statement this issue of human capital juxtaposed to physical 
capital, and I am one of those who has a very difficult time 
with having the government make choices as to whose capital 
should be taxed at a different rate. I am convinced that when 
we look at this proposal, it is going to boost wages overall if 
we bring this about. A study that was done in 1993 found that 
we could boost wages by $1,500 for working Americans over a 5-
year period, and we continue to hear about family tax cuts. 
Remember, those expire, and these do not.
    So, that is why I think this broad-based package is not 
something that is going to simply target individual areas, but 
it is going to have an overall benefit in wages to people. So, 
that is a reason that is not often discussed as to why a broad-
based reduction would be beneficial. But again, I laud the 
President for focusing on education. We are all very concerned 
about it, but it is only half of the equation. We have got to 
make sure that job opportunities are out there, and this kind 
of investment will go a long way toward doing that. And then, 
again, I mentioned earlier this recession problem that we might 
potentially have, and I see this as an insurance policy to help 
avoid recession. So, I think that on an overall basis, it can 
be very, very beneficial for us.
    Mr. English. Thank you; that is a very powerful summary, 
and I appreciate it.
    Representative Cox, you gave a history of revenue under 
changes in the capital gains tax that, in my view, is 
absolutely unanswerable, and I wish this message were pounded 
into people more not only in this institution but also within 
the news media and the general public. I wonder: Reflecting on 
that, and having been here much longer than I have, and having 
seen the process of tax reform move forward, I think you and I 
both would support real tax reform right now. Do you believe 
that dynamic scoring is an important thing to move toward now 
as part of our effort to get toward tax reform that will really 
work and will really grow the economy?
    Mr. Cox. I think honest scoring is what we need for a 
change. The debate about dynamic and static has gone off in an 
odd, tangential direction. It means to some people adjusting 
data or cooking the books or guessing. The truth is that what 
we actually do, and I do not know what you want to call it, 
whether you want to call the status quo static or what have 
you, but the current arrangement between CBO and Joint Tax, 
whatever its label, is characterized chiefly by its false 
results. It is a fraud. It is so far off the mark that it 
should be rejected out of hand for almost any other system.
    The empirical data, which I cited, is readily available to 
this Committee and to this Congress, but it goes well beyond 
our experience from 1978 to 1986 and our experience then 
forward from 1986 to now. We have, of course, the Kennedy tax 
cuts. We have the Mellon tax cuts. We have Mexico's experience. 
We have Canada's experience. We have empirical data coming out 
our ears, and the only thing we know about our arrangements 
with CBO and Joint Tax is that they produce consistently false 
promises. They overpromise and cheat the Treasury when it comes 
to taxes, because they tell us that by keeping the capital 
gains tax rate where it is, we will get revenues that, frankly, 
we are not going to get or alternatively that, by reducing that 
rate, we will lose revenues where, in fact, we would eclipse 
the current levels.
    We are cheating the Treasury. We are cheating the Treasury. 
It is not a question of being able to give more tax relief to 
the American people than we presently do. The government of the 
United States is being cheated out of revenues because of this 
system. That is not a conservative system; that is a stupid 
system.
    Mr. English. Thank you, and thank you, Mr. Chairman.
    Chairman Archer. Does any other Member wish to inquire?
    Mr. Crane. May I just make a comment?
    Chairman Archer. Mr. Crane.
    Mr. Crane. First of all, I want to congratulate all of our 
witnesses for their commitment to strong tax policy and equity 
in our Tax Code, and I want to congratulate Chris Cox on his 
efforts to eliminate the death tax and on his commitment to 
eliminate the stupid capital gains tax.
    One observation I wanted to make relates to an article, and 
I think I may have sent it out to you already from Investors 
Business Daily with regard to the death tax, pointing out that 
it brings in 1 percent of our total revenues annually. Over 7 
years, they say, and these are projections by former Treasury 
economists, if you eliminated it, you would lose about $100 
billion in revenues, but you would cause a creation of $630 
billion in increased capital. I cannot help but believe that 
anyone who sits down and analyzes these figures cannot reach 
the same conclusions that you presented eloquently in your 
testimony, Chris.
    So, I encourage you--I have been a cosponsor of your bill; 
Kenny Hulshof and I have one in, too, that eliminates that 
death tax, and I would hope we would get the growing bipartisan 
consensus that Collin referred to and guarantee that we do 
ultimately abolish the tax. Of course, it must be within the 
context of a balanced budget, too, but we must provide this 
kind of meaningful relief for overburdened Americans.
    Mr. Cox. Chairman Crane, I would just add that precisely 
for the reason you stated, the so-called loss in revenue over a 
period of years is not, in fact, that loss in revenue, because 
that is not all that happens. This is not a closed system in 
which all that exists is a death tax. We have plenty of other 
taxes, and if you are increasing economic growth by $11 billion 
a year, then obviously, you get to tax all that growth, and 
that offsets it. It is the same thing as if we zero out capital 
gains. Nobody thinks we are going to lose revenues to the 
Treasury--or, at least, I should not say nobody; but most 
people do not think that. But, of course, we would lose them 
from capital gains taxes, because there would not be such a tax 
any longer. We would just pick it up elsewhere.
    Likewise, if we repeal the income tax, and we have a 
consumption tax, it is not that the Government gets zero 
revenues; it gets them from a different place.
    Mr. Dreier. If I could just add to that, Phil. In 1993 I 
mentioned that to the Zero Capital Gains Tax caucus that we put 
together. We found that over a 7-year period, a rate that 
actually ends up right around what we have in H.R. 14, which is 
a 14- to 15-percent rate, would over that period of time 
increase the gross domestic product by $1.3 trillion, create 1 
million jobs, and generate $220 billion in revenues to the 
Treasury. And where we are is actually the rate that, it seems 
to me, would optimize those revenues to the Treasury 
specifically from capital gains revenue.
    Mr. Crane. Well, I have argued for years that taxing 
capital gains, taxing interest, taxing dividends, all those 
taxes do violence to all of the moral values we were taught and 
we try to instill in our kids, notwithstanding these penalties 
in place. I have seen economic reports in the past which 
suggest that, but if your objective is to maximize revenue on 
the one hand and the creation of capital on the other, the 
ideal rate is somewhere between 9 and 12 percent. Now, I do not 
know where the economists reached those conclusions. I would 
like to see it all eliminated 100 percent.
    Mr. Dreier. Right.
    Mr. Crane. But you might go back and revise your bill and 
ratchet it down.
    Mr. Dreier. OK.
    Mr. Crane. Thank you.
    Mr. Dreier. That is just in the interest of Chairman 
Archer, I know.
    Chairman Archer. Mr. Rangel.
    Mr. Rangel. Thank you.
    David, these estimates that are so positive that you and 
Congressman Cox and my friend Phil and others talk about are 
the numbers I want. I want to make certain they are accepted by 
the House, the Senate, and the President. I do not see how we 
can talk day in and day out, year after year, about this and 
not be reading from the same rule book. I mean, why do we do 
this to each other?
    Now, either we have got to get rid of the way we estimate 
revenue losses or we have to live by the rules as they now 
exist. I am not saying the estimates are always accurate. I 
think any economist would have a difficult job no matter what 
they estimate. But why would we debate the issue of estimating 
methodology when we are forced to go by the rules as they are 
today? And your alternative rule book is not commonly accepted.
    Mr. Dreier. Well, first, Chris and I have been making the 
case for accuracy, and I appreciate the fact that you recognize 
some validity to it. But let's go--and I tried to respond to 
you in my testimony on that--let's look at this whole package 
that we had. The President's budget says he can bring it in 
balance with $100 billion of tax cuts. H.R. 14 has been scored 
by CBO and Joint Tax at $44 billion. It seems to me that if we 
look at the tremendous benefits, which I have tried to outline 
here, along with what you are convinced, and based on the 
scoring we have gotten, which I disagree with, but we have 
gotten it playing by those rules. It is a $44 billion cost.
    So, that is why I think being less than half the 
President's, it is a responsible way to proceed, because, as 
Jennifer Dunn said in her statement, this is the most important 
item we can do in trying to deal with this issue of balancing 
the budget, economic growth, and increasing wages.
    Mr. Rangel. OK; as long as when we finish, we are reading 
from the same rule book that----
    Mr. Dreier. Well, I am just trying to read from your book 
right now, Charlie.
    Mr. Rangel. Well, it is not my book. It is the one that 
they have given me, and I just hate, once I understand that 
book, for people to start changing rules, even if I like your 
way better. You can be more creative; have more imagination 
and----
    Mr. Dreier. And accurate.
    Mr. Rangel. If I found some way to agree with you about 
this scoring, if I can say that if we make an investment in the 
future of our children, we will get a dividend that we can 
depend on--for example, if we could project that a better 
educated child is going to make more money, be more successful, 
stay out of trouble, and be a good citizen, then I could like 
that kind of scoring. And I think that is one solution to the 
scoring debate--that is, if people want to use dynamic scoring, 
they take a broad range of things into consideration on the 
outlay side, as well as the revenue side. But until the 
estimators use a system like that, we might as well play by the 
rules that now exist. If the estimators are saying that your 
bill will cost $44 billion, then we must find a way to pay for 
that.
    Mr. Dreier. I am glad you will find it.
    Thank you, Mr. Chairman.
    Chairman Archer. Thank you, gentlemen. One last, quick 
question, and then we will excuse you and go to our next panel. 
In your bill H.R. 14, what do you do about the recapture of 
depreciation?
    Mr. Dreier. We do not have any change in depreciation at 
all. We simply have indexation along with that reduction of the 
top rate from 28 to 14 and then the lower rate from 15 to 7\1/
2\.
    Chairman Archer. But let me be sure I understand. Then, you 
would require the recapture of depreciation of ordinary income, 
at the 28-percent rate.
    Mr. Dreier. Right, right; that is correct.
    Chairman Archer. Which current law does----
    Mr. Dreier. That is correct.
    Chairman Archer [continuing]. Before you compute the 
capital gains rate.
    Mr. Dreier. That is correct.
    Chairman Archer. Thank you very much and thank you for your 
excellent testimony.
    Mr. Dreier. Thank you very much, Mr. Chairman.
    Chairman Archer. The Chair would inform the Members of the 
Committee, as well as future witnesses or anybody else 
concerned, that it is the intention of the Chair to recess at 
12 noon for 1 hour and to reconvene at 1 p.m. to continue the 
hearing today.
    So, the Chair invites our next panel: Mark Bloomfield, Jane 
Gravelle, David Wyss, Richard Woodbury, and Thomas Wiggans to 
come to the witness table.
    Mr. Bloomfield, the Chair recognizes you as our first 
witness, and in the event you were not here earlier in the day, 
we would encourage you to keep your verbal presentation to 5 
minutes or less, and without objection, your entire statement 
in writing will be inserted in the record.
    Mr. Bloomfield, welcome. We will be pleased to hear your 
testimony.

 STATEMENT OF MARK BLOOMFIELD, PRESIDENT, AMERICAN COUNCIL FOR 
 CAPITAL FORMATION; ACCOMPANIED BY DR. MARGO THORNING, SENIOR 
               VICE PRESIDENT AND CHIEF ECONOMIST

    Mr. Bloomfield. Thank you, Mr. Chairman. My name is Mark 
Bloomfield; I am president of the American Council for Capital 
Formation, and I am accompanied by Dr. Margo Thorning, our 
senior vice president and chief economist. We are very grateful 
for the opportunity to present testimony to the Committee on 
the subject of capital gains taxation.
    Mr. Chairman, I would like to make three points today. 
First, let me set the predicate for a well-crafted capital 
gains tax cut. That predicate has two parts. One, trends in 
U.S. capital formation are not encouraging. Slow growth in the 
United States over the past two decades can be partially 
attributed to low levels of investment. A recent international 
comparison by the World Bank suggests that countries with high 
levels of investment grow faster than countries with relatively 
low levels of investment. The United States, for example, was 
in the bottom quarter of 16 countries surveyed in both the 
level of investment and average real GNP growth. Two, tax 
policy, Mr. Chairman, has an important impact on capital 
formation and economic growth. To those who would like to 
encourage individual and business decisions to save and invest, 
stimulate economic growth and create new and better jobs, 
capital gains and other forms of savings should not be taxed at 
all. This view was held by top economists in the past and by 
many mainstream economists today.
    Second, let me summarize the positive macroeconomic impact 
of a sound capital gains tax cut, and I am drawing on two new 
analyses of two types of proposals before this Committee. The 
first, basically, is a 20-percent maximum capital gains tax for 
individuals and a 25-percent corporate tax rate. The second 
would be a 14-percent individual rate, a 28-percent corporate 
rate and indexing for inflation. This is the proposal of Mr. 
Dreier and others. These studies that I am mentioning were done 
by mainstream economists Dr. Allen Sinai, chief global 
economist, Primark Decision Economics, and DRI/McGraw-Hill, the 
prominent economic analysis firm represented by David Wyss on 
the panel today. Their results, I believe, would be helpful to 
address the questions of Mr. Rangel, Mr. English, Ms. Dunn, and 
others on the Committee today about the revenue impact and 
economic impact of a capital gains tax cut.
    A soundly crafted capital gains tax cut, number one, would 
increase jobs and economic growth. New analyses by Alan Sinai 
and DRI/McGraw-Hill show that a broad-based and carefully 
crafted capital gains tax cut for individuals and corporations 
reduces the cost of capital, increases investment, GDP, 
productivity growth, and employment. In addition, such a cut 
would essentially be revenue neutral when unlocking and 
macroeconomic consequences are included.
    Number two, it would benefit middle-class taxpayers. A 1996 
CBO draft report documents the widespread ownership of capital 
assets among middle-income tax payers. According to the CBO 
report, in 1989, 31 percent of families with income under 
$20,000 held capital assets, not including personal residences, 
and 54 percent with incomes between $20,000 and $50,000 held 
capital assets.
    Number three, encourage entrepreneurship. Capital gains has 
a particularly powerful impact on the Nation's entrepreneurs, 
and is a major driving force for technological breakthroughs, 
new startup companies, and the creation of high-paying jobs. 
Starting new businesses involves not only entrepreneurs but 
also informal investors, venture capital pools, and a healthy 
public market.
    Number four, it would promote U.S. savings and investment. 
The United States taxes capital gains more harshly than almost 
any other industrial country, according to an OECD survey of 12 
industrialized countries. Most of these countries also have had 
higher rates of investment as 1 percent of GDP than the United 
States over the past two decades.
    Let me conclude with the case for a soundly structured, 
broad-based capital gains tax cut. By reducing the cost of 
capital, it would promote the type of productive business 
investment that fosters growth, output, and high-paying jobs. 
By increasing the mobility of capital, it would assure that 
scarce saving is used in the most productive manner. By raising 
capital values, it would help support values and capital asset 
markets in general and the stock market in particular. By 
increasing the availability and lowering the cost of capital, 
it would aid entrepreneurs in their vital efforts to keep the 
United States ahead in technological advances and translate 
those advances into products and services that people need and 
want. By reducing taxes on their savings, it would treat fairly 
those thrifty Americans who must bear a heavier tax burden than 
the profligate, and because of the combined impact of unlocking 
and the macroeconomic feedback from mainstream economic firms, 
a broad-based capital gains tax cut is likely to at least not 
be a revenue loser and maybe even increase Federal revenues.
    [The prepared statement follows:]

Statement of Mark Bloomfield, President, American Council for Capital 
Formation

                              Introduction

    My name is Mark Bloomfield. I am president of the American 
Council for Capital Formation (ACCF). I am accompanied by Dr. 
Margo Thorning, our senior vice president and chief economist.
    The ACCF represents a broad cross section of the American 
business community, including the manufacturing and financial 
sectors, Fortune 500 companies and smaller firms, investors, 
and associations from all sectors of the economy. Our 
distinguished board of directors includes cabinet members of 
prior Republican and Democratic administrations, former members 
of Congress, prominent business leaders, and public finance 
experts.
    The American Council for Capital Formation has led the 
private-sector Capital Gains Coalition since 1978, when the 
first major post-World War II capital gains tax cut was 
enacted. The Coalition brings together in support of capital 
gains tax relief diverse participants from all sectors of the 
business community venture capital, growth companies, timber, 
farmers, ranchers, small business, real estate, securities 
firms, and the banking and insurance industries.
    This testimony begins with a discussion of trends in U.S. 
capital formation and productivity growth, and the impact of 
tax policy on economic growth. Then we specifically address the 
macroeconomic effects of capital gains tax reductions. We 
conclude our testimony by setting forth three criteria that a 
good capital gains tax cut should meet: it should make economic 
sense; it should be fair; and it should be fiscally 
responsible.
    We commend the emphasis that Chairman Archer has placed on 
the impact of capital gains taxation on the cost of capital, 
saving and investment, and economic growth. A capital gains tax 
cut will help reduce the burden on capital formation imposed by 
current U.S. tax policy. That tax policy must be revised if 
real wages for U.S. workers are to increase, living standards 
are to advance at a faster pace, and the United States is to 
maintain the economic strength necessary to sustain its leading 
role in world affairs.

Trends in U.S. Capital Formation, Productivity Increases, and Economic 
                                 Growth

    Slow growth in the United States over the past twenty years can be 
partly attributed to low levels of investment. A recent international 
comparison by the World Bank suggests that countries with high levels 
of investment experience faster growth than countries with relatively 
low levels of investment. This relationship is clearly demonstrated in 
Table 1 and Figure 1.
    International comparisons aside, even more disturbing is the fact 
that net annual business investment in this country has in recent years 
fallen to only half the level of the 1960s and 1970s. As shown in Table 
2, that rate dropped from an average of 8.9 percent of GDP in the 1960s 
and 1970s to 4.8 percent in the 1990s.
    Harvard Professor Dale W. Jorgenson, one of the nations foremost 
public finance economists, emphasizes the overwhelming importance of 
investment in plant and equipment for economic growth in his recent 
volume, Productivity Postwar U.S. Economic Growth. Professor 
Jorgenson's study analyzes economic growth between peaks in the 
business cycle over the 1948-79 period. Allocating increases in output 
to three sources growth in the capital stock, labor supply, and 
multifactor productivity he found that increases in the capital stock 
had the strongest impact on growth in output.
    Studies by University of California Professor J. Bradford De Long 
and Deputy Secretary of the Treasury Lawrence H. Summers also conclude 
that investment in equipment is perhaps the single most important 
factor in economic growth and development. Their research provides 
strong evidence that, for a broad cross section of nations, every one 
percent of GDP invested in equipment is associated with an increase in 
the GDP growth rate itself of one-third of one percent, a very 
substantial social rate of return.

                     Tax Policy and Economic Growth

    To those who favor a truly level playing field over time to 
encourage individual and business decisions to save and invest, 
stimulate economic growth, and create new and better jobs, capital 
gains (and other forms of saving) should not be taxed at all. This view 
was held by top economists in the past and is held by many mainstream 
economists today.
    This is primarily because the income tax hits saving more than once 
first when income is earned and again when interest and dividends on 
the investment financed by saving are received, or when capital gains 
from the investment are realized. The playing field is tilted away from 
saving and investment because the individual or company that saves and 
invests pays more taxes over time than if all income were consumed and 
no saving took place. Taxes on income that is saved raise the capital 
cost of new productive investment for both individuals and 
corporations, thus dampening such investment. As a result, future 
growth in output and living standards is impaired.
    A consumption-based tax system, under which all saving and 
investment would be exempt from tax, would be more favorable toward 
capital formation and economic growth than is our current income tax 
system, according to analyses by top public finance scholars over the 
past decade and a half. Studies by Stanford University's John Shoven 
and Lawrence Goulder, Harvard's Dale Jorgenson, the University of Texas 
Don Fullerton, and Joel Prakken of Macroeconomic Advisers have used 
macroeconomic models that incorporate feedback and dynamic effects in 
simulating the impact of adopting a consumption tax as a full or 
partial replacement for the income tax. These studies, which use 
different types of general equilibrium models, conclude that U.S. 
economic growth would be enhanced if we relied more on consumption 
taxes, or replaced the income tax with a fundamental tax restructuring 
plan similar to those proposed by several prominent members of the U.S. 
Senate and House of Representatives in recent years.
    In addition, at a recent forum on dynamic revenue estimating 
sponsored by the Joint Committee on Taxation, the majority of the 
economic modelers concluded that if the United States switched from the 
existing income tax to a broad-based consumption tax, the rate of 
economic growth would increase significantly.

          Macroeconomic Impact of Capital Gains Tax Reductions

    In their search for methods of stimulating saving, 
investment, and economic growth, policymakers should give 
strong consideration to lightening the tax burden on investment 
through a significant capital gains tax reduction.
    Low capital gains taxes not only treat savers more fairly 
but also help hold down capital costs. Public finance 
economists refer to the tax on capital gains as a tax on 
retained income. It is retained income that funds a large part 
of business investment. The higher the capital gains tax, the 
more difficult it is for management to retain earnings (rather 
than pay out dividends) for real investment in productive 
projects.
    Although the short-term outlook for the U.S. economy is 
favorable, worries about the future appear to be multiplying. 
For example, many public finance experts such as Professor John 
Shoven conclude that this country's long-term strength and 
economic stability depend on increasing saving and investment 
to ensure that the retirement of the baby boom generation does 
not sink the economy into a sea of red ink. A cut in the 
capital gains tax to a top marginal rate of 15 to 20 percent 
would by no means act as an economic panacea. However, it would 
surely help encourage saving, help maintain the values of 
capital assets (e.g. real estate and stocks), promote 
investment by both mature and new businesses, and more fairly 
tax individual savings.
    Substantial reductions in capital gains taxes for 
individuals and corporations would have important economy-wide 
consequences:

                   Increase Jobs and Economic Growth

    A new study by Dr. Allen Sinai, president and chief global 
economist at Primark Decision Economics and the WEFA Group and 
a highly respected economic forecaster, concludes that a well-
crafted, broad-based capital gains tax rate reduction has 
significant benefits for the U.S. economy.
    Dr. Sinai's analysis demonstrates that a broad-based 
capital gains tax proposal providing a 50 percent exclusion for 
individuals and a 25 percent corporate capital gains tax rate 
would reduce the cost of capital (defined as the pretax return 
required by investors) by almost three percent. Reduced capital 
costs lower the hurdle rate for new business investment and 
induce increases in the rate of growth of capital formation, 
investment, productivity, GDP, and employment (see Table 3). 
Lower capital gains taxes support the value of equities as well 
as other capital assets.
    A capital gains tax reduction would also tend to shift the 
financing of business activity from debt to equity, and induce 
portfolio allocations by households toward equity to take 
account of changes in expected after-tax returns on stocks and 
bonds.

                     Benefit Middle-Class Taxpayers

    Investments in capital assets are widely held by the middle 
class. According to data compiled by the Investment Company 
Institute, almost 60 percent of households with income of 
$50,000 or less own mutual funds. A 1996 Congressional Budget 
Office (CBO) draft report also documents the widespread 
ownership of capital assets among middle-income taxpayers. 
According to the CBO report, in 1989, 31 percent of families 
whose incomes were under $20,000 held capital assets (not 
including personal residences) and 54 percent with income 
between $20,000 and $50,000 held capital assets.
    Middle-and low-income taxpayers also hold a significant 
share of the total dollar value of capital assets, even when 
personal residences are excluded. The CBO study shows that 30 
percent of the dollar value of such assets (excluding housing) 
was held by families with incomes of $50,000 or less in 1989.

                       Encourage Entrepreneurship

    Capital gains taxation has a particularly powerful impact 
on this nations entrepreneurs. These individuals are a major 
driving force for technological breakthroughs, new start-up 
companies, and the creation of high-paying jobs. Starting new 
businesses involves not only entrepreneurs but also informal 
investors, venture capital pools, and a healthy public market. 
All taxable participants are sensitive to after-tax rates of 
return, which is why the level of capital gains taxation is so 
important.
    Foremost is the entrepreneur. If the tax on potential 
capital gains is a higher rate, either the pool of qualified 
entrepreneurs will decline or taxable investors will have to 
accept a lower rate of return. In either case, the implications 
for the U.S. economy are clearly negative. To be successful, 
the entrepreneur needs capital. Fledgling start-ups depend 
heavily on equity financing from family, friends, and other 
informal sources. Professors William Wetzel and John Freear of 
the University of New Hampshire, in a survey of 284 new 
companies undertaken in the late 1980s, found taxable 
individuals to be the major source of funds for those raising 
$500,000 or less at a time. The point to be stressed is that 
individuals providing start-up capital for these new companies 
pay capital gains taxes and are sensitive to the capital gains 
tax rate.
    Small businesses and entrepreneurs face higher capital 
costs than Fortune 500 companies. For them, a significant 
capital gains tax differential can make a big difference in 
their decisions affecting jobs and growth.

                           Raise Tax Receipts

    Critics of lower capital gains taxes argue that such cuts 
will reduce federal revenues and thus add to the budget 
deficit, absorb national saving, and raise interest rates and 
capital costs. Both economic analysis and experience 
effectively refute this view.
    Scholars have researched and debated two elements affecting 
capital gains tax revenues, the unlocking of unrealized gains 
and the macroeconomic impact of a low tax on capital gains.
    Revenue estimates used in congressional and Treasury 
Department analyses ignore macroeconomic impacts but do 
incorporate an unlocking or behavioral response on the part of 
taxpayers to changes in capital gains tax rates. Estimates of 
unlocking are extremely sensitive to assumptions about the 
elasticity of taxpayer response. Very minor differences in 
assumptions can result in large differences in expected 
revenues.
    In the late 1980s, experts at the prestigious National 
Bureau of Economic Research (NBER) examined the question of the 
revenue-maximizing capital gains tax rate: At what point is 
there sufficient unlocking to compensate for the static revenue 
loss resulting from a reduction in the tax? The NBER study by 
former Harvard Professor Lawrence Lindsey (a recently retired 
member of the Board of Governors of the Federal Reserve), which 
was based on academic models of the responsiveness of taxpayers 
to changes in the capital gains tax rates, found that the 
revenue-maximizing rate ranged between 9 and 21 percent. The 
NBER study did not take into account the additional revenue 
stemming from the positive macro consequences of increased 
employment and growth which result from a significant reduction 
in capital gains tax rates.
    Although government revenue estimates do not factor in the 
macroeconomic consequences of lower capital gains tax rates on 
U.S. capital costs, investment, and economic growth, previous 
research indicates these effects can have a favorable impact on 
overall tax revenues. In addition, the new dynamic analysis by 
Dr. Sinai shows that the government could gain revenue from a 
capital gains tax reduction (see Table 3).
    Actual experience also indicates that lower capital gains 
taxes have a positive impact on federal revenues. The most 
impressive evidence involves the period from 1978 to 1985. 
During those years the top marginal federal tax rate on capital 
gains was cut almost in half from 35 percent to 20 percent but 
total individual capital gains tax receipts nearly tripled, 
from $9.1 billion to $26.5 billion annually.

                   Promote U.S. Saving and Investment

    Our international competitors recognize the contribution a 
lower capital gains tax rate can make in promoting capital 
formation, entrepreneurship, and new job creation. The United 
States, on the other hand, taxes capital gains more harshly 
than almost any other industrial nation. A survey by the OECD 
of twelve industrialized countries shows that the U.S. capital 
gains tax rate on long-term gains on portfolio securities 
exceeds that of all countries except Australia and the United 
Kingdom, and these two countries index the cost basis of an 
asset (see Table 4). Germany, Japan, and South Korea exempt or 
tax only lightly capital gains on portfolio stock. Not only do 
virtually all industrialized as well as developing countries 
tax individual capital gains at lower rates than the United 
States, they also accord more favorable treatment to corporate 
capital gains (see Figure 2).
    It is important to note that most of the countries shown in 
Table 1 have had higher rates of investment as a percentage of 
GDP than the United States over the past two decades. This fact 
may in part reflect the encouragement of saving and investment 
due to their lower capital gains tax rates.

                               Conclusion

    A soundly structured, broad-based cut in tax rates on 
capital gains would significantly benefit all Americans. By 
reducing the cost of capital, it would promote the type of 
productive business investment that fosters growth in output 
and high-paying jobs. By increasing the mobility of capital, it 
would help assure that scarce saving is used in the most 
productive manner. By raising capital values, it would help 
support values in capital asset markets in general and the 
stock market in particular. By increasing the availability and 
lowering the cost of risk capital, it would aid entrepreneurs 
in their vital efforts to keep the United States ahead in 
technological advances and translate these technological 
advances into products and services that people need and want. 
By reducing taxes on their savings, it would treat fairly those 
thrifty Americans who must bear a heavier tax burden than the 
profligate. And, because of the combined impacts of unlocking 
and macroeconomic feedback, a broad-based capital gains tax cut 
could increase federal revenues.
    Mr. Chairman, the case for an early broad-based cut in 
capital gains tax rates is exceedingly strong. We urge this 
Committee and both Houses of Congress to enact such legislation 
at the earliest feasible time.
      

                                

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    Ms. Johnson [presiding]. Thank you, Mr. Bloomfield.
    Ms. Gravelle.

  STATEMENT OF JANE G. GRAVELLE, SENIOR SPECIALIST, ECONOMIC 
             POLICY, CONGRESSIONAL RESEARCH SERVICE

    Ms. Gravelle. Madam Chairman, Members of the Committee, I 
would like to thank you for the opportunity to appear before 
you today to discuss the President's capital gains tax cut 
proposals and the implications of capital gains tax cuts for 
savings and investment.
    The President's capital gains tax cut is directed at owner-
occupied housing. For most individuals, it would effectively 
eliminate capital gains tax on the sale of a principal 
residence. Because of the many ways to avoid paying this tax 
currently, a relatively small number of homeowners are subject 
to the tax. The President's tax proposal would have modest 
effects on savings and investment for two reasons: First, the 
provision is a small one, costing only $200 to $300 million per 
year according to administration estimates. The main benefits 
of the proposal are not so much in its effects on savings and 
investment but rather that it would relieve most homeowners of 
the onerous recordkeeping requirements, prevent people from 
making decisions based on tax avoidance motives, and perhaps be 
fairer to individuals who have a need to sell.
    Even if the scope of the economic effect of the capital 
gains tax cut is larger, for example, because more general 
capital gains provisions might be considered, there is little 
reason to believe that significant effects on savings and 
growth will occur. First, we cannot be sure whether cutting 
capital gains taxes on capital income will increase savings. It 
may surprise you to know that economists have long recognized 
that the response of savings to the rate of return is 
theoretically uncertain due to the opposing forces of income 
and substitution effects. When the rate of return rises, a 
substitution effect might cause an individual to prefer more 
consumption in the future and save more, but at the same time, 
the income effect allows him to actually save less to reach a 
particular target.
    Therefore, because of this theoretical ambiguity, it is 
necessary to turn to the empirical research. Unfortunately, the 
body of empirical research does not suggest a large positive 
effect on savings from increasing the rate of return, and, 
indeed some studies find a negative effect; that is, some 
studies indicate that cutting capital gains taxes might even 
reduce savings.
    The process of altering the capital stock through change in 
the savings rate is also a very slow one, so that one would not 
expect large effects in the short run even with a large 
response. And finally, this type of tax cut would not have a 
large effect on output because it is not large in itself. This 
is true even for a broader capital gains tax cut, such as a 50-
percent exclusion accompanied by indexing. I estimate that were 
that directly translated into reduction of the cost of capital, 
the exclusion would reduce the cost of capital by 9 basis 
points and with the addition of indexation by about 16 basis 
points, very small effects. That is simply because the capital 
gains tax is not a very large part of our current tax system.
    I would also like to briefly summarize the results of the 
simulation model I have developed that traces over time the 
response to a tax cut of this magnitude. In doing this 
estimate, I used those results from the literature that were 
actually conducive to a larger positive, in other words, they 
were very generous to a larger positive effect. Even after 5 
years, I found the capital stock increased by less than two-
tenths of 1 percent; the output level by only one-twentieth of 
1 percent. After 110 years, output increased by only half of 1 
percent.
    To see why these effects are so small, let me discuss the 
first year. We might find the rate of return rising by about 4 
percent. Using even a generous savings response, the increase 
in the savings rate would only be 1.6 percent, but savings is 
only about 2 percent of the capital stock, which means the 
capital stock will increase by only three-one hundredths of 1 
percent and the output by one-one hundredth of 1 percent. Thus, 
even under optimistic assumptions, the effects of a larger 
capital gains tax cut are small.
    Models that find very large effects of capital gains tax 
cuts are using very large elasticities and very fast adjustment 
periods that simply are not consistent with the economic 
evidence. I would like to also add that arguments that have 
been made that a capital gains tax cut will stimulate 
investment in the short run by causing a rise in stock market 
prices and lowering equity, in my view, are not consistent with 
correct economic modeling, because they do not trace the 
process by which this asset price occurs.
    There have also been arguments that capital gains tax cuts 
may be important for venture capital. That may be true, but 
venture capital is a very, very small part of total investment 
in the economy. In the latest data I saw, it accounts for 
seven-tenths of 1 percent of total investment in the economy. 
Most capital gains tax cuts will not go to venture capital.
    I do not mean by this discussion to imply that capital 
gains tax cuts are not desirable. There are arguments for and 
against them. But I think the important point for this 
Committee to remember is that probably the most direct and 
certain route to increasing savings is to increase the public 
sector savings by decreasing the deficit or increasing a 
surplus, should we ever have one. And in this context, I would 
like to add that the current revenue estimating by the Joint 
Tax Committee for capital gains is not static estimating; it 
includes a very generous dynamic estimate, and, in fact, that 
dynamic estimate might be a little too generous. So, I think it 
is very important to keep your eye on the revenue costs when 
you are considering capital gains taxes, if you are interested 
in the effect on long-run growth and savings.
    Thank you.
    [The prepared statement follows:]

Statement of Jane G. Gravelle, Senior Specialist, Economic Policy, 
Congressional Research Service

    Mr. Chairman and Members of the Committee, I am Jane G. 
Gravelle, a Senior Specialist in Economic Policy at the 
Congressional Research Service of the Library of Congress. I 
would like to thank you for the opportunity to appear before 
you today to discuss the President's capital gains tax cut 
proposals and the implications of capital gains tax cuts for 
savings and investment.
    The President's capital gains tax cut is directed at owner-
occupied housing. For most individuals, it would effectively 
eliminate capital gains tax on the sale of a principal 
residence by allowing a $500,000 exclusion for a married couple 
and a $250,000 exclusion for a single person or head of 
household. This exclusion can be used once every two years. 
This proposal would replace two existing provisions. One 
provision allows deferral of gain that is rolled over into a 
new residence--if the new residence costs as much as the old, 
all gain is deferred. The second provision allows a one time 
$125,000 exclusion for individuals aged 55 and over. And, of 
course, like any capital gains tax, the tax can be avoided 
completely if the asset is held until death.
    Because of the many ways to avoid paying the tax, a 
relatively small number of homeowners are subject to the tax. 
These taxpayers are likely to fall into two categories: older 
individuals whose gains exceed the exclusion or who have 
already used the exclusion and younger individuals who are not 
eligible for an exclusion. In both cases, these would be 
individuals who desire to reduce their investment in housing, 
perhaps by buying a smaller residence or perhaps by moving into 
a rental unit or other living facility. In many cases, these 
individuals may be facing adverse circumstances (loss of 
health, or a decline in economic circumstances) that causes 
this contraction in housing consumption.
    The President's tax proposal will have modest effects on 
savings and investments for two reasons. First, the provision 
is a small one, costing only $200 to $300 million per year 
according to Administration estimates. The main benefits of the 
proposal are not so much in its effects on savings and 
investment, but rather that it would relieve most homeowners of 
onerous record-keeping requirements, prevent people from making 
decisions based on tax avoidance motives, and perhaps be fairer 
to individuals who have a need to sell.
    Note, however, that even though this provision is directed 
at housing, it might make more capital available to business 
use by reducing the lock-in effect of the housing capital gains 
tax. For example, individuals moving from a high cost to a low 
cost area may feel less pressure to reinvest in a large house, 
and individuals who would like to downsize and invest the 
proceeds elsewhere would be freer to do so.
    In fact, this provision might have a larger behavioral 
effect than implied by its revenue cost, because it 
influences--and imposes an implicit burden on--those who do not 
pay tax. Indeed, the principal argument for simply allowing an 
exclusion for most people is that the current law, while 
collecting very little revenue, is costly because of its 
influence on behavior, as individuals seek to avoid the tax.
    Even if the scope of the economic effect of a capital gains 
tax is larger, either because the current treatment has an 
implicit cost or because more general capital gains tax 
provisions might be considered, there is little reason to 
believe that significant effects on savings and growth will 
occur.
    First, it may be surprising to some to learn that we cannot 
be sure whether cutting taxes on capital income will increase 
savings. Economists have long recognized that the response of 
saving to the rate of return is uncertain due to the opposing 
forces of ``income'' and ``substitution'' effects. When the 
rate of return rises, a substitution effect might cause an 
individual to prefer more consumption in the future (because 
the price of future consumption has fallen in terms of foregone 
present consumption) and increase savings. At the same time, 
there is an income effect--the higher rate of return can allow 
savings to be smaller and still increase consumption in the 
future (and in the present as well). For example, if an 
individual were saving a certain amount for retirement, he 
could obtain that objective with a smaller amount of savings 
when the rate of return goes up.
    Because of this ambiguity, it is necessary to turn to 
empirical research to determine whether private savings will 
increase, and empirical evidence would be necessary in any case 
to determine the magnitude of any effect. While it is very 
difficult to perform this analysis, this body of research 
suggests that effects of higher rates of return on savings have 
small positive effects on savings behavior and, in some 
studies, negative effects.\7\ That is, some studies indicate 
that cutting capital gains taxes might even reduce savings.
---------------------------------------------------------------------------
    \7\ For a summary of this literature, see Jane G. Gravelle, The 
Economic Effects of Taxing Capital Income, Cambridge, Mass., MIT Press, 
1994, p. 27.
---------------------------------------------------------------------------
    The process of altering the capital stock through a change 
in the savings rate is a very slow one that takes many years. 
Even with a large percentage increase in savings, the effect on 
the capital stock and on economic output will be modest because 
savings is very small relative to the capital stock.
    Finally, it is likely that the effect of the capital gains 
tax cuts on economic output and growth will be modest, even 
with a large response, because the tax change itself is not 
that large relative to the economy. This is true even for a 
capital gains tax cut of much broader scope than that of the 
President's. For example, by my calculations, a fifty percent 
capital gains exclusion has the effect of reducing the cost of 
capital by 9 basis points, and the combination of the exclusion 
and indexation reduces the cost by about 16 basis points.\8\
---------------------------------------------------------------------------
    \8\ This information and the simulation that follows was presented 
in greater detail to The Committee on Finance, United States Senate, 
February 15, 1995. The calculation of basis points relfected 
realizations in 1992; the effects might be somewhat larger because 
realizations may have been depressed in that year, but the magnitudes 
will be similar.
---------------------------------------------------------------------------
    I would like to briefly summarize some results of a 
simulation model that traces, over time, the response to a 
broader capital gains tax cut of this general magnitude, 
equivalent to a two percentage point reduction in the capital 
income tax rate, or a reduction in the cost of capital of 18 
basis points. While taking my estimated responses from the 
economics literature, I used those results favorable to a 
larger positive effect of the tax. A savings response at the 
upper end of the estimates in the empirical literature is 
chosen. This response is in the form of a savings elasticity 
(the percentage change in the savings rate divided by the 
percentage change in the rate of return), and is set at 0.4. 
This estimate was reported by Michael Boskin in one of the 
earlier studies of savings response.\9\ Such a measure implies 
that a ten percent increase in the rate of return will lead to 
a four percent increase in the savings rate.
---------------------------------------------------------------------------
    \9\ Michael Boskin, Taxation, Savings and the Rate of Interest, 
Journal of Poilitical Economy, vol. 86, January 1978, pp. S3-S27.
---------------------------------------------------------------------------
    Several aspects of this simulation were chosen to be 
favorable to a large effect, including not only a larger, and 
positive, savings elasticity, but also an assumption that any 
revenue losses are recouped through some mechanism that does 
not otherwise alter the economy's economic behavior. Even after 
five years, however, the capital stock increased by less than 
\2/10\ of a percent, the labor supply by \1/100\ of a percent, 
and the output level by \1/20\ of a percent. Even after 110 
years, output increased by only one half of one percent. 
Eventually, the process reaches a final equilibrium, which 
results in a 2.25 percent increase in the capital stock, a .07 
percent increase in the labor supply, and a 0.62 percent 
increase in output.\10\
---------------------------------------------------------------------------
    \10\ In the long run, our concern is about changes in standard of 
living, that is available consumption in the steady state. Since the 
savings rate must be higher to maintain the normal growth of the higher 
capital stock, the percentage increase in consumption is slightly 
smaller, at 0.49 percent.
---------------------------------------------------------------------------
    It is relatively straightforward to see why these effects 
are so small in the short run. Consider the first period after 
the rate of return rises. Suppose it rises by about 4 percent. 
That implies an increase in the savings rate of 1.6 percent (4% 
times the elasticity of 0.4). But savings is about two percent 
of the capital stock, which implies that the capital stock will 
increase by only \3/100\ of a percent. Finally, given that 
capital contributes only twenty-five percent of output, the 
effect on output is less than \1/100\ of a percent.
    Thus, even under optimistic assumptions, the effects of 
even a much larger capital gains tax cut on savings appears to 
be small.
    It is important to note that models that have found very 
large effects on the capital stock of tax cuts, including the 
capital gains tax cut, use the assumption of a very large 
savings response and a rapid adjustment period. Such an 
assumption is not grounded in statistical evidence from the 
economics literature.\11\
---------------------------------------------------------------------------
    \11\ Note also that one argument used to justify a large savings 
response, international capital inflows, is not germane to this usse, 
since the capital gains tax applies to residents regardless of the 
location of capital and does not apply to foreign investors.
---------------------------------------------------------------------------
    More recently, arguments have been made that capital gains 
tax cuts will stimulate investment in the short run by causing 
a rise in stock market prices, which would make equity finance 
cheaper to firms. A consistent model of the economy would 
suggest two important limits on this process. First, total 
asset prices (of stocks and bonds) cannot rise unless there is 
some increase in overall purchases, which should be preceded by 
an increase in savings. Shifts between the two will do nothing 
for the cost of capital. Some attempts to model the effect of a 
capital gains tax cut begin by simply translating a lower 
capital gains tax into a higher stock market price, without 
taking account of the effects on interest rates. But asset 
prices are not set exogenously--they are a consequence of 
supply and demand, and depend on the nature of those supply and 
demand factors. If anything, a capital gains tax cut is a 
relatively indirect route to subsidizing investment, as, say, 
compared to an investment subsidy, since it first requires a 
bidding up of stock prices and then an expansion in equity 
finance.
    Secondly, there is no reason to expect a permanent rise in 
stock market prices due to a capital gains tax cut. Even if 
asset prices increased, the value would fall until stock prices 
again reflected the value of underlying assets. The expectation 
that this price effect would be transitory should moderate its 
effect in the first place.
    Some have argued that capital gains tax cuts would be 
effective in increasing the amount of venture capital. Of 
course, there are already some provisions in the tax law that 
benefit new stock issues in small firms. In general, however, 
it is important to note not only that very little direct 
evidence for a strong response of venture capital exists, but, 
more importantly, only a very small part of capital gains tax 
relief would go to venture capital. According to data on 
venture capital commitments reported in a study by Poterba, 
formal venture capital accounted for only \7/10\ of one percent 
of total investment. Moreover, most of the suppliers of venture 
capital are not subject to capital gains taxes, particularly 
individual capital gains taxes. (Individuals accounted for only 
12 percent of funds).\12\
---------------------------------------------------------------------------
    \12\ James M. Poterba. Venture Capital and Capital Gains Taxation. 
In Tax Policy and the Economy, National Bureau of Economic Research, 
Cambridge, MIT Press, 1989.
---------------------------------------------------------------------------
    Returning to the general savings analysis, under less 
favorable assumptions (e.g., effects on the budget deficit are 
not offset and/or the relationship between savings and the rate 
is return is negative), the capital gains tax cut could 
contract the economy and slow economic growth by reducing 
national savings.
    This discussion is not meant to imply that capital gains 
tax cuts are not desirable. There are some efficiency arguments 
in favor of capital gains tax cuts, particularly for corporate 
stock. Some people have reservations about cutting capital 
gains taxes, however, because of the distributional and revenue 
consequences. But as a route to increased savings, the evidence 
from economics--both theoretical and empirical--suggests some 
reservations about the efficacy of lower capital gains tax 
rates in increasing savings.
    What alternatives might be more successful in increasing 
savings? Some highly stylized economic models suggest that tax 
provisions that benefit only new physical investment, as would 
occur with a shift to a consumption tax, might have a 
pronounced effect on savings. While these types of tax 
revisions might be more successful than tax cuts that benefit 
old capital, there is little evidence that such dramatic 
responses are likely. Periods in history that were 
characterized by such changes were not accompanied by the 
dramatic savings responses, especially in the short run, that 
some of these models predict.
    While this analysis suggests that it is difficult to 
influence private savings via tax revisions, most economists do 
agree that there is one relatively straightforward way in which 
the government can increase national savings--increasing public 
sector savings. Reductions in the deficit or additions to a 
surplus would be likely to translate directly into increased 
savings. For that reason, most economists believe that it is 
important to ensure that adoption of tax incentives do not add 
to the budget deficit, if increases in national savings is an 
important goal.
      

                                

    Chairman Archer [presiding]. Thank you, Ms. Gravelle.
    Mr. Wyss, we would be pleased to receive your testimony.

 STATEMENT OF DAVID WYSS, RESEARCH DIRECTOR, DRI/MCGRAW-HILL, 
                    LEXINGTON, MASSACHUSETTS

    Mr. Wyss. Thank you, Mr. Chairman, Members of the 
Committee.
    Chairman Archer. Did I pronounce your name correctly?
    Mr. Wyss. Yes; it is W-y-s-s.
    Chairman Archer. Thank you.
    Mr. Wyss. I would like to thank you for inviting me to 
discuss capital gains taxation and its impact on the economy. I 
should start by saying that DRI has normally been pretty 
skeptical about ideas that tax cuts will raise enough revenue 
to pay for themselves, but I think capital gains is one area 
where this is true. The capital gains cut is one tax that does 
have enough leverage to increase the economy enough to pay its 
own bill, and it is one area where dynamic scoring, I think, is 
really required.
    Generally, dynamic scoring is the correct way to look at 
any change in the tax rates, but historically, it has fallen 
into disfavor because of overpromising, because it becomes an 
exercise in competitive dynamism, as everyone tries to 
outpromise everyone else. And, therefore, we have moved away 
from it. I really feel that by a consistent use of mainstream 
economics, looking at a variety of economic models, it would be 
possible to use it, but I realize that that is not the task of 
today's Committee meeting.
    The capital gains tax is revenue neutral, not only or even 
primarily because of its impact on increasing economic growth. 
We actually feel the impact on the economy is relatively small 
because the capital gains tax is relatively small compared with 
the economy. You are talking about a tax reduction on the order 
of $15 billion. Even with a lot of leverage--and we think 
capital gains does have a lot of leverage--our analysis 
indicates that real GDP is only increased by about 0.4 percent 
at the end of 10 years.
    That does not sound like a lot, but I would like to remind 
people that that is about $60 billion at that time, and if you 
think that is small enough not to pick up, I will be happy to 
take a finders fee on it. [Laughter.]
    Mr. Wyss. It is also very large not just in absolute 
magnitude, but it is very large relative to the size of the tax 
cut. This means we are getting a multiplier of about four on 
the size of the tax cut. That is not enough to make it revenue 
neutral by itself, but it is a good start. Ordinary taxes paid 
on that are an offset to a good part of the capital gains cut.
    The real leverage on revenues, however, comes not just from 
the impact on the economy but the impact of the capital gains 
tax in increasing asset values and increasing capital 
realizations. On the question of asset values, I do not think 
there is any mystery: Any investor is going to equalize the 
aftertax rate of return on various classes of assets. If you 
lower the rate of taxation on equity, for example, the price of 
equity has to go up in order to equalize the return between 
that and, say, Treasury bonds, which I see no reason to be 
affected by capital gains taxes. That means that increase in 
asset value eventually comes back to the Treasury. It is clawed 
back, to use a Briticism, in terms of higher capital gains 
receipts, albeit at the lower rate.
    The third source of revenue comes from the increased 
turnover that you are likely to get as people are less locked 
in to their existing capital. The current capital gains tax 
creates inefficiencies in the market because people do not want 
to sell an inferior asset for fear of having to pay tax on it. 
Obviously, if you have complete capital gains in an asset, and 
you are being taxed at 28 percent, any asset you buy has to 
yield about 40 percent more than the asset you are selling just 
to make up for the tax payment you have to make up front to the 
Treasury. If this lock-in effect is diminished, people will 
turn over their assets more quickly, and this creates some 
additional tax revenue, particularly up front.
    That additional revenue is important in the short run, 
because it is an offset, particularly in the first 5 years. 
There is an enormous amount of unrealized capital gain out 
there to turn over. Current estimates are that we have between 
$6 and $7 trillion of unrealized capital gains in this economy. 
Even a very small increase in turnover would yield a large 
amount of tax revenue.
    Overall, we believe that a moderate capital gains 
reduction, and the primary analysis we did was on S. 66, the 
Hatch-Lieberman bill, would result in neutral or, in our 
estimate, slightly positive revenue change. In other words, the 
bill is revenue positive. It raises more revenue than it loses 
on a static basis. If you reduce rates too much, this is no 
longer true, because you are clawing back at lower rates. 
Clearly, if you reduce tax rates to zero, the volume is not 
going to make up for the reduction in rates.
    Exactly where the revenue maximizing rate lies, I am not 
certain. Our analysis suggests that it is below 28 percent; 
probably close to 20 percent. But we would like to do some more 
analysis over time to figure out where it should be.
    The final analysis, though, is that even if it is only 
revenue neutral, the tax law change helps the economy. It helps 
productivity. It helps, obviously, the owners of capital, 
because they are taxed at a lower rate. It helps the workers 
because of the increase in capital stock, the increase in 
productivity, and the increase in employment. It raises enough 
revenue to pay for itself, so it hurts no one. If you have a 
bill which helps most people and hurts nobody, what is the 
possible reason for not doing it.
    Thank you.
    [The prepared statement follows:]

Statement of David Wyss, Research Director, DRI/McGraw-Hill, Lexington, 
Massachusetts

    Mr. Chairman, members of the Committee:
    Thank you for inviting me to discuss capital gains taxation 
and its impact on the economy. DRI/McGraw-Hill has long been 
skeptical about any claims that tax cuts will raise more 
revenue than they cost. The capital gains tax is the one tax, 
however, where this may be true. At least for moderate changes 
in the capital gains tax rate, our analysis indicates that the 
impetus the lower rate gives to asset valuation and to the 
economy roughly offsets the lower static tax revenues. Within a 
reasonable range of tax rates, the capital gains tax rates 
appears roughly revenue neutral.
    This is one area where dynamic scoring really seems 
required. Dynamic scoring is, generally, the correct way to 
look at any form of taxation, but the problem with it 
historically has been the ability to distort the dynamic scores 
by letting wishful thinking dominate economic analysis. We feel 
by consistent use of economic techniques it is possible to do 
dynamic scoring. It is questionable whether it is possible to 
do it within a political framework.
    The capital gains tax is revenue neutral not primarily 
because of its impact on the economy, but because of its impact 
on asset values. In general, we believe that the impact on the 
economy is relatively small. This would be expected. After all, 
the capital gains tax cut is only worth about $15 billion on a 
static basis, and even with substantial leverage it is hard for 
$15 billion to have an enormous effect on a $7 trillion 
economy. Our analysis suggests that, even after ten years, the 
impact on overall GDP is 0.4%, clearly not an enormous number, 
but hardly a trivial one. In fact, over that ten year period, 
real GDP would be raised by an aggregate of over $200 billion.
    This may be a small share of GDP, but it is certainly a 
very large share of the $15 billion annual static cost of the 
capital gains tax. Moreover, some additional tax revenue will 
come from the higher value of existing assets. When the capital 
gains tax rate is cut it increases the value of owning shares 
of stock. As the price of those shares rises, owners pay taxed 
on that increased amount. Those additional taxes offset the 
static revenue loss.
    Additional revenue also comes from higher turnover. Capital 
gains taxes lock owners into their stock positions. People are 
unwilling to sell stock because if they sell the stock, they 
will have to pay capital gains at a 28% rate. Sub-optimal stock 
positions are thus locked.
    The estimates of higher turnover are probably the most 
questionable part of any analysis of the impact of capital 
gains. In the past, capital gains cuts have usually come as 
part of larger tax packages. It is very difficult to 
disentangle turnover from the overall impact of the rest of the 
tax code. Moreover, capital gains realizations depend heavily 
on what has been happening in the stock market which is also 
moved sharply by changes in the capital tax. The unlocking 
effect seems clear from anecdotal reports and simple logic but 
its magnitude is somewhat questionable. We feel our estimates 
are conservative--additional turnover of only 5% of unrealized 
capital gains over the next ten years.
    There will be some negative effect as taxpayers shift 
income away from ordinary income and into capital gains. If the 
capital gains rate is reduced, people have a greater incentive 
to take income in the form of tax-advantaged capital gains 
rather than ordinary income. The restriction of passive loss 
deductions, however, makes this a more difficult game to play 
than in the 1980s. We estimate the impact at about $2 billion a 
year. Prior to the 1986 tax law we would have estimated a 
substantially higher figure, $5 to $10 billion annually.
    Overall, we believe that a moderate capital gains 
reduction, on the order of that proposed in the Hatch-Lieberman 
bill, will result in a small gain in revenue. Too large a cut 
in rates, however, is no longer revenue neutral. Much of the 
clawback from revenue comes from applying the capital gains 
rate to the higher asset values. If the rate is reduced too 
far, the tax on the rise in assets is not sufficient to offset 
the static revenue loss. Our analysis of HR14, for example, 
indicates that the bill would be a significant revenue loser, 
costing well over $100 billion on net over a ten-year period. 
The Dreier bill would have a greater impact on the economy and 
on the stock market, but because the stock market gains are 
taxed at a lower rate, it would not raise enough revenue to 
offset its cost.
    This is not an argument against indexation. Indeed, our 
study suggests that indexation is more effective, dollar-for-
dollar, than rate cuts. Indexation cuts rates only on future 
gains, and does not reward the past. We do caution against 
trying to cut the rate and introduce indexation, however.
    One argument against a capital gains rate cut is that it 
accrues only to the rich. Although it is certainly true that 
the rich have more capital than the poor, the poor don't lose 
in a capital gains cut. Pension portfolios will gain in value, 
and the middle class have a rising portfolio of 401K plans. The 
great bulk of the assets of the middle class, and particularly 
the younger middle class, is tied up in their homes. More 
direct relief on capital gains in housing could spread the 
benefits more equally. But even if households have no capital 
assets themselves, they will benefit from the higher investment 
and resulting higher productivity created by the capital gains 
rate cut.
    The capital gains cut helps most people and hurts no one. 
The overall impact on the economy, though small, is clearly 
positive. Reducing capital gains will not remake the economy, 
but it helps modestly at no cost to the Treasury. We find it 
difficult to understand why the bill should not be passed.

 The Capital Gains Tax, Its Investment Stimulus, and Revenue Feedbacks

    The impact of a capital gains tax cut on the economy and on 
tax collections has been investigated for decades. The evidence 
suggests to almost all economists that a capital gains cut is 
good for the economy and roughly neutral for tax collections. 
Although static analysis of the tax suggests the federal 
government loses revenue, a dynamic analysis suggests that the 
government can gain revenue. Such dynamic gains depend on the 
time interval examined and on the feedback effects from a 
stronger economy. By encouraging investment, a capital gains 
tax reduction becomes a true supply-side tax cut, and perhaps 
the only cut that really might fully pay for itself.
    Cutting the capital gains tax will boost investment by 
lowering the cost of capital to businesses. The only 
preferences now offered for individuals are a maximum rate of 
28% for gains versus 39.6% for ordinary income, and the 
deferral of taxation on accrued gains until the underlying 
asset is sold. A new preference that included just 50% of the 
gain in ordinary income would thus cut the effective top 
marginal rate paid by capital gains recipients to 19.8% from 
the current 28%. Together with a reduction in the corporate 
rate on gains from 35% to 25%, this shift would, in a static 
analysis, lose about $15 billion of federal revenue per year. 
(From the perspective of an investor facing both state and 
federal capital gains taxes, the current marginal tax rate on 
capital gains is 32%, assuming a 6% state and local rate 
deductible against the federal income tax. The new effective 
rate would be 23.5%.)
    The lower tax rate on capital gains unambiguously raises 
the value of assets subject to the tax because the same, 
related stream of pre-tax earnings is now worth more after-tax 
to the investor. This affects the stock market most. DRI 
analyzes share prices as the after-tax, discounted present 
value of dividends and capital gains (driven by retained 
earnings).
    If all holdings were subject to the tax, the proposed lower 
tax rate on gains would need to raise share prices 8% to 
equalize the risk-adjusted rate of return on shares with that 
on bonds. This calculation assumes that bond yields would not 
be affected by the lower capital gains rate. It assumes that 
all of the correction required to avoid an unjustifiable yield 
differential is produced by a rise in the price-earnings ratio 
of stocks. This assumption of unchanged bond yields is 
reasonable when considering a solitary change in capital gains 
taxation. That is because bond yields represent the discounted 
value of future short-term interest rates, adjusted for risk, 
and there is no immediate reason why short-term rates should be 
affected by the solitary tax change.
    However, we recognize not all asset holdings are subject to 
capital gains taxes. Tax-sheltered investments (such as pension 
funds and 401K and IRA holdings) and foreign investments now 
account for about half of all equity holdings. Assets passed 
through an estate without a sale before death escape capital 
gains taxes, although heavy estate taxes apply to any accrued 
appreciation plus the original principal invested.
    As share prices rise in response to a tax rate cut in the 
above-noted scenario, the expected pre-tax rate of return of 
equity would drop, inducing non-taxable investors to shift into 
bonds. If we assume that the degree of risk aversion, and thus 
the trade-off between risk and return, is the same for these 
investments as for non-tax-exempt holdings, the impact on share 
prices will be reduced by their ratio to total holdings. This 
implies that in an environment with half the investors exempt 
from taxation, equity price-earnings ratios will rise by only 
4%, half the 8% gain calculated above. Note that this would be 
a permanent increase in the price-earnings ratio corresponding 
to any given bond yield. Experience suggests that the move will 
not occur until the bill is signed by the President, but then 
it will come quickly.
    The capital-gains tax cut would lower the net cost of 
capital by about 3%. This 3% estimated reduction is a blend of 
an 4% reduction in the cost of equity and an unchanged cost of 
debt finance. The core cost of equity equals the dividend yield 
(reduced 4%, as indicated above) plus expected dividend growth 
(assumed to be unchanged at about 6%). Other factors equal, 
this shift would raise the level of business spending by about 
1.5%, or $18 billion in 2007. Over a 10-year period, the 
capital stock would rise 1.2% above its baseline level, 
increasing productivity by roughly one-third this percentage, 
or 0.4%.

                             Budget Impact

    The effect on capital gains tax collections is complicated 
and potentially controversial. However, a decomposition of the 
impact into discrete components can replace some of the emotion 
in the debate with rationally discussible magnitudes:
    1. In a static analysis, the lower rates will reduce tax 
revenues proportionately.
    2. However, lower rates unlock assets, creating higher 
turnover and increasing collections in the short run.
    3. The higher value of assets, and thus asset prices, 
raises total capital gains, and thus increases revenue.
    4. Income reclassification from ordinary income to capital 
gains will cut revenue.
    5. The stronger resulting economy and higher GDP raises 
total tax revenue.
    The static loss is easy to calculate since it is simply the 
change in the tax rate times the level of capital gains 
receipts. There are only two complications: first, there may be 
an impact on state tax revenues that are tied to federal income 
definitions and, second, capital gains taxes are not broken out 
separately in the statistics. Using estimates based on 1991 
returns, the lower rate would lose about $11 billion per year. 
Based on gains since 1991, we estimate the current impact at 
$15 billion.
    The unlocking/higher-turnover effect will increase revenues 
in the early years of the program. When the capital gains tax 
rate is reduced, assets become more liquid in the sense that 
the tax loss involved in selling them is a lower percentage of 
the asset's value. This switch makes individuals ready to sell 
more often, and by increasing the turnover raises revenue in 
the early years of the program. Estimates based on past CBO 
papers suggest that this unlocking could add $10 billion to 
revenue in the first year. The additional revenue would 
diminish rapidly, however, since the change only moves forward 
the realization of capital gains. Under some models, the impact 
turns negative in the third and fourth year. In the long run, 
there is still some positive effect in our analysis because a 
higher turnover implies that fewer capital gains expire on the 
death of the owner.
    The higher asset value will be the primary positive 
contributor to tax revenues. A 4.0% share price increase will 
raise total stock market valuation by $280 billion. If 15% is 
sold within the first year (about the current turnover rate in 
the stock market) and taxed at 19.8%, this effect would raise 
capital gains revenue by $8 billion. Taxable gains on other 
assets (primarily privately held businesses) might rise by 
about one-half this amount.
    The increased gap between the ordinary income and capital 
gains rates will induce individuals to reclassify income in 
order to lower their tax liability. This income 
reclassification was, in fact, one of the primary reasons cited 
for going to an equal treatment in the 1986 tax bill. There is 
evidence to suggest that the change was successful in widening 
the income-tax base. Reversing this 1986 reform would clearly 
increase the incentive to convert ordinary income into capital 
gains, for example, by deferring income in closely held 
enterprises or shifting from wage income to stock options. The 
size of the impact is uncertain, but it could easily cost $5 
billion per year in reduced tax revenue. At least, this was the 
magnitude cited in 1986 when the change was made in the 
opposite direction. We have assumed only half this effect, 
since we believe the changes in passive loss rules make income-
shifting less easy.
    The stronger growth of the economy produced by a solitary 
change in capital gains taxation will add to both capital gains 
and ordinary income tax collections. Our model suggests that 
after 10 years real GDP could be 0.4% higher than in the 
baseline, because of the capital gains tax rate change and its 
repercussions on investment. In 1992 dollars, this extra growth 
would add $34 billion to national income. In 2007 dollars, the 
impact would be $116 billion, adding $30 billion to federal 
revenue.
    The usual static analysis does not consider either the 
increase in asset values or the impact of a stronger real 
economy. Only the rate reduction and the higher turnover and 
income reclassification are usually included in the analyses 
done by the Congressional Budget Office or other government 
agencies. The difference between the estimates illustrates the 
importance of using dynamic estimates of the impact of tax 
changes. Much of the literature from the extreme right, which 
indicates that the capital gains tax is a huge money-maker, 
illustrates the dangers as well.
    This analysis so far has examined only the macroeconomic 
implications. The distribution of the benefits is also an 
important political and economic issue. A narrow view of the 
capital gains tax cut is that it will favor the wealthy, who 
have more capital than the poor. Although the rich get most of 
the gains, no one loses. Often overlooked benefits flow to all 
workers and middle income citizens, and the overall economy 
wins. The middle class will benefit from greater appreciation 
in their pensions, now increasingly structured as defined 
contribution plans in which all investment returns are captured 
by the employee. Small businessmen will gain from more generous 
tax treatment of the gains on their enterprise. And all 
employees will see wage gains tied to investment-driven higher 
productivity.

                                               Table 1. Estimated Impact of a 50% Capital Gains Exclusion
                                                      (Federal revenues, billions of 1997 dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                    1998       1999       2000       2001       2002       2003       2004       2005       2006       2007      Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Static Impact..................      ($14)      ($15)      ($15)      ($16)      ($16)      ($17)      ($18)      ($18)      $(19)      ($20)     ($168)
Higher Turnover................        $15         $8         $5         $3         $2         $3         $3         $3         $3         $3        $48
Asset Prices...................        $13        $12        $10         $9         $8         $8         $8         $8         $8         $8        $92
Income Reclassification........       ($2)       ($4)       ($2)       ($2)       ($2)       ($2)       ($2)       ($2)       ($2)       ($2)      ($22)
Higher GDP.....................         $0         $1         $2         $3         $5         $7         $9        $10        $12        $14        $63
  Total........................        $12         $2       ($0)       ($3)       ($3)       ($1)         $0         $0         $2         $3        $13
--------------------------------------------------------------------------------------------------------------------------------------------------------



                                          Table 2. Estimated Impact of Indexing Capital Gains with 14% Top Rate
                                                      (Federal revenues, billions of 1997 dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                    1998       1999       2000       2001       2002       2003       2004       2005       2006       2007      Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Static Rate Impact.............      ($23)      ($24)      ($25)      ($26)      ($27)      ($28)      ($29)      ($30)      ($31)      ($33)     ($276)
Indexing.......................         $0         $0         $0       ($2)       ($3)       ($4)       ($5)       ($6)       ($7)       ($8)      ($35)
Higher Turnover................        $16         $8         $5         $3         $2         $3         $3         $2         $2         $2        $47
Asset Prices...................        $14        $13        $11         $9         $7         $7         $7         $7         $7         $7        $87
Income Reclassification........       ($2)       ($3)       ($3)       ($3)       ($3)       ($3)       ($3)       ($3)       ($3)       ($3)      ($29)
Higher GDP.....................         $0         $2         $3         $5         $8        $11        $14        $15        $18        $21        $95
  Total........................         $4       ($4)       ($9)      ($15)      ($16)      ($15)      ($14)      ($15)      ($14)      ($14)     ($112)
--------------------------------------------------------------------------------------------------------------------------------------------------------



          Table 3. Cumulative Impact of Tax Reductions in S. 66
                            [Total 1998-2007]
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Real GDP (billions of 1992 $)..............................       $185
Real capital spending (billions of 1992 $):
  Business equipment.......................................        $83
  Total fixed investment...................................       $103
Capital stock (% difference)...............................        1.1
Output per hour (% difference).............................        0.4
Cost of capital (% difference) (pretax return required by
 an investor)..............................................        -3%
Total federal tax receipts (billions of current $).........       +$13
------------------------------------------------------------------------

                         Indexing Capital Gains

    The proposal to index capital gains has a similar impact to 
the exclusion from tax. It also cuts the cost of capital to the 
firm, and raises the value of assets, including especially 
common stocks. The impact will depend on the amount of 
inflation expected by the market, and on the details of the 
law.
    Over the past, inflation has accounted for about half of 
capital gains. That average, however, includes the high-
inflation 1974-1985 period. We believe the market is currently 
discounting a 3% inflation rate, which would only account for 
about one-third of anticipated capital gains.
    Our analysis assumes the indexation comes on top of a 
reduction in the capital gains rate to 14%, as in HR 14. Thus, 
the impact, or the cost of capital, is less than half as great 
as if it were done on its own. It also, of course, loses only 
half the revenue it would otherwise. Unfortunately, because the 
higher stock values are clawed back at a much lower tax rate, 
the dynamic scoring of the bill does not offset its static 
loss.. A net loss of about one-third the static loss results.
    This is not an indictment of indexation. In fact, our model 
indicates that indexation gives a greater impact on investment 
per dollar of tax revenue lost. The analysis does, however, 
suggest that although capital gains rates are revenue-neutral 
for moderate changes, if they are reduced too far they will 
lose revenue.
    The additional static tax loss is very small in the near 
term, since the bill does not index for past (pre-1997) 
inflation. The impact builds over time, however, as more of the 
gains can be indexed. By 2007, the static loss from indexing is 
estimated at $8 billion.
    Asset prices will rise proportional to the effective 
reduction in the capital gains rate in future years. This means 
that although indexation has little immediate impact on the 
effective capital gains tax rate, it does have full impact on 
asset prices and capital costs. The increase in turnover is 
difficult to estimate in this bill. In general, indexation 
would have only a small near-term impact on turnover, since 
pre-1997 inflation is not forgiven.
    Income reclassification is less likely with indexation than 
with exclusion. There is no advantage to reclassifying income 
as capital gains unless the underlying asset is held long 
enough and its base price is high enough to make the inflation 
adjustment attractive.
    The impact on the economy is proportional to the impact on 
asset values. The economic impact results from the lower cost 
of capital to business, which increases investment. The 
marginal impact of adding indexation to the 50% exclusion is 
about one-third the impact of the exclusion. (Note that these 
magnitudes would have changed if done in the opposite order.)

                                Summary

    Our analysis shows that the Hatch Lieberman bill is 
essentially revenue-neutral. The static losses are largely 
offset by the increase in the value of assets and the stronger 
domestic economy over the ten-year period. Our analysis shows a 
marginally positive result, but well within the margin of 
error.
    In essence, the bill does nobody any harm and does business 
and does a capital owner some good. The proposal lowers capital 
costs and thus raises business investment improving 
productivity and income growth in the long run. The higher 
incomes raise tax revenues offsetting about one-third of the 
static revenue loss. Most of the rest of the revenue loss is 
offset by the higher turnover of capital assets and by the 
increase in the value of the assets caused by the lower tax 
rate.
    Combining a sharper reduction in the rate with indexation, 
as in HR 14, is not revenue neutral. There is a proportionate 
impact on the economy, and the stronger domestic economy 
offsets nearly one-third of the rise of the static revenue 
loss, as in our analysis of Hatch-Lieberman. Asset values also 
rise, but these are clawed back at a lower tax rate and, 
therefore, do not offset as much of the revenue. Similarly, the 
higher turnover is taxed at only 14% instead of 19.8%, yielding 
a smaller impact on revenues. We, thus, find that the bill 
loses $112 billion over a ten-year period, with only about two-
thirds of the static loss made up by income gains elsewhere.
      

                                

    Chairman Archer. Thank you, Mr. Wyss.
    Our next witness is Richard Woodbury. If you will identify 
yourself for the record, we would be pleased to receive your 
testimony.

  STATEMENT OF RICHARD WOODBURY, PRESIDENT, WOODBURY  CORP.,  
SALT  LAKE  CITY,  UTAH; ON  BEHALF  OF  NATIONAL  ASSOCIATION  
                          OF  REALTORS

    Mr. Woodbury. Thank you, Mr. Chairman. My name is Rick 
Woodbury, president of Woodbury Corp., a real estate brokerage, 
management, and development firm located in Salt Lake City, 
Utah. I appear today on behalf of the National Association of 
Realtors, but part of my comments are also presented on behalf 
of several other national real estate organizations which are 
listed at the end of my statement.
    First, I will comment on President Clinton's proposal 
related to owner-occupied residential real estate, then, on 
some issues of concern to commercial and investment real estate 
owners and investors. It is important to note that issues 
pertaining to capital gains on the sale of a principal 
residence are very different from capital gains issues 
pertaining to commercial and investment real estate. The 
proposal that taxpayers filing a joint return be permitted to 
exclude up to $500,000 of gain on each sale of a principal 
residence is a dramatic simplification of the current law and 
should be viewed and supported on its merits as a 
simplification.
    Under current law, rollover rules permit a homeowner to 
exclude the gain on sale of a personal residence from taxation 
so long as the proceeds of the sale are reinvested in homes of 
equal or greater value within 2 years. Also, there is a one-
time exclusion of $125,000 if the taxpayer is over 55 years of 
age. Although these rules have served families well, they are 
the source of very burdensome recordkeeping requirements over a 
long period which are often ignored or, at best, very poorly 
understood by the taxpayers. The new rule would largely 
eliminate this problem, because only 2 percent of the existing 
home sales occur at prices above $500,000. In order to have a 
gain of $500,000, you would have to have a sale of 
substantially higher than that. The new rule would eliminate 
tax considerations and potential IRS conflicts and thus major 
recordkeeping burdens in almost all home transactions.
    In addition, rollover rules have been criticized as forcing 
people to buy even more expensive housing, even if they do not 
need it or even if they do not really want to incur the debt 
load necessary to carry it. It also creates dilemmas for 
homeowners who relocate from high cost areas to lower cost 
housing areas.
    Under the new proposal, housing decisions would be based on 
family needs, not on the Tax Code. This is a good policy. A 
family could still trade up, but it could also move down to 
smaller or less expensive homes when no longer needed. We also 
view home equity as a principal source of saving and a safety 
net for most Americans. The new proposal would allow most 
people to realize all of the benefit of that saving. This may 
be important for families in reduced circumstances who are 
forced to sell a home due to lost employment or medical 
emergencies. Such families would not need to incur a tax cost 
if they sold their homes at a time of greatest need and decided 
to rent for awhile rather than reinvest.
    Even though the National Association of Realtors supports 
the proposed residential exclusion, we do not believe it can 
substitute in any way for an across-the-board capital gains tax 
cut. The commercial investment industry and a host of 
individual investors and owners as well firmly and 
unequivocally support an across-the-board capital gains tax cut 
with at least two criteria: Number one, that the rate cut be 
substantial enough to be a meaningful incentive and number two, 
that it apply equally among all types of capital assets. The 
equal application of capital gains treatment is especially 
critical to owners of real estate. For some time it has been 
rumored, and we even had a discussion on this in the previous 
testimony, that a final capital gains bill would include 
adverse changes to rules for depreciation recapture. Now, my 
staff just pointed out to me that we do not understand that 
H.R. 14 does not have depreciation recapture changes, even 
though the previous panel said so, and we think they may have 
misunderstood the question, Mr. Chairman, but maybe we misread 
the bill.
    But in any case, there have been discussions that the 
reduction of taxable basis due to straight line depreciation 
will not receive the full benefit of capital gains tax 
reduction. The real estate industry vigorously opposes any 
proposal that would adversely change depreciation recapture 
rules. Real estate is intrinsically a wasting asset which, due 
to natural deterioration, wear and tear from use and 
obsolescence, does not, unlike wine or cheese or art, gain 
value through use or through time lapses. Straight-line 
depreciation is a time-honored, fair, and reasonable allowance 
for this reasonable effect. Increases in the price of real 
estate result from inflation or extrinsic economic factors 
which are treated as capital gains as relates to all other 
capital assets.
    Again, real estate supports a broad-based capital gains tax 
reduction but opposes any change to current law on depreciation 
recapture which we believe would put real estate on an unlevel 
playingfield in relation to other types of capital assets. One 
of the benefits of a capital gains rate cut is that it would 
produce an unlocking of assets as taxpayers rearrange their 
portfolios to release gain and to redeploy their capital to 
maximize return. Data released on March 12, 1997, by the Joint 
Committee on Taxation illustrates vividly just how locked in 
the real estate industry has become. These data measure 
reported capital gains transactions for all asset types. The 
data show that between 1989 and 1994, both the number of real 
estate sales transactions and the dollar volume as a percentage 
of total capital gains transactions declined tenfold.
    Obviously, then, real estate markets seem frozen, and 
investor assets are locked in. Additionally, a chart presented 
at the end of this statement illustrates what the value of $1 
invested in real estate and in stock in 1986 would be worth 
today. The chart also plots inflation during that period. Real 
estate prices have not even kept up with inflation, while the 
value of stocks has soared 400 percent. Real estate markets are 
healthier today than they were 5 years ago, but price 
appreciation has not been a hallmark of real estate investments 
since the 1986 Tax Reform Act.
    These data help substantiate another fact about the real 
estate market: Price Waterhouse has studied commercial real 
estate sales since 1985 and reports that during the period from 
1985 to 1996, 60 percent of those sales occurred at prices that 
were below the original purchase price. If the proposed 
depreciation recapture proposal were to be enacted, any 
property sold below purchase price would not experience any 
benefits of the capital gains cut. What does that mean? It 
means that if real estate receives fewer benefits from a 
capital gains cut relative to assets, there would be little or 
no unlocking of real estate investment and no new jobs created. 
No one can predict just how much unlocking would occur after 
the capital gains cut; however, from my experience, buildings 
are often upgraded after a sale. For every $1 million spent in 
upgrades, 27 jobs annually are created. Using Department of 
Commerce data, we can speculate that the sale and upgrade of 
even 2,000 buildings nationally might create as many as 300,000 
annual jobs.
    In closing, we urge you to recognize the unique features of 
residential and commercial real estate. We urge you to adopt 
President Clinton's simplification proposal for the treatment 
of the sale of a principal residence, but we also urge a broad-
based capital gains cut as critical for growth and jobs 
creation. It must apply equally to all assets. There is no 
reason to penalize real estate investors, owners and developers 
by changing recapture rules and robbing the real estate 
industry of an equal opportunity to continue to improve itself.
    Thank you very much.
    [The prepared statement and attachments follow:]

Statement of Richard Woodbury, President, Woodbury Corp., Salt Lake 
City, Utah; on Behalf of National Association of Realtors

    The National Association of Realtors (NAR) appreciates the 
opportunity to testify concerning President Clinton's Fiscal 
Year 1998 Budget. This statement is presented on behalf of 
NAR's approximately 720,000 members. NAR represents virtually 
every facet of the real estate industry, including residential 
and commercial Realtor brokers and salespersons, developers, 
counselors, appraisers and property managers.
    Real estate contributes about 16% of the goods and services 
that comprise our national economy. The industry has repeatedly 
demonstrated its capacity to lead the nation out of recession 
into economic recovery and growth. NAR supported the 1995 
Contract With America provisions that would have reduced the 
tax rate on capital gains, recognized capital losses on the 
sale of a principal residence, indexed the cost basis of 
capital assets for inflation, permitted first-time home buyers 
to make penalty-free withdrawals from their Individual 
Retirement Accounts (IRAs), and increased the amount of the 
unified gift and estate tax credit. Unfortunately, President 
Clinton vetoed these important measures. We believe that his 
veto was detrimental to our members, and, moreover, that it had 
the effect of keeping many Americans locked into investments, 
and barred them from rearranging their portfolios to make the 
most productive use of their savings and their real estate 
holdings.

                     Capital Gains and Real Estate

    NAR enthusiastically and actively supports all efforts to 
restore a meaningful capital gains differential. An exclusion 
and indexing are both important elements of a differential, and 
we fully support both approaches. NAR supports S. 66, a bill 
introduced in the Senate by Senators Hatch (R-UT) and Lieberman 
(D-CT).
    NAR would not object to an approach such as that included 
in S. 306, offered by Senator Wendell Ford (D-KY), and its 
companion bill, introduced in the House by Mr. Bentsen (D-TX). 
This approach would create a sliding scale capital gains tax 
rate. The rate for an asset held for one year would be 28%. The 
rate would be reduced by 2 percentage points for each 
succeeding year, down to a minimum rate of 14% for an asset 
held 8 years or more.
    One of the things that we know about American is that they 
buy real estate. Generally, they buy as much real estate as 
they can afford. They buy homes, condos, cottages at the lake, 
hunting lodges, speculative parcels, a safe new home for mother 
and farms and ranches.
    The incidence of the ownership of real estate is more 
widespread than one might expect. Federal Reserve data in the 
Survey of Consumer Finances show a remarkably high incidence of 
ownership of real estate by all individuals, and especially in 
income classes below $50,000. The 1992 Survey shows that 63.8% 
of all families own a principal residence, and that 20% of all 
families own investment real estate. Among families with 
$25,000-$50,000 of income, 69% own a home, and a surprising 20% 
also own investment real estate. Among families in the $50,000-
$100,000 income category, 85% own their home, and 30% own 
investment real estate.
    The reasons for ownership are varied, and some of those 
reasons, we fully admit, are likely to be influenced by the tax 
effects of ownership. The important fact to note is that 
nonowner occupied real estate is more widely held than CDS, 
mutual funds, or stocks and bonds. Since real estate is so 
widely held, the markets for it are large and diverse. (Source: 
1992 Survey of Consumer Finances, Federal Reserve Bulletin, 
Oct., 1994.) We strongly believe that the power of those 
markets can be augmented through the unlocking power of reduced 
capital gains taxes.

          $500,000 Exclusion on Sale of a Principal Residence

    President Clinton has proposed that taxpayers filing a 
joint return be permitted to exclude up to $500,000 of gain 
($250,000 on a single return) on the sale of a principal 
residence. Owners qualify if the home has been used as a 
principal residence for two of the five previous years. Gain in 
excess of these amounts will be taxable at capital gains rates. 
Thus, a homeowner who filed a joint return and realized a gain 
of $600,000 would receive $500,000 tax-free, and $100,000 of 
gain would be taxable at capital gains rates.
    Under current law, the so-called ``rollover'' or deferred 
gain rules of Internal Revenue Code Section 1034 govern 
transactions involving the sale or exchange of a principal 
residence. Under the rollover rules, a taxpayer may exclude all 
gain on the sale of a personal residence from taxation, so long 
as the proceeds of the sale are reinvested in a home of the 
same or greater value. Each time a homeowner sells and 
reinvests, he/she is required to calculate the deferred gain, 
and make an adjustment to the purchase price of the new home to 
reflect the deferred gain in the tax basis of the home. In 
addition, the tax basis must be adjusted by the cost of any 
improvements that are made to the home. The taxpayer is 
required, for this purpose, to differentiate between repairs 
and improvements. Over the course of a lifetime, all this 
record keeping becomes subject to error, omission, and 
misunderstanding. In addition, the documentation becomes 
burdensome to maintain over the course of a lifetime. Not 
surprisingly, the IRS has indicated that taxpayer compliance 
with these requirements is low.
    The rollover rules of current law have also been criticized 
for their impact on housing decisions. Critics have alleged 
that current law forces people to over-consume housing. Stated 
another way, the rules have the effect of forcing people to buy 
ever more expensive housing, even though they might not need 
it, and even though they may not want to incur the debt load 
needed to carry it. In addition, homeowners who relocate from 
high housing cost areas are perceived as driving up the cost of 
housing when they relocate to lower cost areas.
    As homeowners grow older, they currently have the option to 
make a once-in-a-lifetime exclusion of up to $125,000 of gain 
on the sale of their residence at age 55 or older. While this 
provision enjoys a broad base of support, it has been 
criticized because it applies only once, and because spouses 
who take the exclusion and are subsequently widowed are not 
permitted to use the exclusion again, even if the individual 
remarries someone who has never used the exclusion.
    Now, President Clinton has proposed replacing the rollover 
and $125,000 exclusion rules with a single $500,000/$250,000 
exclusion that may be used as often as once every two years by 
homeowners of any age. NAR supports this proposal. First, it is 
an exceptional simplification of current law. In fact, we 
believe that it merits support for this reason alone. Next, 
this is the ultimate ``Get the IRS out of your life'' proposal. 
Only a very small number of transactions annually will be 
taxable, so nearly all taxpayers will be relieved of the 
burdensome record keeping requirements of current law. In 
addition, this proposal preserves the savings value of the 
home. For most individuals, their home is the primary source of 
savings. Finally, the proposal has the great advantage of 
allowing individuals to make their housing decisions based on 
their circumstances, and not on the basis of the tax code. For 
the first time, the proposal would allow individuals to trade 
up, stay in roughly the same circumstances, or trade to a 
smaller and/or less expensive home. This is of critical 
importance to boomers and to empty-nesters who wish to change 
the configuration of their savings and housing arrangements.
    Today, less than two percent of all existing home sales 
occur at price levels above $500,000. Thus, in order for the 
gain to exceed $500,000, the sales price will generally be 
substantially higher than the $500,000 amount. The practical 
effect of this provision is to provide substantial record 
keeping and simplification relief to all but a very small 
number of taxpayers. Table I (attached) illustrates the volume 
of sales in different price categories nationally and 
regionally.
    NAR commends the Administration for developing this 
remarkable simplification proposal. We view it principally as a 
simplification provision that happens to fall within the 
capital gains regime. We view it as a proposal that is 
desirable and supportable on its own merits as a 
simplification. We do not view it as a substitute for a broad-
based capital gains reduction, and we believe it should be 
evaluated as separate from that debate.

                 Loss on Sale of a Principal Residence

    The early 1980's saw the beginning of a phenomenon that 
came to be known as ``rolling recessions,'' in which different 
regions of the country experienced recessions, even though the 
national economy was performing reasonably well. This 
phenomenon was accompanied by a circumstance that had not 
occurred widely during the entire post-World War II period. For 
the first time, homeowners in these regions experienced losses 
on the sales of their personal residences. Over the last 15 
years, this situation has occurred in regions as diverse as the 
oil belt, the Rocky Mountain states, New England and, most 
recently, California (and southern California in particular).
    Since the purchase of a home has generally been considered 
a personal expenditure, losses on the sale of a personal 
residence have not been recognized for tax purposes. Chairman 
Archer has sought for many years to ameliorate this 
circumstance as a matter of fairness. After all, a home is 
generally the greatest source of individual savings. Taxpayers 
who are in the difficult position of incurring a loss on that 
sale are often in an economically vulnerable posture. In 1995, 
the Chairman proposed and Congress passed provisions that 
allowed these taxpayers to receive capital loss treatment if 
their home sold at a loss. Earlier versions of a relief 
provision allowed a basis adjustment at the time of purchase of 
a replacement residence. NAR supports either method of 
providing relief in these circumstances.
    NAR wishes to bring the Committee's attention a situation 
that is becoming increasingly common in areas where the market 
value of housing is declining. In many circumstances in some 
regional markets, homeowners are found to be ``under water'' or 
``upside down'' on their mortgages: they owe more on the 
mortgage than they can realize on the sale of a principal 
residence. First-time homeowners who have purchased under low 
down payment programs are especially vulnerable. If an 
individual purchases a home with a 3%-5% down payment, and the 
market value declines by 10%, then the individual is 
technically ``under water.'' If those individuals were forced 
to sell, they could easily come out of the transaction owing 
more than they would realize. An example can illustrate this 
problem.
    Family A purchases a home under a low down payment program 
that requires only a 3% down payment The purchase is for 
$100,000, with $3,000 down and mortgage indebtedness of 
$97,000. (This configuration is often typical of VA and FHA 
mortgages.) After a few years of ownership, A must sell the 
home. At the time of the sale, the outstanding mortgage is 
$92,000. A is able to realize only $89,500 on the sale. A must 
pay closing costs and commissions, even though there is not 
enough cash to satisfy the mortgage or to make these payments. 
A successfully works out an arrangement with the lender in 
which A will pay $88,000 on the note, and be forgiven $4,000 of 
the debt. Thus, A has a loss on the sale of $10,500, and at the 
same time has incurred a tax liability on the $4,000 of 
forgiven debt.
    This situation occurs in about 3% of the sales currently 
being closed in California. It can even occur, in some 
locations, in situations where the homeowner has made down 
payments of 10% or more. It defies logic that the homeowner 
would incur a loss, and at the same time generate a tax 
liability. Thus, NAR believes that the loss on sale provisions 
should also address this circumstance. Since the loss on sale 
provisions are based on fairness and equity, it seems that this 
discharge of indebtedness problem should be dealt with in the 
same context.

                     Broad-based Capital Gains Cuts

    The capital gains issues that affect residential real 
estate are substantially different from those that affect 
commercial and investment real estate. Even after the $500,000 
exclusion, loss on sale and discharge of indebtedness 
provisions are favorably resolved, the more fundamental issue 
of capital gains taxes for all capital assets, not just real 
estate, will linger.
    Before its repeal in 1986, the capital gains exclusion 
operated as a sort of rough justice to give taxpayers some 
incentive to hold property for the long haul, while giving an 
imprecise recognition to the effects of inflation on an 
investment. Real estate tends to be a very illiquid investment, 
so it was particularly important to the holders of real estate 
that some means of mitigating the impact of inflation would be 
available. The repeal of the capital gains exclusion in 1986 
destroyed even that imprecise mechanism. Lower tax rates simply 
did not overcome the impact of removing the exclusion.
    The dirty little secret of current law is that middle 
income Americans who have the good fortune to realize a capital 
gain are not treated as favorably as higher income individuals. 
The effect of the higher tax rates enacted in 1993 was that one 
class of upper-income taxpayers enjoys a tax benefit equivalent 
to a 30% exclusion. Individuals in the 15% and 28% tax brackets 
pay that rate on the full amount of any capital gain they might 
realize. By contrast, individuals in the 31%, 36% and 39.6% 
brackets pay no more than 28% tax rates on the full amount of 
any of their capital gains. For individuals in the 39.6% 
bracket, this rate differential is the equivalent of a 30% 
exclusion.
    A significant volume of capital gains transactions occurs 
for individuals in the 15% and 28% brackets, which reach to 
about $85,000 on a joint return. This income group has the 
largest number of capital gains transactions by volume, even 
though the dollar amount is relatively small. Many of those 
taxpayers will have only a limited number of capital gains 
transactions in a lifetime, yet their limited number of assets 
is presently taxed less advantageously than the larger, 
diversified portfolio of an upper income individual. A broad-
based capital gains cut, accomplished by an exclusion or a 
sliding scale rate cut, and combined with indexing, would 
redress the fundamental unfairness of having two classes of 
taxpayers--those with a capital gains differential, and those 
without a differential.
    NAR fully subscribes to the view of capital gains advocates 
that a cut in capital gains tax rates would unlock significant 
amounts of investment that would be plowed back into ever-more 
productive uses. We cannot quantify what the volume of new 
transactions would be. Measuring pent-up demand is all but 
impossible, because there is no baseline that can be fixed for 
transactions that don't occur. Every Realtor we meet, however, 
has stories to tell about properties that would have sold, 
except that the tax beating of current law would be too great. 
Realtors have hardship stories, as well, about people in 
reduced circumstances forced to sell their assets, only to face 
large tax bills.
    Indexing--NAR supports proposals that permit indexing on 
the sale of assets. While many of our members would hope to 
have a look-back provision, we acknowledge that such a 
provision would be costly to enact, and difficult to 
administer. We take no position on the choice of index used, 
but simply urge that the compliance provisions associated with 
administering an indexing scheme be as simple as possible. We 
look forward to working with the IRS to develop record keeping 
and compliance programs that will be easily understood by 
taxpayers. Taxpayers will need some education about the record 
keeping challenges posed by an indexing scheme, and we are 
committed to doing our part in assisting in that effort.

                         Depreciation Recapture

    For more than a year, rumors have circulated that a capital 
gains cut would create new rules for depreciation recapture. 
This rumor was confirmed in a Wall Street Journal story on 
February 14, 1997, noting that Joint Tax Committee Chief of 
Staff Ken Kies was urging that previously-allowed depreciation 
deductions be recaptured and taxed at 28%, with any remaining 
gain taxed at the new, reduced rate. His rationale is that 
current law, which permits capital gains treatment of 
depreciation recapture, creates unfair advantages for real 
estate and could lead to tax sheltering. We reject this view, 
and further urge that current law as provided in Code Section 
1250 be retained.
    After the Tax Reform Act of 1986, commercial real estate 
values plummeted. Since 1990, that market has been 
recapitalized. Between 1990 and the present, however, there has 
been very little, if any, appreciation for commercial real 
estate. According to analysis performed by Price Waterhouse, 
about 60 percent of all commercial real estate transactions 
between 1985 and 1995 have occurred at a price that is less 
than the original purchase price. If the depreciation recapture 
rate were to remain at 28% or more, the owners of those 
properties would receive no benefit whatever from the capital 
gains cut. Thus, they would be at a disadvantage relative to 
other assets that receive the full benefit of rate reduction 
and they would not, at present, be inclined to sell or improve 
those properties.
    Even today, real estate assets are locked in, as owners are 
reluctant to sell and pay the high taxes associated with a real 
estate transaction. Data released on March 12, 1997 by the 
Joint Committee on Taxation illustrate vividly just how locked 
in the real estate industry has become. These data measure 
reported capital gains transactions. Between 1989 and 1994, 
both the number of real estate sales transactions and the 
dollar volume of those transactions declined tenfold. If the 
full benefits of a capital gains rate cut are not extended to 
the real estate industry and investors because of changes to 
recapture, no unlocking of assets and capital would occur, and 
no new jobs would be created.
    We also note that owners who invested for long holding 
periods would be seriously disadvantaged, because they would 
bear disproportionate recapture burdens. Holding the recapture 
rate at 28 percent has the effect of raising the tax rate on 
the entire investment, no matter how long it is held. Where the 
asset has been held for long periods of time, the recapture 
amount could be quite large as a proportion of the total amount 
of gain in excess of adjusted basis. The greater the proportion 
of recapture to gain, the more the tax rate would be distorted 
(and increased relative to other assets) under the rumored 
proposal.
    A fundamental principle in the past 20 years of capital 
gains debates has been that all capital assets should be 
treated in the same manner, and that no industry or class of 
assets should be singled out for discriminatory treatment. We 
believe that the proposed recapture regime does not satisfy 
this standard. We believe that it discriminates against real 
estate. Given the performance of real estate markets in recent 
years, we believe it would be singularly unfair to impose real 
estate-specific taxes on an industry that is still somewhat 
fragile.
    Table 2 illustrates that very fragile condition and 
compares it with the price volatility in the stock market, as 
measured by the Dow Jones and Standard Poor's indices. The 
chart shows the value of a dollar invested in real estate in 
1985, and compares it with the value of a dollar invested in 
securities. The chart refers to price effects only, and not to 
rate of return. What it does illustrate, however, is the 
extraordinary surge in the market value of securities over that 
period, compared with a very flat real estate market. Notably, 
this chart is not adjusted for inflation. Thus, it shows that a 
dollar invested in real estate in 1985 is worth less than a 
dollar if the property sold today, while a dollar invested in 
the stock market in 1985 would yield about $4 today. If the 
chart were adjusted for inflation, the real estate price in 
1996 would be even less than shown on the graph.
    Because of the continuing interest in simplification and 
tax reform, we feel obligated to note that the proposed 
recapture regime would be very complex. Even as presently 
drafted, recapture is, at best, very complex. The proposed 
regime would graft yet another layer of complication onto this 
already-burdensome set of rules. We believe that it is 
inappropriate to advocate complex solutions at this time, 
particularly when those complexities do not improve the 
fairness of the code or enhance the performance of an 
individual's business or the national economy.
    We therefore believe that the proposed recapture regime 
would achieve none of the unlocking of gain that is envisioned 
by capital gains advocates. In many markets, there has been 
little appreciation in real estate for several years. 
Accordingly, individuals who sold properties under the proposed 
regime would find that much, if not all, of their gain was 
attributable to depreciation recapture, and not to 
appreciation. Thus, a taxpayer who experienced minimal 
appreciation would not be any better off than under current 
law, while the owners of appreciated non-real estate capital 
assets would receive far more benefit from a capital gains tax 
rate reduction. Only a scheme that retains existing Section 
1250 recapture taxes would keep all asset owners on a level 
playing field.

                     Individual Retirement Accounts

    President Clinton, Mr. Thomas and Chairman Roth all have 
all offered proposals to expand the classes of taxpayers 
eligible to make tax-deductible contributions to an Individual 
Retirement Account (IRA) and/or to a new tax-deferred ``back-
loaded'' savings vehicle. NAR supports these proposals, because 
they expand the savings pool. Expanded national savings should 
have beneficial effects in keeping interest rates low. No 
sector of the economy is more sensitive to interest rates than 
housing, and so we support these endeavors.
    In the context of improved and expanded IRA provisions, we 
urge that the Committee include a provision that has passed the 
House at least 3 times this decade, twice in 1992 and again in 
1995. This provision permits a penalty-free withdrawal from an 
IRA or 401(k) plan for use as a down payment by a first-time 
home buyer. Significantly, it also permits a parent or 
grandparent to make penalty-free withdrawals to assist a child 
or grandchild in making a down payment for a first-time home 
purchase. NAR actively advocated this approach in earlier 
years, and strongly believes that the ``parent and grandparent 
pass-through'' is crucial to making any new IRA plan a genuine 
vehicle for advancing first-time home purchases. NAR's research 
shows that young people are increasingly relying on family 
members to fund some portion of their home purchase down 
payments. Accordingly, this parent/grandparent feature of the 
proposal is a critical feature of the efforts to permit IRA 
withdrawals to further home ownership.

                      Table 1. Total Existing Single Family Home Sales by Price Class--1996
----------------------------------------------------------------------------------------------------------------
                                                                                                     Percent of
                     Region                                  Price Class             No. of Sales      Sales
----------------------------------------------------------------------------------------------------------------
United States..................................  $0 to $250,000....................     3,627,142          88.77
                                                 $250,000 to $500,000..............       377,955           9.25
                                                 Above $500,000....................       $80,903           1.98
  Total........................................                                        4,086,000D
Northeast......................................  $0 to $250,000....................       513,315          84.15
                                                 $250,000 to $500,000..............        78,873          12.93
                                                 Above $500,00.....................        17,812           2.92
  Total........................................                                           610,000  .............
Midwest........................................  $0 to $250,000....................       992,242          94.77
                                                 $250,000 to $500,000..............        49,628           4.74
                                                 Above $500,00.....................         5,130           0.49
  Total........................................                                         1,047,000  .............
South..........................................  $0 to $250,000....................     1,393,659          91.93
                                                 $250,000 to $500,000..............       103,088           6.8
                                                 Above $500,00.....................        19,253           1.27
  Total........................................                                         1,516,000  .............
West...........................................  $0 to $250,000....................       725,314          79.53
                                                 $250,000 to $500,000..............       147,653          16.19
                                                 Above $500,00.....................        39,034           4.28
  Total........................................                                           912,000  .............
----------------------------------------------------------------------------------------------------------------

      

                                

    Chairman Archer. Thank you, Mr. Woodbury.
    Our last witness for this panel is Thomas Wiggans, and if 
you will identify yourself for the record, we will be pleased 
to receive your testimony.

    STATEMENT OF TOM WIGGANS, PRESIDENT AND CHIEF EXECUTIVE 
OFFICER, CONNECTIVE THERAPEUTICS, INC., PALO ALTO, CALIFORNIA; 
        ON BEHALF OF BIOTECHNOLOGY INDUSTRY ORGANIZATION

    Mr. Wiggans. Thank you, Mr. Chairman. My name is Thomas 
Wiggans, and I am the president and chief executive officer of 
Connective Therapeutics, which is a biotechnology company based 
in Palo Alto, California. I appreciate this opportunity to 
discuss the merits of capital gains incentives on behalf of the 
700-member companies and organizations of the Biotechnology 
Industry Organization, and a coalition of eight groups that are 
representing more than 15,000 entrepreneurial firms in all 50 
States.
    I suppose you would expect an entrepreneur to cut to the 
bottom line, and that is what I am going to do. We support 
enactment of an across-the-board capital gains incentive 
accompanied by much needed improvements to the current law 
providing incentives for direct investment in stocks of 
emerging companies. In particular, H.R. 420, the Matsui-English 
bill and H.R. 1033, the Dunn bill, seem to be particularly well 
crafted, appropriate, and elegant solutions to this issue.
    So, that is who I represent and what I represent. What I 
would like to do for just a couple of minutes is tell you who I 
am, where I come from, and what people like me do out there. I 
have heard a lot of comments this morning about ``dynamic'' 
versus ``static'' scoring. I will tell you about what I believe 
is a very dynamic segment of our economy.
    I am an entrepreneur. I run a company that has been funded, 
so far, with $50 million in investor capital, starting with 
venture capital investment, patient capital that is held for 
years and years. We are using that investment to develop 
products to treat serious skin and connective tissue diseases. 
I work with remarkable technology, brilliant scientists, 
extremely committed employees and investors who are willing to 
invest and lock up their investment for years at a time.
    Our company is a young biotechnology company. One of our 
first products has shown great promise in the treatment of a 
condition called scleroderma. It is a very serious, 
debilitating, untreatable condition that affects women, has a 
5-year mortality rate of 50 percent and, as I mentioned, is 
untreatable. So, while I am here in a tax forum, let me remind 
you, and try to emphasize, what freeing up capital to firms 
like mine ultimately results in: New therapies for very sick 
patients and new job creation.
    Connective Therapeutics has 60 employees, up from zero 4 
years ago when it was founded. We occupy a facility in Palo 
Alto that previously housed a pioneering biotechnology company 
developing cancer therapies. It subsequently became successful 
and moved out into larger facilities now employing hundreds of 
people. We are around the corner from a small building with a 
simple plaque on it that indicates it is the site where the 
first integrated circuit was developed. So, I come from a part 
of the country where new technologies and new medical advances 
arise on a daily basis.
    I think all of us out there are living the great American 
dream. We are combining great ideas with talented people; throw 
in a little terror associated with the possibility of total 
failure, and the exhilaration of developing therapies for 
people who have no hope, and you have an equation that works. 
Where I come from, there is no shortage of great ideas; there 
is no shortage of great science, remarkable vision, or 
limitless energy. Companies rely on equity and sweat equity to 
achieve their goals. There is no shortage of sweat equity; 
however, equity capital is the single, most precious, limiting 
factor to our success.
    Capital to fund ideas has made America great; capital to 
fund my company has brought exciting new therapies to patients, 
and unleashing capital will further turbocharge America's 
entrepreneurial engine. We ask you to give us the tools we need 
to form new investment and bring these therapies forward.
    From where I come from, the call here in Washington for 
capital gains incentives seems to have reached a deafening 
roar. But for the entrepreneurs I work with in Silicon Valley 
and for entrepreneurs throughout America, it is not the call, 
but who answers the call; it is who steps up and gets the job 
done. What I am here to ask you to do is step up and get the 
job done and pass these incentives to release capital and fund 
companies like mine.
    Thank you very much.
    [The prepared statement and attachments follow:]

Statement of Tom Wiggans, President and Chief Executive Officer, 
Connective Therapeutics, Inc., Palo Alto, California; on Behalf of 
Biotechnology Industry Organization

    Mr. Chairman and Members of the Committee:
    My name is Tom Wiggans and I am President and CEO of 
Connective Therapeutics, a biotechnology company based in Palo 
Alto, California that develops products to treat diseases of 
the skin and connective tissues. I appreciate this opportunity 
to discuss the merits of capital gains relief for venture 
capital investments.
    I am proud to be able to speak to you as an entrepreneur 
whose firm has been funded by $50 million in investor capital. 
Without investors taking risks by buying stock in firms like 
mine, much life-saving biomedical research will go unfunded, 
and America's technological leadership will falter.
    My firm is a member of the Biotechnology Industry 
Organization (BIO), an association of 700 biotechnology 
companies. I am honored to say that the capital gains 
incentives for entrepreneurs and emerging companies of the type 
I will describe here have also been endorsed by the Alliance 
for Business Investment (an association of money-center 
commercial banking corporations whose venture capital 
subsidiaries fund small and medium-sized emerging companies), 
American Entrepreneurs For Economic Growth, American 
Electronics Association, Council of Growing Companies, National 
Association of Small Business Investment Companies, National 
Venture Capital Association, Software Publishers Association, 
and the American Bankers Association. These organizations 
together represent over 15,000 entrepreneurial firms in all 50 
states.

                Recommendations for Capital Gains Relief

    As all entrepreneurs must do, let me start with the bottom 
line: we support enactment of an across-the-board capital gains 
incentive accompanied by needed improvements to the current law 
incentive targeted at direct investments in the stock of 
emerging companies. The 1995 Balanced Budget Act included a 
two-tiered capital gains incentive similar to what we propose 
here. This Committee will consider several bills in the course 
of your deliberations on capital gains relief. We especially 
call to your attention H.R. 420, introduced by Representatives 
Bob Matsui, Phil English, and Jim McCrery, and H.R. 1033, 
recently introduced by Representative Jennifer Dunn.

                        Connective Therapeutics

    Connective Therapeutics is a young biotechnology company 
whose first product is being tested for the treatment of a very 
serious, untreatable disease. This product is a compound that 
did not show clinical effectiveness in its first medical 
indication in research by a major pharmaceutical company, but 
it has now been shown to hold great promise for the treatment 
of scleroderma, a rare, debilitating and untreatable condition 
affecting skin connective tissue and a condition which almost 
always continues to worsen and result in death.
    Scleroderma primarily affects women between the ages of 20 
and 50, and the five year mortality rate is 50 percent. We also 
are researching products to treat other progressive, often 
fatal fibrosis of the lungs, kidneys, and liver. We recently 
completed our first clinical trial involving scleroderma 
patients.
    The original developer of this compound had the foresight 
to make it available to my new company. However, it was 
investors who were willing to put their capital at risk who 
allowed our company to begin testing the compound in 
scleroderma patients. What we have at my company is an exciting 
story about the entrepreneurial biotechnology industry and the 
hope and risk associated with development of a breakthrough 
drug.
    From 1992 to 1994 I served as Chief Operating Officer of 
CytoTherapeutics, a biotechnology company based in Providence, 
Rhode Island, which is developing cell transplantation 
technology for the treatment of serious central nervous system 
disorders, such as Parkinson's Disease and Alzheimer's Disease. 
I have a BS in Pharmacy from the University of Kansas and an 
MBA from Southern Methodist University.

                   Capital Formation to Fund Research

    You need to understand one simple fact about the 
biotechnology industry: most of our firms fund research on 
deadly and disabling diseases from investor capital, not 
revenue. Without investors taking the risk of buying the stock 
of our companies, much of our vital research would end. Now you 
understand why our industry cares so much about capital gains 
incentives and about incentives for venture capital in 
particular.
    Almost without exception, our industry cannot borrow 
capital. Our principal, and for most of us, our only source of 
capital is equity capital. This is why a capital gains 
incentive focused in part specifically on direct equity 
investments in stock is so exciting to us and to other 
entrepreneur-led industries.
    It is also important to emphasize that capital gains taxes 
affect the value of founder's stock and employee stock options. 
They are direct equity investors in an entrepreneurial firm. 
Approximately 78 percent of biotechnology firms provide stock 
options to all of their employees. And we have such a young 
industry that many founders are still in charge. The leadership 
of founders and the talent of employees motivated by stock 
options are critical to innovations by entrepreneurial firms.
    Bringing a biotech drug product to the market today is both 
a lengthy and expensive process. From the initial testing of 
the drug to final approval from the Food and Drug 
Administration can take 7-12 years, and this process can cost 
anywhere from $150 to $359 million. Both the length and cost of 
this process are a tremendous impediment for small 
biotechnology companies attempting to bring a product to the 
market. Patient capital is critical. Investors have already 
invested $50 million in my company and they will have to wait 
several more years before we and they will know whether the 
products we have under development will generate a reasonable 
rate of return.

         International Competitiveness and Foreign Competition

    As is the case with many of the high-tech industries that I 
represent today, the United States currently has the dominant 
biotechnology industry when compared with any other country in 
the world. Precisely because the U.S. is preeminent in the 
field of biotechnology, it has become a target of other 
country's industrial policies. In 1991, the Office of 
Technology Assessment (OTA) found that Australia, Brazil, 
Denmark, France, South Korea and Taiwan (Republic of China) all 
had targeted biotechnology as an enabling technology. 
Furthermore, in 1984, the OTA identified Japan as the major 
potential competitor to the United States in biotechnology 
commercialization.\1\  The Japanese government has aggressively 
helped fund and support the development of their private 
sector. For instance, they instituted a policy whereby existing 
drugs would have their prices lowered, while allowing premium 
prices for innovative or important new drugs, thus forcing 
companies to be innovative and to seek larger markets.\2\
---------------------------------------------------------------------------
    \1\ U.S. Congress, Office of Technology Assessment, Biotechnology 
in a Global Economy 243 (October 1991).
    \2\ Id. at 244-245.
---------------------------------------------------------------------------
    The competitiveness of the U.S. biotechnology industry 
means that U.S. patients with rare deadly and disabling 
diseases have hope. It means that they can look to American 
biotech companies to develop the therapies and cures which will 
ease their suffering.

                        Capital Gains Incentives

    The entrepreneurial sector strongly endorses broad-based 
capital gains relief paired with a venture capital incentive. 
We believe that these two capital gains incentives are 
complementary and will ensure that venture capital is available 
for America's entrepreneurs and emerging companies. The 1995 
Balanced Budget Act included a two-tiered capital gains 
incentive similar to what we propose here. This Committee will 
consider several bills in the course of your deliberations on 
capital gains relief. We especially call to your attention H.R. 
420, introduced by Representatives Bob Matsui, Phil English, 
and Jim McCrery, and H.R. 1033, recently introduced by 
Representative Jennifer Dunn.
    Including a venture capital incentive recognizes that not 
all investments in capital assets are the same. Venture capital 
investments typically involve more risk, and potentially 
provide greater economic and social benefits, than other types 
of investments. Venture capital investors are more likely to 
lose some or all of their principal. Moreover, the holding 
periods for these investments tend to be quite long, stretching 
over several years at least. At the same time, venture capital 
investments can be the most productive, economically and 
socially, creating whole new industries and revolutionizing our 
standard of living.

 The Existing Venture Capital Gains Incentive Does Not Work As Intended

    In 1993, Congress enacted Section 1202 of the Internal 
Revenue Code in an effort to provide an added capital gains 
incentive for investments in qualifying small business stock. 
Unfortunately, this provision as finally enacted ended up with 
several limitations on its usefulness, and thus it is not 
working as intended. Nevertheless, the concept of an incentive 
for new, direct, long-term investments in small company stock 
is sound.
    Section 1202 provides a 50-percent exclusion for gain from 
the sale of qualified small business stock. To qualify, stock 
must be acquired at original issuance and held for 5 years. The 
principal limitations in Section 1202 include a capitalization 
limit of $50 million not indexed for inflation; availability of 
the incentive only to individual taxpayers; a per taxpayer 
limit of 10 times the basis of the investment or $10 million 
(whichever is greater); an exemption for only half of the 
excluded gains from the alternative minimum tax (AMT); a 
required five year holding period; and substantially modified 
definitions dealing with working capital requirements.
    Section 1202, because of the limitations it contains, has 
been completely ineffective in forming capital for 
entrepreneurs and emerging companies. The working capital 
requirement definitions are unworkable. The AMT provision is 
unduly burdensome, as the AMT recaptures the capital gains tax 
benefits and for many taxpayers cancels out any incentive to 
make the investments. Corporations, as well as individuals, are 
a vital source of venture capital. It is essential that 
incentives for further growth in new businesses reduce taxes on 
corporate investments in the same manner as on investments by 
individuals.

                 Proposed Improvements to Section 1202

    The Balanced Budget Act of 1995, vetoed by the President, 
would have provided a number of needed improvements to Section 
1202. This year, several measures have again been proposed to 
deal with the problems in existing law.
    H.R. 420 would modify Section 1202 by increasing the 
exclusion to 75 percent for direct investments held for 3 years 
(instead of 5 under current law). Favorable treatment would 
extend to the stock of a corporation with capitalization of up 
to $100 million (increased from $50 million today). Section 
1202 investments would be exempt from the AMT, which is 
critical to attract the type of investments entrepreneurs need. 
H.R. 420 would permit corporations to invest in qualified small 
business stock. Finally, it includes an incentive for investors 
to rollover their gains into another qualified incentive. H.R. 
1033 contains substantially the same provisions as H.R. 420.
    Because Section 1202 is current law, the revenue cost for 
these proposed amendments is modest. Amendments similar to the 
ones we propose here (found in S. 959) were found in 1995 by 
the Joint Tax Committee to cost $200 million over five years, 
$400 over seven years, and $700 million over ten years. This 
means that amending Section 1202 to make it an effective 
incentive is an extraordinarily cost effective proposal.

            Benefits of a Workable Venture Capital Incentive

    Entrepreneurs create jobs and capture markets. The 
electronics, biotechnology, and other high technology 
industries have changed our economy and changed our lives. The 
venture capital incentive in H.R. 420 applies to a variety of 
businesses which raise capital with stock offerings, and it 
will be utilized by high technology firms that are capital and 
research intensive and have no other source of capital 
available, as well as by other dynamic venture-backed 
businesses that create jobs all across the country.
    The role of entrepreneurs in creating jobs and economic 
growth in our economy is documented in a research analysis I 
have appended to my testimony. Let me cite just a few of the 
findings:
      Comparison to Fortune 500: Between 1980 and 1990 
U.S. private sector employment grew by 19 million jobs, but 
employment in the Fortune 500 firms dropped by 3 million jobs. 
This means that employment in the non-Fortune 500 firms had to 
grow by 22 million jobs to make up for the loss with the larger 
firms.
      The Inc. annual survey of the 100 fastest growing 
small public companies documented the same point. The median 
five year sales growth for the companies was an astounding 
2,239% and the median sales had grown from $1,796,000 to 
$47,144,000 in five years. The median number of employees had 
risen from 31 to 260 in five years and the median productivity 
of the employees had risen from $52,289 to $167,310 in five 
years. The top ranked firm, AmeriData Technologies, sells 
computers and integrates computer systems and its sales had 
grown 135,647% in the past five years.
      Venture Capital-Backed Firms: Venture capital-
backed firms are prolific creators of jobs. Venture-backed 
firms increased employment by an average of 20% per year from 
1990 to 1994 at a time when Fortune 500 firms lost nearly 1% of 
their employees per year. By the time a venture-backed firm is 
six years old, it typically employs 282 people. The percentage 
of these jobs taken by engineers, scientists, and managers is 
61%, four times the percentage of the workforce as a whole.
      The staggering research intensity of high 
technology firms is confirmed each year in the Business Week 
survey on Research and Development expenditures. The survey 
measures the percentage of increase in absolute terms and also 
the research intensity as a percentage of sales or on a per 
employee basis. The 1995 survey finds a 14% increase in R and D 
by electrical and electronics firms, which spent $9.6 billion 
on research, 5.7% as a percentage of sales, and $8,257 per 
employee. Office equipment and sales firms spent $15,898 per 
employee on research, health care firms spent $18,451 per 
employee, and chemicals spent $10,289 per employee. The all 
industry averages are 4% increases, 3.5% as a percentage of 
sales, and $7,651 per employee.
      Staples, the office supply superstore, is today 
the country's biggest retailer of office supplies. Sales in 
1995 were $3.1 billion; net income was $73.7 million. By the 
end of 1995 it employed 22,000 people and expected to hire an 
additional 10,000 in 1996. It paid $44.5 million in state and 
federal income tax in 1996. In 1987 Staples had one store in 
Brighton, Massachusetts, and needed capital to expand. A small 
business investment company was willing to step in and provide 
the needed equity financing, $1.5 million.
    These stunning facts and those in the appendix demonstrate 
the need to enact a capital gains incentive including 
improvements to the 1993 venture capital incentive. 
Entrepreneurial firms are the ones which can dramatically 
change our whole health care system, clean up our environment, 
link us in international telecommunication networks, and 
increase our capacity to understand our world. The firms are 
founded by dreamers, adventurers, and risk-takers who embody 
the best we have to offer in our free-enterprise economy.

                   The Need for Capital Gains Relief

    We support a two-tiered incentive. A broad-based capital 
gains incentive that applies to currently held assets is vital 
to unlocking the current ownership of capital assets. Reducing 
the penalty for sale of these assets will free up capital to be 
invested in more productive investments. In addition, many 
other sectors of the economy do not rely on direct equity 
investments and there is a powerful rationale for providing a 
capital gains incentive for these investments.
    America's entrepreneurs rely on equity investments to fund 
research and development. Most of them have no sales and, 
therefore, no ability to borrow funds. To raise capital they 
must issue stock, to angel investors, to venture capitalists, 
or to investors in public offerings. Capital raised from equity 
offerings does not involve carrying costs. It tends to be 
patient capital, precisely what struggling entrepreneurs need. 
This is exactly the type of capital formation covered by H.R. 
420.
    An incentive focused on direct purchases of stock provides 
an incentive for founders and company employees who acquire 
stock through the exercise of stock options. Founders and their 
employees take a major risk when they leave established firms 
to found start-ups. They often take a major cut in pay with the 
hope that the value of their stock will justify their decision. 
We must provide an incentive for outside investors, but it may 
be even more important to provide an incentive for founders and 
their employees. No one is more valuable to our economy than 
our entrepreneurs.

                               Conclusion

    In conclusion, we support a broad-based reduction in 
capital gains taxes and we believe it should be paired with 
improvements to the targeted venture capital incentive in 
current law. We believe this combination will be the most cost-
effective incentive for capital formation for entrepreneurs.
    Thank you again for the opportunity to testify. I am happy 
to answer your questions.
      

                                

Venture Capital Gains Incentive: H.R. 420, Matsui/English/McCrery

Enacted in 1993 Budget Reconciliation Bill:

      50% capital gains exclusion for new investments--
not sale of previously acquired assets--new investments made 
after effective date, August 1993
      only if investments made directly in stock--not 
secondary trading, founders stock, stock options, venture 
capital, public offerings, common, preferred, convertible 
preferred
      only if made in stock of a small corporation--
defined as a corporation with $50 million or less in 
capitalization--ceiling not indexed for inflation
      only if investment held for five years
      only if investment made by an individual 
taxpayer--not by a corporate taxpayer
      50% of the excluded gains not covered by the 
Alternative Minimum Tax (AMT)
      limit on benefits per taxpayer of 10 times basis 
or $10 million, whichever is greater
      technical problems--redemption of stock, spending 
speed-up provision

H.R. 420--Eight proposed amendments to incentive:

      (1) 75% capital gains exclusion--up from 50%
      only new investments--same
      only if direct investments--same
      only if investment in stock--same
      (2) only if investment held for three years--same 
(see rollover provision below)--reduction from five years
      (3) define small corporation as one with $100 
million in capitalization and index for inflation--up from $50 
million with no indexing
      (4) apply to corporate taxpayers--now only 
applies to individual taxpayers
      (5) 100% exemption from AMT--now 50% exemption
      (6) delete 10 times or $10 million limitation
      (7) fix technical problems--modify redemption of 
stock, spending speed-up provision
      (8) add rollover provision--provide for a 
deferral of gains taxes for those who reinvest proceeds from 
sale of a qualified venture capital asset in another qualified 
venture capital asset
      

                                

Summary of 1995 Balanced Budget Bill

Capital Gains Incentives (Conference Bill)

1. Broad-Based Capital Gains Tax Relief

    1) Individual taxpayers would be allowed a deduction of 50 
percent of any net capital gain for capital assets held for at 
least one year. The top effective tax rate on capital gains 
would thus be 19.8 percent. Gains rate of 7.5 percent for 
taxpayers in 15 percent tax bracket. Repeals current 28 percent 
capital gains maximum rate. Same as in House-passed bill, H.R. 
1215, and S. 959.
    2) Does not apply to sale of collectibles.
    3) Applies to sale of previously acquired assets sold after 
the effective date of the incentive (unlocking effect) and to 
new investments held for at least one year.
    3) Capital gains of corporate taxpayers would be subject to 
a maximum capital gains rate of 28 percent.
    5) Indexing of the basis of capital assets is not included.
    6) None of the deduction is included as a preference item 
in the Alternative Minimum Tax (AMT).
    7) Gains provision would be effective for sales of capital 
assets held for at least one year after January 1, 1995.

2. Venture Capital Gains Incentive

    1) Provides a maximum 14 percent venture capital incentive 
for investments in the stock of a small business held for at 
least five years. (Senate bill provided a 75% exclusion--a 9.9% 
rate)
    2) Applies only to new investments made after August 10, 
1993 (the original effective date for the venture capital 
incentive included in the 1993 Budget Reconciliation Act) and 
held for at least five years. (Does not reduce holding period 
to three years.)
    3) Small business must have $100 million or less in 
aggregate gross assets and stock must be purchased directly 
from the company (does not include secondary trading of stock).
    4) Capital gains of corporate taxpayers would be subject to 
a maximum capital gains rate of 21 percent.
    5) Indexing of the basis of capital assets is not included.
    6) None of the deduction included as a preference item in 
the Alternative Minimum Tax (AMT).
    7) Repeals and amends various restrictions in 1993 venture 
capital provision.
    8) Does not include rollover provision from Senate bill.
      

                                

Summary of 1995 Balance Budget Bill

Capital Gains Incentives (Conference Bill)

 
------------------------------------------------------------------------
                                                Venture Capital Gains
        Broad-Based Gains Incentive                   Incentive
------------------------------------------------------------------------
 Applies to investments in any capital      Applies to investments in
 asset.                                      stock of small corporation
                                            Includes both common or
                                             preferred stock issued by
                                             corporation
                                            Only purchases of stock
                                             directly from company--does
                                             not cover secondary trading
                                            Corporation must have $100
                                             million or less in
                                             aggregate gross assets
50% of gains not taxed (effective top tax   Sets 14% maximum gains rate
 rate of 19.8%).                             (no use exclusion approach)
Must hold investment for at least one year  Must hold investment for at
                                             least 5 years
Applies to sale of assets after January 1,  Applies to sale of assets
 1995.                                       acquired after August 10,
                                             1993 (effective date for
                                             1993 venture capital
                                             incentive)
Applies to sale of assets acquired before   Does not apply to assets
 January 1, 1995, if held for at least one   acquired before effective
 year (unlocking effect).                    date
None of untaxed gains included in           None of untaxed gains
 Alternative Minimum Tax.                    included in Alternative
                                             Minimum Tax
Individual and corporate investors covered  Individual and corporate
                                             investors covered
Maximum corporate gains tax rate is 28%...  Maximum corporate gains rate
                                             is 21%
                                            Does not include Senate
                                             rollover provision
------------------------------------------------------------------------

      

                                

Senate 75% Exclusion and Rollover Provision (Dropped in Conference)

    The Senate budget bill in 1995 went to the conference with 
a venture capital incentive which was modified in the 
conference.
    1. 75% Exclusion: Senate bill provided for a 75% capital 
gains exclusion for venture capital investments--contrasted 
with a 50% exclusion for non-venture capital investments.
    The effective rates were 9.9% for venture capital 
investments and 19.8% for non-venture capital investments.
    In the conference the 50% exclusion for non-venture capital 
investments was retained, but the 75% exclusion was modified to 
a 14% maximum rate.
    One can set a capital gains incentive either as an 
exclusion or a maximum rate or both.
    The 14% maximum rate provides only a 1% incentive to 
taxpayers in the 15% tax bracket. An exclusion is the better 
way to provide an incentive to these taxpayers.
    2. Rollover Provision: The Senate bill provided that 
taxpayers which realized gains on a venture capital investment 
could defer paying tax on the gains if they rollover their 
investment over into another venture capital investment within 
a short period of time. This rollover provision then provided 
that the holding period on the next and subsequent venture 
capital investments would be one year, not five years.
    This provision was dropped in the conference.
    The provision provides an incentive for investors to keep 
their investments at work and not to divert them to non-venture 
capital investments.
    3. Revenue Scores: The Hatch-Lieberman bill, on which the 
Senate bill was based, included a 75% exclusion, the rollover 
provision, a complete exemption from the AMT for both broad-
based and venture capital investments, and it was scored as 
losing $700 million over seven years. The rollover provision 
was scored as losing less than $50 million over seven years.
      

                                

Amendments to 1993 Venture Capital Incentive Included in H.R. 420

    H.R. 420 amends Section 1202, the venture capital incentive 
enacted as part of the 1993 Budget Reconciliation Act, in the 
ways described below. With these amendments the incentive will 
be effective in forming capital for entrepreneurs.
    The amendments do the following:
    1. Capitalization Ceiling:
    increase the capitalization ceiling from $50 million to 
$100 million and index the ceiling for inflation (defines which 
companies stock qualifies for the gains incentive)--increasing 
ceiling includes stock offerings of more capital intensive 
companies
    2. Corporate Taxpayers: apply venture capital incentive to 
corporate taxpayers--increases capital investments in small 
companies by corporate taxpayers
    3. Holding Period: Reduces holding period from five to two 
years.
    4. Per Taxpayer Benefits Limit: eliminate the 10 times or 
$10 million per taxpayer limitation on benefits per gains 
realization--permits taxpayers to offset losses on risky 
investments with winnners on others
    5. Alternative Minimum Tax: exempt all of the excluded 
gains from the alternative minimum tax--avoids zero sum game of 
granting exclusion and then recapturing benefits of exclusion 
by AMT
    6. Working Capital Rules: fix the working capital rules 
which require that 50% of the capital raised be expended within 
two years and bars companies from redeeming stock even if it is 
for a business purpose--companies which violate these rules 
invalidate any tax benefits for investors--rules have been 
unworkable rules and prevent any use of the 1993 incentive to 
form capital
    7. Capital Gains Rollover: provide for a deferral of gains 
taxes (a rollover provision) for those who reinvest proceeds 
from sale of a qualified venture capital asset in another 
qualified venture capital asset--encourages investors to 
maintain commitment to venture capital investments
    8. Exclusion Differential: increase capital gains exclusion 
from 50% to 75% (both individuals and corporations)--provides 
differential with broad-based capital gains exclusion.
    Revenue Implications of Amendments: The Joint Committee on 
Taxation has ruled in 1995 that amendments similar to these 
(found in S. 959, Hatch-Lieberman bill) would lose the 
following amounts of revenue: $200 million--over five years; 
$400 million--over seven years; and $700 million--over ten 
years.
      

                                

Role of Entrepreneurs in America's Economy (Excerpt from 
``Entrepreneurs Agenda'' \3\

                      Fundamental American Values

    The role  of entrepreneurs cannot be entirely described in 
economic terms. It is critical to understand that entrepreneurs 
epitomize the fundamental American values of the rights of the 
individual, freedom of speech and choice, democracy and 
restraints on bureaucracy and concentrations of power, and 
private ownership of property.
---------------------------------------------------------------------------
    \3\ The Entrepreneurs Agenda was published by the Entrepreneurs 
Coalition in June of 1996. The Coalition is composed of the 
Biotechnology Industry Organization, Council of Growing Companies, the 
Nasdaq Stock Market, National Venture Capital Association, and Software 
Publishers Association.
---------------------------------------------------------------------------
    These are the values which have characterized America from 
its founding and define our values in relationship to the rest 
of the world. These are the values which characterize--and are 
championed by--entrepreneurs.
    The Declaration of Independence states that all men have 
certain unalienable rights among which are life, liberty, and 
the pursuit of happiness. Among the grievances listed in the 
Declaration are the cutting off of our trade with all parts of 
the world and among the rights asserted were the rights to 
establish commerce.
    Our country was founded to secure economic, not just 
political, freedom from England and the Constitution we adopted 
focuses on such commercial issues as regulating commerce and 
trade, regulating bankruptcies, coining money, fixing the 
standard of weights and measures, establishing post offices, 
and promoting the progress of science and useful arts with 
patents and copyrights.
    We are the land of opportunity and there are no Americans 
which utilize these opportunities like entrepreneurs. 
Entrepreneurs see opportunities where others do not. They turn 
the opportunities into reality for themselves, their employees, 
their customers, and the society as a whole.
    Those who champion change always meet resistance. They are 
confronted by skeptics, roadblocks, bureaucracies, defenders of 
the status quo, and hostility. But, they persevere and fashion 
a new reality. We can laugh at the initial thoughts of some of 
America's most successful entrepreneurs and scientists.
    ``The phonograph...is not of any commercial value.'' Thomas 
Edison, 1880.
    ``There is no likelihood that man can ever tap the power of 
the atom.'' Robert Millikan, Nobel Prize winner in physics, 
1920.
    ``There is no reason for any individual to have a computer 
in their home.'' Ken Olsen, President of Digital Equipment 
Corporation, 1977.
    ``I think there is a world market for about five 
computers.'' Thomas J. Watson, Chairman of IBM, 1943.
    ``It is an idle idea, to imagine that...automobiles will 
take the place of railways in the long distance movement 
of...passengers.'' American Road Congress, 1913.\4\
---------------------------------------------------------------------------
    \4\ Entrepreneurs: Architects of Innovation, Paradigm Pioneers and 
Change, Eric K. Winslow and George T. Solomon, Journal of Creative 
Behavior, Second Quarter 1993 at 80-81.
---------------------------------------------------------------------------
    Fortunately, these entrepreneurs and many others are 
capable of brilliant insights and have a profound capacity to 
learn from their mistakes and preserve.
    Entrepreneurs are often unconventional, idiosyncratic, 
restless, even odd. They have passion and a vision of the way 
the world ought to be. Entrepreneurs thrive in ambiguous 
environments.\5\
---------------------------------------------------------------------------
    \5\ ``Where is the Passion...and Other Elements of Innovation,'' F. 
Hertzberg, in Key Issues in Creativity, Innovation, and 
Entrepreneurship, Bruce G. Whiting and George T. Solomon, 1989.
---------------------------------------------------------------------------
    Fundamental to the growth of a free and open society is the 
need for an informed electorate and freedom of thought and 
expression. Entrepreneurship is the embodiment of those 
democratic values. It is all about pluralism and diversity. 
Entrepreneurs threaten and challenge stifling bureaucracies. 
They check concentrations of power. They champion the 
creativity and independence of individuals.
    Entrepreneurship is all about choice. Entrepreneurship is 
the outgrowth of the free expression of ideas. Entrepreneurship 
is the outgrowth of a capitalist economy that rewards 
initiative. By definition, entrepreneurship requires for its 
very existence a social and political system that fosters 
individuality, freedom, creativity, growth, and change.
    Fostering entrepreneurship in turn fosters the growth of 
American values and our abiding faith in progress. A rising 
standard of material wealth, a sense of progress, and a believe 
in opportunities for individuals is indispensable for our 
political, economic and social stability.
    Freedom and choice makes the entrepreneurial behavior 
possible. Entrepreneurship in turn makes freedom and choice 
possible. The synergy is fundamental to our nation's successes 
and leadership.
    Studies of entrepreneurs find that the primary, driving 
motivation of the entrepreneur is independence. The motivation 
is not money as is popularly assumed.\6\ There can be no more 
American value than the value of independence--first for our 
country and always for the individual.
---------------------------------------------------------------------------
    \6\ Albert Shapeero, Taking Control, commencement address at Ohio 
State University, 1982 (cited in Public Policy Affecting 
Entrepreneurship, Venture Capital, and Technology, Gerald L. Feigen, 
Small Business Administration).
---------------------------------------------------------------------------
    The economic definition of an entrepreneur can be abstract 
and sterile. One definition of ``entrepreneurship'' focuses on 
``the process activity of creating value by bringing together a 
unique combination of resources for the purpose of exploiting 
an opportunity.'' \7\ A simpler definition is that provided by 
Peter Drucker, legendary business observer: ``An entrepreneur 
is someone who gets something new done.'' \8\ These formal 
definitions do, however, focus on quintessential American 
values--resourcefulness, action, and practicality.
---------------------------------------------------------------------------
    \7\ ``Sustaining the Entrepreneurial Society,'' Michael H. Morris, 
prepared for the Small Business Foundation of America.
    \8\ ``Flashes of Genius,'' Inc. (Special Issue: State of Small 
Business, May, 1996) at 43 (italics in original).
---------------------------------------------------------------------------
    Candidates and policy makers should support the 
Entrepreneurs Agenda because it reflects fundamental American 
economic and social values and benefits the individual, the 
economy, and the community.

                       Entrepreneurs Create Jobs

    Entrepreneurs are synonymous with jobs. This is the common 
view in America, but it is also the view of economists who have 
documented it in numerous studies.
    Comparison to Fortune 500: The bottom-line is dramatically 
stated: between 1980 and 1990 U.S. private sector employment 
grew by 19 million jobs, but employment in the Fortune 500 
firms dropped by 3 million jobs.\9\ This means that employment 
in the non-Fortune 500 firms had to grow by 22 million jobs to 
make up for the loss with the larger firms.
---------------------------------------------------------------------------
    \9\ ``Risk and Innovation: The Role and Importance of Small High-
Tech Companies in the U.S. Economy,'' National Academy of Engineering, 
1995, at v.
---------------------------------------------------------------------------
    We are seeing an accelerating decline in the ability of 
Fortune 500 firms to maintain their competitiveness. The 
replacement rate for Fortune 500 firms was approximately 8% in 
the 1960s, jumped to 30% in the 1980's, and approached 40% in 
the 1990s. Almost half of the largest industrial firms are now 
replaced by new firms every five years. For high technology 
firms approximately 25% of the firms are replaced every five 
years.\10\
---------------------------------------------------------------------------
    \10\ A Profile of Small High Technology Business in the United 
States, Office of Science and Technology Policy, Executive Office of 
the President, Joseph S. Broz, David C. Cranmer, and Mark DeSantis, 
1992, at 18.
---------------------------------------------------------------------------
    Rate of Growth: In 1994 small-business-dominated industries 
added jobs to the economy at 1.3 times the national rate of 
increase of 3.5% while large-business-dominated industries 
added jobs to the economy at one-third the national rate (only 
a 1% increase).\11\
---------------------------------------------------------------------------
    \11\ Small Business Administration data.
---------------------------------------------------------------------------
    Number of firms: The Office of Science and Technology 
Policy (OSTP) estimated in 1992 that there are 75,000 to 
100,000 small high-technology firms in the United States with 
1.75 to 2 million direct employment.\12\ This figure does not 
include the suppliers, retailers, or service personnel whose 
employment is dependent on these businesses. OSTP puts these 
statistics in perspective as follows:
---------------------------------------------------------------------------
    \12\ A Profile, OSTP, at 1.
---------------------------------------------------------------------------
    While the small high technology business sector represents 
only a few percent of the total small business sector work 
force, the economic, technological, and social impact of these 
technically based firms is profound (due to the impact of their 
products on our daily lives).\13\
---------------------------------------------------------------------------
    \13\ Profile, OSTP, at 1.
---------------------------------------------------------------------------
    OSTP found that the ``small high-tech firms are dynamic in 
the creation of new jobs.'' In the decade from 1976 to 1986, it 
found that ``employment growth in the high-tech sector was the 
highest of any sector of the economy.'' \14\ Small high-tech 
firms contributed over one-third of the increase in new jobs 
for the entire high-tech sector and firms with fewer than 20 
employees ``accounted for fully half of this growth.'' In 
aggregate numbers, the high technology firms contributed 
``nearly four times their expected share of new jobs.'' \15\
---------------------------------------------------------------------------
    \14\ A Profile, OSTP, at 2.
    \15\ A Profile, OSTP, at 2 (citing Paul Hadlock, Daniel Hecker, and 
Joseph Gannon, High Technology Employment: Another View, Monthly Labor 
Review July 1991 and Bruce D. Phillips, The Increasing Role of Small 
Firms in the High-Technology sector: Evidence from the '80's, Business 
Economics January 1991)
---------------------------------------------------------------------------
    Comparison to Basic Industries: The comparison between 
small and medium-sized high technology firms and the ``once 
dominate basic U.S. industries, such as steel, autos, and 
consumer electronics'' is particularly startling. From January 
1989 to September 1991, ``durable goods manufacturers lost 8.3% 
in total employment. In contrast, during the same period, small 
and mid-sized technology manufacturers increased employment by 
10.6%.'' \16\
---------------------------------------------------------------------------
    \16\ A Profile, OSTP, at 2 (citing CorpTech, Inc., 1991, and U.S. 
Department of Labor, Bureau of Labor Statistics, Statistical Abstract, 
1991).
---------------------------------------------------------------------------
    Hot Growth Companies: The Business Week annual survey of 
100 ``hot growth'' companies provides graphic evidence of the 
growth potential of entrepreneurial firms.\17\ This year's 
survey found average sales increases of 60%, average profit 
increases of 140%, and average rate of return increases of 27%. 
The total market capitalization of the 100 firms companies is 
$40 billion. Of the 100 firms, 33 were ranking on the same list 
the year before. The top ranking growth companies included 
Remedy (ranked no. 1), a software company with a 160.5% 
increase in sales, a 272.9% increase in profits, and a 43.4% 
increase in return on capital. Software and computer-service 
providers made up 23 of the listed companies, while semi-
conductors, components, and telecommunications added 10 more. 
As the article states in bold type, ``Unslackable demand for 
technology fueling many of this year's highfliers.'' \18\
---------------------------------------------------------------------------
    \17\ To qualify for the list a company must excel in a three year 
average growth of sales, profits, and return on invested capital. 
Companies must have had annual sales of more than $10 million and less 
than $150 million, a current market value of more than $1 million, a 
current stock price of greater than $2, and be actively traded in a 
public capital market.
    \18\ Hot Growth Companies: Corporate America is Slowing? Don't Tell 
These Dynamos, Business Week, May 27, 1996, at 110-126.
---------------------------------------------------------------------------
    The Inc. annual survey of the 100 fastest growing small 
public companies documented the same point.\19\ The median five 
year sales growth for the companies was an astounding 2,239% 
and the median sales had grown from $1,796,000 to $47,144,000 
in five years. The median number of employees had risen from 31 
to 260 in five years and the median productivity of the 
employees had risen from $52,289 to $167,310 in five years. The 
top ranked firm, AmeriData Technologies, sells computers and 
integrates computer systems and its sales had grown 135,647% in 
the past five years.\20\
---------------------------------------------------------------------------
    \19\ To qualify for the list companies had to be independent, 
publicly held companies, had to have gone public no later than December 
31, 1995, there had to be an active market for their stock, and they 
had to have had sales of no less than $200,000. The only criteria for 
ranking was sales growth.
    \20\ Show Time: Thirty-one of this year's Inc. 100--the fastest-
growing small public companies in American--became public just last 
year. Next year, expect more, Inc., May 1996, at 34-42.
---------------------------------------------------------------------------
    Critical Technologies: Many of the new technologies and 
industries seen as critical to the Nation's future economic 
growth are closely identified with small business.\21\ And, the 
establishment of these firms is relatively recent. Even though 
the late 1980s saw a sharp decline in the company formation 
from the earlier part of the decade, almost half of all U.S. 
high-tech companies operating in 1993 were formed since 
1980.\22\
---------------------------------------------------------------------------
    \21\ Science and Engineering Indicators--1993 (U.S. National 
Science Board, 1994) at 185.
    \22\ Science and Engineering Indicators--1993 (U.S. National 
Science Board, 1994), at 185.
---------------------------------------------------------------------------
    For example, the Board reports that 60% of the computer-
related, biotechnology firms and software firms were founded 
since 1980. The 1980-1993 period saw the founding of 490 
automation companies, 358 biotechnology companies, 1,253 
computer hardware companies, 243 advanced material companies, 
296 photonics and optics companies, 3,395 software companies, 
807 electronic component companies, 593 telecommunications 
companies, and 7,246 in chemicals, defense-related, energy, 
environmental, manufacturing equipment, medical, 
pharmaceutical, subassembly and components, test and 
measurement, and transportation companies. Fully 48 percent of 
the total of 22,728 companies in these fields were founded 
between 1980 and 1993.
    These statistics may drastically understate the growth in 
these sectors. For example, while the Science Board reports the 
creation of 358 biotechnology companies during this period, the 
keeper of the most reliable statistics on this subject--Ernst 
and Young--reports that 974 biotechnology companies were 
founded between 1980 and 1993 \23\--a difference of 272%.
---------------------------------------------------------------------------
    \23\ Biotech 96: Pursuing Sustainability: The Tenth Industry Annual 
Report, Kenneth Lee and Steven Burrill, September 1995 at 43. This 
report covers both public and non-public companies.
---------------------------------------------------------------------------
    Venture Capital-Backed Firms: Venture capital-backed firms 
are prolific creators of jobs. Venture-backed firms increased 
employment by an average of 20% per year from 1990 to 1994 at a 
time when Fortune 500 firms lost nearly 1% of their employees 
per year. By the time a venture-backed firm is six years old, 
it typically employs 282 people. The percentage of these jobs 
taken by engineers, scientists, and managers is 61%, four times 
the percentage of the workforce as a whole.\24\
---------------------------------------------------------------------------
    \24\ Economic Impact of Venture Capital Study, Coopers and Lybrand 
(Sixth Annual study), 1996.
---------------------------------------------------------------------------
    Nasdaq-Listed Companies: Companies traded on the Nasdaq 
Stock Market make up four tenths of one percent of all public 
and private companies in the United States and have an 
employment base of approximately three million people (2.5% of 
the U.S. total), but in the period from January 1990 through 
June 1994 they created over one-half million new jobs or more 
than 16 percent of all new jobs. During the same time period 
Fortune 500 firms lost about 200,000 jobs per year. Compared to 
a national growth rate of about 3 percent, 51 percent of the 
Nasdaq companies are growing at 20 percent or higher. This is 
equivalent to a 100 person firm growing to at least 145 
employees in a four and a half year period. Fully 80 percent of 
this explosive job growth comes in Nasdaq firms with 1,000 or 
more employees. The key seems to be firms with an average 
revenue base of $100 million--a take-off point for growth.\25\
---------------------------------------------------------------------------
    \25\ The Role of Nasdaq Companies in the U.S. Economy, Cognetics, 
Inc., June 1, 1995.
---------------------------------------------------------------------------
    Women-Owned Businesses: Growth in the number of women-owned 
businesses has been particularly spectacular. The number of 
women-owned sold proprietorships, partnerships, and 
subchapter's corporations has risen from 2.6 million in 1982 to 
5.889 million in 1992. For this entire decade the increase is 
125 percent or 8.5 percent compounded annually--more than twice 
the rate of all businesses. When the 511,000 women-owned 
subchapter C corporations are added, the total rises to 6.4 
million firms. In 1992 women owned 32.1 percent of all firms in 
the United States. Women-owned firms with employees constituted 
11 percent of the total of new businesses between 1987 and 
1992, a 32 percent growth rate. These firms with employees 
provided 94 percent of the total revenue for the women-owned 
business sector--receipts which totaled $1.5 trillion in 1992--
and now make up one-fifth of all the 6.4 million women-owned 
firms.\26\
---------------------------------------------------------------------------
    \26\ U.S. Census and Small Business Administration data.
---------------------------------------------------------------------------
    Software Industry Trends/Competitiveness: Although the 
software industry boasts some large, well-known companies, a 
recent survey showed that more than 80 percent of the industry 
is actually made up of software companies with annual revenues 
under $10 million.\27\ The employment of large numbers of 
highly skilled workers, heavy investment in research and 
development, and high growth of production and exports further 
qualify the U.S. software publishing industry as an excellent 
example of a developing entrepreneurial industry.
---------------------------------------------------------------------------
    \27\ 1996/1997 Software Business Practices Survey, Price Waterhouse 
LLP, Massachusetts Software Council, Software Publishers Association, 
and Information Technology Association of America (6th Annual)(1996), 
at 38.
---------------------------------------------------------------------------
    Between 1987 and 1993, the annual average growth rate for 
the industry increased by 20 percent. During this five year 
period, international sales grew by an average annual rate of 
13 percent per company, representing $26,665, and 48 percent 
for the entire period. The growth in international sales would 
be much larger, at least double by conservative estimates, if 
it were not for widespread international piracy of software. 
Protection of intellectual property rights is a high priority 
for the Entrepreneurs Coalition.
    The U.S. has nearly 500,000 people directly employed in 
software development, and the numbers are growing rapidly. 
According to statistics developed by the U.S. Department of 
Commerce and the WEFA Group, between 1987 and 1993 software 
industry employment increased by 10.5 percent annually.\28\
---------------------------------------------------------------------------
    \28\ Economic Contribution of the Packaged Software Industry to the 
U.S. Economy, August, 1994; WEFA Group, at 15.
---------------------------------------------------------------------------
    Employee compensation, a highly important criterion for 
measuring the industry's contribution towards the economy, also 
reflects the software industry's prosperity and growth. Labor 
compensation grew at an annual average rate of 8.4 percent, or 
$18,256, between 1987 and 1992, and the average compensation 
measured by total payroll grew at an annual rate of 20.1 
percent during the same five year period.\29\
---------------------------------------------------------------------------
    \29\ Ibid.
---------------------------------------------------------------------------
    Stability and Growth: Inc. found in 1996 that 
entrepreneurial firms are remarkable durable. It surveyed the 
entire Inc. 500 group from the class of 1985 and found that 
only 19% were no longer in business or could not be located. 
Another 275 had been sold to a new owner, six percent had gone 
public, and 48% were still privately held under the same 
ownership. The companies had generated $7.4 billion in revenue 
in 1984 and $64 billion in 1994 and 29,000 employees in 1984 
and 127,000 in 1995. The 32 companies which went public grew by 
$18.9 billion in revenues from 1984 to 1994, and they created 
59,900 new full-time jobs. That's an average of 30% revenue 
growth per year and an average of 1,872 new jobs created by 
each company each year. Microsoft is one of these companies, 
along with Oracle, Solectron, Tech Data Corp., and Merisel--all 
high technology companies. In this process 10,000 jobs were 
lost at the 95 companies which no longer exist or could not be 
found, but this was dwarfed by the job gains at the 233 
companies which survived and remained independent of 92,000--a 
net job growth of 81,900.\30\
---------------------------------------------------------------------------
    \30\ Martha E. Mangelsdorf, The Startling Truth About Growth 
Companies, Inc. (Special Issue: State of Small Business, May 1996), at 
85.
---------------------------------------------------------------------------
    Workplace Quality of Life: In the age of ``economic 
anxiety'' there are powerful reasons to work for 
entrepreneurial firms. In a major survey of attitudes towards 
their workplace quality of life, Inc. found that employees of 
small entrepreneurial firms were more likely to say that they 
had an opportunity ``at work to learn and grow,'' that the 
mission of their employer makes them ``feel your job is 
important,'' that they used a higher percentage of their 
ability, that they wanted to be a leader in their firm someday, 
that the management did ``what is necessary to make your 
company a great place to work,'' and that their company was a 
``good workplace for all of the people (and not) for only the 
privileged few.'' \31\
---------------------------------------------------------------------------
    \31\ Jeffrey L. Seglin, The Happiest Workers in the World, Inc. 
(Special Issue: State of Small Business, May 1996), at 62.
---------------------------------------------------------------------------
    Stability was a hallmark of these companies. In another 
survey by Inc. 68% of these firms still have their headquarters 
in the same town and a majority of those that had relocated 
moved less than 20 miles away. Only 4% had moved their 
headquarters across state lines.\32\
---------------------------------------------------------------------------
    \32\ Martha E. Mangelsdorf, The Startling Truth About Growth 
Companies, Inc. (Special Issue: State of Small Business, May 1996), at 
85.
---------------------------------------------------------------------------
    High Tech Sector Job Growth: Small high technology firms 
with 500 or fewer employees created over 400,000 jobs in 1990, 
four times their expected share of new jobs. In one recent one-
year period 40% of the jobs created were in the computer-
related industries and seventy-six percent of the total number 
of high technology jobs created were in firms of between 50 and 
500 employees.\33\ The study found that small, high-technology 
firms create more new jobs than any sector of the economy--and 
they keep producing jobs.
---------------------------------------------------------------------------
    \33\ A Profile, OSTP, at.
---------------------------------------------------------------------------
    Entrepreneurial firms continue creating new jobs because of 
growth of the existing firms and growth of the number of firms. 
The OSTP study found small, high-technology firms are 300 
percent more likely to create a new job than any other type of 
firm. The rate of job growth changes by the size of the firm:

                         Number of High Technology Firms by Employment Size in 1976-1986
----------------------------------------------------------------------------------------------------------------
                                                                        Number of Business
                         Employment Size                         --------------------------------  Annual Growth
                                                                       1976            1986          Rate (%)
----------------------------------------------------------------------------------------------------------------
1-99............................................................          50,245        8350,245           5.22%
100-499.........................................................           2,554           3,789           4.02%
500-999.........................................................             292             459           4.63%
1,000-9,999.....................................................             432             520           1.87%
10,000 & up.....................................................             133             135           0.15%
                                                                 -----------------------------------------------
  Totals........................................................          53,656          88,453         * 5.13%
----------------------------------------------------------------------------------------------------------------
* A Profile, OSTP, at 17 (emphasis added)(citing William K. Scheirer, ``The Population and Birth Rates of High
  Technology Firms, 1976-1986,'' study commissioned by U.S. Small Business Administration).

    The more entrepreneurial the firm, the more growth in jobs. 
The highest job growth is focused in a small group of high-
growth entrepreneurial firms--10 percent of small companies 
created 75 percent of new jobs created since 1970.
    Job growth rates of 10-12 percent as a yearly average for 
high technology companies are common according to a CorpTech 
study based of the NSF Science and Engineering Indicators. This 
study shows net growth of jobs by industry:

 
------------------------------------------------------------------------
                                    Employment Growth     No. of Jobs
                                      Rate Last Year   Created Last Year
------------------------------------------------------------------------
Automation........................               12.6             58,471
Biotechnology.....................               10.6             16,468
Computer hardware.................               14.5            148,304
Computer software.................               13.9            103,479
Advanced materials................                5.8             32,452
Photonics & optics................                8.4             27,654
Telecommunications................             * 12.7             61,280
------------------------------------------------------------------------
* A Profile, OSTP study, at 20.

    Impact of Job Growth: Over 400,000 jobs were created in the 
high technology sector by small technology firms in 1990 
alone.\34\ Small high tech firms created four times their 
expected share of new jobs and in a one-year period, 40% of the 
jobs created were in computer-related industries.\35\ The OSTP 
study found that small high-tech firms contributed 38% of the 
2.2 million new jobs in the entire high technology sector 
between 1976-1986. These figures are twice as high as the 
growth rate for the economy as a whole.\36\
---------------------------------------------------------------------------
    \34\ A Profile, OSTP study, at 30 (citing Science and Engineering 
Indicators--1991).
    \35\ A Profile, OSTP study, at 30.
    \36\ A Profile, OSTP study, at 30.
---------------------------------------------------------------------------
    In the period of 1977-1987 employment in computer and data 
processing firms grew by an astonishing 252%, creating 450,000 
new jobs. Employment in firms producing scientific and 
measuring instruments grew 210%, medical and ophthalmic goods 
grew 62%, office and computing equipment grew by 35%, and 
electronic components and accessories grew 25%. This compares 
to a drop in employment for firms producing general industrial 
machinery of 9%, a drop of 44% for engines and turbines, a drop 
of 40% for Radio, TV, and communications equipment, and a drop 
of 47% for firms in construction and related machinery.\37\
---------------------------------------------------------------------------
    \37\ State of Small Business Report, 1992, Small Business 
Administration, at 83.
---------------------------------------------------------------------------
    Economic Stars: These entrepreneurial new businesses grow 
and can become the nation's largest and most successful 
corporations. Microsoft, Hewlett Packard and Genentech are all 
billion-dollar businesses that began as entrepreneurial 
startups. Today these firms employ more than 100,000 employees.
    Almost half of the largest industrial firms in the United 
States are now replaced by ``upstarts'' every five years. Of 
the 1,400 largest high-technology firms in the United States, 
41 percent have been created since 1980, 31 percent since 1983 
and 14 percent since 1987--clearly age and size are not a 
protection. The new startup of today may be the billion-dollar 
corporation of tomorrow.
    Self-Made Wealth: Ten years ago, 40% of the Forbes Four 
Hundred Richest People in America were entrepreneurs, self-made 
individuals who created their own wealth rather than inheriting 
it. By 1994, 80% of the wealthiest were self-made.\38\
---------------------------------------------------------------------------
    \38\ William E. Wetzel, ``Economic Policy in an Entrepreneurial 
World,'' Venture Capital Journal, August 1995, at 53.
---------------------------------------------------------------------------
    High-Wage Jobs: The industries comprising the Coalition are 
prime examples of this subject. The average salary in the U.S. 
biotechnology industry is $50,000. Biotech companies directly 
employ over 108,000 jobs in the U.S. Over two thirds of 
biotechnology companies employ less than 50 workers.\39\ The 
percentage of highly skilled engineers, scientists, and 
managers generated by young venture capital-backed companies is 
over 4 times the percentage of skilled jobs created in the 
economy as a whole (61% vs. 14%).\40\ At small businesses with 
less than 500 employees, 54.8% earn more than $21 per hour as a 
starting salary, vs. only 45.2% at firms with more than 500 
employees. This indicates that recently hired workers in small 
firms are obtaining a major share of high-wage jobs. Large 
firms continue to shed high-wage jobs, particularly management 
jobs.\41\
---------------------------------------------------------------------------
    \39\ Biotechnology Compensation and Benefits Survey, Radford 
Associates/Alexander and Alexander Consulting Group (1995) and Biotech 
'96: Pursuing Sustainability, Ernst and Young (10th Annual Survey).
    \40\ Sixth Annual Economic of Venture Capital Study, NVCA/Coopers 
and Lybrand LLP., 1996.
    \41\ The Third Millennium: Small Business and Entrepreneurship in 
the 21st Century, Small Business Administration, Office of Advocacy, 
from data compiled by Joel Popkin and Company (Special publication 
prepared for delegates to the 1995 White House Conference on Small 
Business).
---------------------------------------------------------------------------
    In addition to high wages, entrepreneurial firms use 
incentive stock options to compensate and motivate employees. 
These stock options tend to be granted to all employees, not 
just the elite management. For example, in the biotechnology 
industry 80% of the firms had stock option plans and 82% of 
these were company wide.\42\
---------------------------------------------------------------------------
    \42\ Biotechnology Compensation and Benefits Survey, Radford 
Associates/Alexander and Alexander Consulting Group, 1995.
---------------------------------------------------------------------------
    Quality of Life Impact: These entrepreneurial firms create 
new products that in themselves create or stimulate new 
industries. Entrepreneurial companies have a multiplier impact 
on the creation of jobs and new economic growth. For example 
the creation and growth personal computer and biotechnology--
whole new industries--resulted from the catalyst of 
entrepreneurial firms. Changes in job growth also signal 
changes in the structure of the larger economy. The growing 
significance of entrepreneurial firms to job growth signals a 
change of the economy and appreciation for the underlying 
strength and dynamism of the economy. We are in a massive 
restructuring of the American economy--the transition from a 
declining industrial/manufacturing economy to an emerging 
entrepreneurial/innovation-driven economy.

          Entrepreneurs are Leaders in Research and Innovation

    Research and innovation is one of the keys to economic 
growth and American high-technology firms are the word's 
leaders in innovation.
    Technological Change: The State of Small Business Report 
finds that technological change is responsible for a 
significant portion of increases in the standard of living.\43\ 
The Office of Science and Technology Policy reports, A large 
and growing body of research indicates that new, small firms 
are the major force for technological change in our economy by 
innovating more efficiently than their larger counterparts.\44\
---------------------------------------------------------------------------
    \43\ State of Small Business Report, 1994, Small Business 
Administration, at 109.
    \44\ A Profile, OSTP, at 2.
---------------------------------------------------------------------------
    The Council of Economic Advisors finds that advances in 
knowledge contribute importantly to the Nation's real economic 
growth; about one-half of all growth in output per capital has 
been attributed to the technological knowledge and managerial 
and organizational know-how \45\ and that technology changes 
alone are responsible for about 30 percent of the increases in 
gross domestic product between 1947 and 1992.\46\ It has found 
that technological change has played a central role in economic 
growth \47\ and that these innovations have led to a 
transformation of society over the past two centuries.''\48\
---------------------------------------------------------------------------
    \45\ Economic Report of the President, 1989, U.S. Council of 
Economic Advisors, at 223.
    \46\ Economic Report of the President, 1994, U.S. Council of 
Economic Advisors, at 44.
    \47\ Economic Report of the President, 1990, U.S. Council of 
Economic Advisors, at 111.
    \48\ Economic Report of the President, 1992, U.S. Council of 
Economic Advisors, at 111.
---------------------------------------------------------------------------
    Research Intensity: Small firms tend to be more research 
intensive. This research intensity is critical to our standard 
of living. The estimated rate of return on private R and D 
spending range from 20% to 50%, but the rate of return to 
society has been estimated to be about double the private rate 
of return.\49\
---------------------------------------------------------------------------
    \49\ Economic Report of the President, 1989, U.S. Council of 
Economic Advisors, at 223.
---------------------------------------------------------------------------
    The percentage of domestic employees who were R and D 
scientists and engineers was 6.41 percent in small R and D 
firms and 4.05 percent in large firms and R and D funds as a 
percentage of domestic net sales were 4.25 percent in small 
firms and 3.89 percent in large firms.\50\
---------------------------------------------------------------------------
    \50\ State of Small Business Report, 1994, Small Business 
Administration at 115-117 (citing U..S. Census data).
---------------------------------------------------------------------------
    One study of intellectual property finds small technology 
firms to be more research-intensive than larger firms. The 
median R and D expenses as a percent of sales was 5% of less 
for large firms with intellectual property and 11% for small 
firms.\51\ 14% of the small firms having R and D expenses which 
were more than 40% of sales and there were no large firms with 
R and D expenditures of this magnitude.\52\
---------------------------------------------------------------------------
    \51\ State of Small Business Report, 1994, Small Business 
Administration, at 117.
    \52\ State of Small Business Report, 1994, Small Business 
Administration, at 117.
---------------------------------------------------------------------------
    The staggering research intensity of high technology firms 
is confirmed each year in the Business Week survey on R and D 
expenditures.\53\ The survey measures the percentage of 
increase in absolute terms and also the research intensity as a 
percentage of sales or on a per employee basis. The 1995 survey 
finds a 14% increase in R and D by electrical and electronics 
firms, which spent $9.6 billion on research, 5.7% as a 
percentage of sales, and $8,257 per employee. Office equipment 
and sales firms spent $15,898 per employee on research, health 
care firms spent $18,451 per employee, and chemicals spent 
$10,289 per employee. The all industry averages are 4% 
increases, 3.5% as a percentage of sales, and $7,651 per 
employee.
---------------------------------------------------------------------------
    \53\ ``Blue-Sky Research Comes Down to Earth,'' Business Week, July 
3, 1995, at 78-80.
---------------------------------------------------------------------------
    In terms of spending per employee the top ten firms were 
all high technology firms: Biogen (biotechnology), $210,654 per 
employee; Genetics Institute (biotechnology), $114,943; 
Genentech (biotechnology), $112,030; Immunex (biotechnology), 
$102,719; Amgen (biotechnology), $91,266; S3 (multimedia 
chips), $82,548; Cyrix (computer hardware) $80,113; Adobe 
Systems (software), $70,993; Platinum Technology (hardware and 
software), $69,787; and Altera (hardware and software), 
$68,956.
    In relation to sales the top research firms were Genetics 
Institute, 82.6%; Biogen, 65%; Platinum Technology, 54.2%; 
Immunex, 53.7%; Chiron (biotechnology), 44.7%; Genentech, 
40.8%; Continuum (software), 34.3%; Viewlogic Systems 
(hardware), 30.8%; Alza (biotechnology), 29.2%; and MacNeal-
Schwendler (software), 29.2%.
    In terms of total spending on research the top firms were 
General Motors, $7 billion; Ford Motor, $5.2 billion; IBM, $3.4 
billion; AT&T, $3.1 billion; Hewlett-Packard, $2 billion; 
Motorola, $1.9 billion; Boeing, $1.7 billion; Digital 
Equipment, $1.3 billion; Chrysler, $1.3 billion; and Johnson 
and Johnson, $1.3 billion.
    Another study regarding firms with new products found that 
small firms obtained more patents per sales dollar than larger 
firms even though small firms were less likely to obtain 
patents than larger firms, indicating that the finding 
understates the point.\54\
---------------------------------------------------------------------------
    \54\ State of Small Business Report, 1994, Small Business 
Administration, at 119 (citing a study by John Hansen, Utilization of 
New Data for the Assessment of the Level of Innovation in Small 
American Manufacturing Firms, study commissioned by the SBA, 1989).
---------------------------------------------------------------------------
    Biotechnology Industry Research: The biotechnology industry 
is one of the most research intensive industries in the 
civilian manufacturing sector. The average biotechnology 
company spends $71,000 per employee on research, more than nine 
times the U.S. corporate average of $7,650.\55\ Ernst & Young 
\56\ reports that biotechnology companies spent $7.7 billion on 
research and development in 1995, up eight percent over 1994.
---------------------------------------------------------------------------
    \55\ Back to Basics, Business Week, July 3, 1995, at 78.
    \56\ A fiscal year for Ernst & Young is from July 1 through June 
30. Therefore, 1995 indicates July 1, 1994 through June 30, 1995.
---------------------------------------------------------------------------
    Software Industry Research: The success of the software 
industry, and its growth of high paying, high-skill jobs is 
attributable to its heavy investment in research and 
development of new products. Approximately 85 percent of the 
products sold by U.S. software companies are developed in-
house. At the typical U.S. software company, the largest 
department, in terms of number of employees, is the research 
and development department. U.S. software companies spend 
approximately 15 percent of their revenue on R&D, with half of 
R&D expenditures going to salaries and benefits for employees. 
Only by maintaining high levels of R & D spending can U.S. 
software companies retain their global technological 
leadership.
    The industry as a whole designates 20 percent of employee 
resources for research and development of new products. A 
recent study found that small and mid size companies allocate 
more resources to R&D than do their larger counterparts in the 
industry. Specifically, companies with revenue less than $1 
million and between $1-$10 million designate 30 and 23 percent 
of their respective labor resources.\57\
---------------------------------------------------------------------------
    \57\ 1996/97 Software Business Practices Survey, Price Waterhouse 
LLP, Massachusetts Software Council, Inc., Software Publishers 
Association, Information Technology Association of America (sixth 
annual) 1996, at 38.
---------------------------------------------------------------------------
    Research at Venture Capital-Backed Firms: Venture capital-
backed companies tend to be research-intensive. By the time a 
typical venture-backed company is five years old, it has 
already invested $13.5 million to create breakthrough products 
and services. From 1990 to 1994 these firms increased their R 
and D investment by 36%, compared to only 11% for Fortune 500 
firms. The average R and D per employee is $20,000, compared to 
only $9,000 for a Fortune 500 firm. Over the past five years, 
venture-backed companies increased their investment in R and D 
at twice the rate of Fortune 500 companies, 30% compared to 
14.7%. \58\
---------------------------------------------------------------------------
    \58\ Economic Impact of Venture Capital Study, Coopers and Lybrand 
(Sixth Annual), 1996.
---------------------------------------------------------------------------
    Firm-University Ties: The relationship between 
entrepreneurs and research-intensive universities is found in 
another study. New small technology-based firms were found to 
be much more likely to be formed close to these universities, 
non-profit research institutions and other high technology 
firms.\59\
---------------------------------------------------------------------------
    \59\ State of Small Business Report, 1994, Small Business 
Administration, at 120 (citing a study by Stephen Geoffrey Graham, The 
Determinants of the Geographical Distribution of the Formation of New 
and Small Technology-based Firms, 1981 Michigan State University Phd. 
Dissertation).
---------------------------------------------------------------------------
    Research intensity is directly related to innovations which 
can change our economy and change our lives. It is no surprise 
to find that research-intensive firms are prolific innovators.
    Small Firms as Innovators: The Small Business 
Administration has completed a comprehensive study of 8,074 
innovations in 363 industries from 46 technology, engineering, 
and trade journals and found that small firms were responsible 
for 55 percent of the innovations.\60\ The study found that 
small firms produce twice as many product innovations per 
employee as large firms and twice as many significant 
innovations per employee.\61\ A previous study has estimated 
that the ratio is 2.45 innovations per employee of small to 
large firms.\62\
---------------------------------------------------------------------------
    \60\ State of Small Business Report, 1994, U.S. Small Business 
Administration, at 113.
    \61\ State of Small Business Report, 1994, at 114.
    \62\ Earl E. Bomberger, The Relationship Between Industrial 
Concentration, Firm Size, and Technology Innovation (SBA commissioned 
report cited in 1994 State of Small Business Report at 114, note 20.)
---------------------------------------------------------------------------
    List of Innovations: The Small Business Administration has 
prepared an impressive list of important innovations brought to 
market by small firms.\63\ The list includes air conditioning, 
air passenger service, the airplane, artificial skin, assembly 
line, audio tape recorder, biomagnetic imaging, catalytic 
petroleum cracking, continuous casting, cotton picker, 
defibrillator, DNA fingerprinting, double-knit fabric, 
electronic spreadsheet, FM radio, geodesic dome, gyrocompass, 
heart valve, helicopter, human growth hormone, hydraulic brake, 
integrated circuit, microprocessor, optical scanner, oral 
contraceptives, outboard engine, overnight national delivery, 
pacemaker, personal computer, photo typesetting, polaroid 
camera, portable computer, prestressed concrete, pressure 
sensitive cellophane tape, programmable computer, quick-frozen 
foods, safety razor, six-axis robot arm, soft contact lens, 
solid fuel rocket engine, strobe lights, supercomputer, vacuum 
tube, xerography, X-ray telescope, and the zipper. There are 
undoubtedly tens of thousands of other examples.
---------------------------------------------------------------------------
    \63\ State of Small Business Report, 1994, at 113.
---------------------------------------------------------------------------
    The reasons for high innovation levels in small, high-tech 
firms are varied. Some studies focus on the greater economic 
incentive to innovate in small firms and the bureaucracy of big 
firms. Other studies suggest large firms may over-specialize 
and cite reduced contact between customers and developers. 
Whatever the reasons, the data clearly show the effectiveness 
of innovation of small, entrepreneurial, high-technology firms.

                     Entrepreneurs Are Competitive

    High technology firms provide the competitive advantage 
American needs in new, high-growth industries. Success in this 
competition is critical to America's economic prospects and 
standard of living.
    Level of Competition: Americans have the perception that 
the level of competition has increased the pressure on U.S. 
firms. This perception is accurate and arises from the fact 
that the share of our gross national product that is involved 
in internationally traded goods has doubled from 1950 to 1990 
and now stands at 22.3 percent.\64\ This percent is projected 
to rise to one-third during the next decade. There is increased 
pressure.
---------------------------------------------------------------------------
    \64\ Data Resources Inc. projections.
---------------------------------------------------------------------------
    Competition is increasing from both developed and 
developing countries and our vulnerability to pressure from 
imports and our dependence on exports is growing. There is 
pressure for higher quality and lower prices, better service, 
and more innovation. The life-cycle of products, and the 
ability of the innovator to maintain dominance in a given 
market, has decreased.
    Entrepreneurial firms are able to handle this pressure to 
compete.
    Venture Capital-Backed Firms: Venture capital-backed firms 
aggressively grow export sales to improve our balance of 
payments. Their average export sales growth was 57% (1993-
1994), up from 11% (1991-1992). This shows that these firms are 
exploiting newly opened markets. The average venture-backed 
firms grew its sales to employee 9 percent each year, more than 
three times the productivity growth rate for the Fortune 500 
companies.\65\
---------------------------------------------------------------------------
    \65\ Economic Impact of Venture Capital Study, Coopers and Lybrand 
(Sixth Annual), 1996.
---------------------------------------------------------------------------
    Our high technology firms are ready, willing, and able to 
compete in international markets and they are our greatest 
single economic strength in an increasingly competitive world 
economy.
    Biotechnology Industry Competitiveness: A case study of 
American competitiveness is the biotechnology industry. The 
United States currently has the dominant biotechnology industry 
when compared with any other country in the world. Precisely 
because the U.S. is preeminent in the field of biotechnology, 
it has become a target of other country's industrial policies. 
In 1991, the Office of Technology Assessment (OTA) found that 
Australia, Brazil, Denmark, France, South Korea and Taiwan 
(Republic of China) all had targeted biotechnology as an 
enabling technology. Furthermore, in 1984, the OTA identified 
Japan as the major potential competitor to the United States in 
biotechnology commercialization.\66\
---------------------------------------------------------------------------
    \66\ U.S. Congress, Office of Technology Assessment, Biotechnology 
in a Global Economy 243 (October 1991).
---------------------------------------------------------------------------
    The OTA also identified the manner in which Japan had 
targeted biotechnology. The report stated,
    In 1981, the Ministry of International Trade and Industry 
(MITI) designated biotechnology to be a strategic area of 
science research, marking the first official pronouncement 
encouraging the industrial development of biotechnology in 
Japan. Over the next few years, several ministries undertook 
programs to fund and support biotechnology.
    One of the Japanese ministries, the Ministry of Health and 
Welfare (MHW), instituted a policy whereby existing drugs would 
have their prices lowered, while allowing premium prices for 
innovative or important new drugs, thus forcing companies to be 
innovative and to seek larger markets.\67\
---------------------------------------------------------------------------
    \67\ U.S. Congress, Office of Technology Assessment, Biotechnology 
in a Global Economy 244-245 (October 1991).
---------------------------------------------------------------------------
    It is widely recognized that the biotechnology industry can 
make a substantial contribution to U.S. economic growth and 
improved quality of life. For example:
     The National Critical Technologies Panel, 
established in 1989 within the White House Office of Science 
and Technology Policy by an Act of Congress, \68\ calls 
biotechnology a ``national critical technology'' that is 
``essential for the United States to develop to further the 
long-term national security and economic prosperity of the 
United States.'' \69\
---------------------------------------------------------------------------
    \68\ National Competitiveness Technology Transfer Act, Pub. L. No. 
101-189, 103 Stat. 1352 (42 U.S.C. Sec. 6681 et seq.).
    \69\ White House Office of Science and Technology Policy, Report of 
the National Critical Technologies Panel 7 (1991).
---------------------------------------------------------------------------
     The private sector Council on Competitiveness also 
calls biotechnology one of several critical technologies that 
will drive U.S. productivity, economic growth, and 
competitiveness over the next ten years and perhaps over the 
next century.\70\
---------------------------------------------------------------------------
    \70\ Council on Competitiveness, Gaining New Ground: Technology 
Priorities for America's Future 6 (1991).
---------------------------------------------------------------------------
     The United States Congress' Office of Technology 
Assessment calls biotechnology ``a strategic industry with 
great potential for heightening U.S. international economic 
competitiveness.'' OTA also observed that the ``wide-reaching 
potential applications of biotechnology lie close to the center 
of many of the world's major problems--malnutrition, disease, 
energy availability and cost, and pollution. Biotechnology can 
change both the way we live and the industrial community of the 
21st century.'' \71\
---------------------------------------------------------------------------
    \71\ U.S. Congress, Office of Technology Assessment, New 
Developments in Biotechnology: U.S. Investment in Biotechnology-Special 
Report at 27 (July 1988).
---------------------------------------------------------------------------
     The National Academy of Engineering characterizes 
genetic engineering as one of the ten outstanding engineering 
achievements in the past quarter century.\72\
---------------------------------------------------------------------------
    \72\ National Academy of Engineering, Engineering and the 
Advancement of Human Welfare: 10 Outstanding Achievements 1964-1989 2 
(1989).
---------------------------------------------------------------------------
    Global Competiveness of the Software Industry: The software 
industry is another example of a competitive U.S. industry. The 
software industry is a modern and evolving electronic industry 
with revenues of more than $200 billion and a growth rate of 
13% a year. Software is now one of the world's largest and 
fastest-growing industries. Before the mid-1980's, most 
computers were mainframes and minis that were sold with 
proprietary software created by the manufacturer for the 
computer. The hardware and operating systems software were 
bundled together (the software was placed in the hardware), and 
the customer usually paid for the software through the price 
that was paid for the computer.
    The development of personal computers spawned independent 
software companies that sold software separately to PC buyers. 
At the time, mainframe and mini hardware manufacturers began to 
unbundle their products presenting independent software 
companies with the opportunity to compete by offering ``open 
systems'' of software for mainframes and minis that offered 
customers more flexibility, performance and features.
    Since then, the growth and competitiveness of the U.S. 
software industry has exploded. The software industry 
(prepackaged software, custom computer programming services, 
and computer integrated design) contributed $36.7 billion of 
value to the U.S. economy in 1992. Employment in the software 
industry increased at double digit rates through much of the 
1980's. It is estimated that nearly 500,000 people are 
currently employed in the software industry.
    Beyond the core industry, it is estimated that nearly 2 
million U.S. jobs are tied to software programming, a number 
which clearly eclipses all of our major international 
competitors.
    The U.S. software industry is also an export engine. The 
U.S. makes an estimated 75% the pre-packaged software sold 
worldwide, an amount exceeding $100 billion.

                Foreign Sales Exports of U.S. Industries
------------------------------------------------------------------------
                       Industry                         1994  (billions)
------------------------------------------------------------------------
Chemicals and allied products........................              $51.6
Agricultural sector..................................               42.6
Automotive parts and accessories.....................               37.1
Aerospace............................................               35.8
Computers and peripherals............................               30.4
Petrochemicals.......................................               26.6
Prepackaged Software Sales...........................               26.3
Food and kindred products............................               25.6
Electronic components and accessories................               24.5
Motor vehicles and car bodies........................               22.0
Semiconductors and related devices...................               18.0
Organic chemicals....................................               12.3
Telecommunications equipment.........................               12.3
Paper and allied products............................               11.1
Drugs................................................                7.6
Textile mill products................................                5.2
------------------------------------------------------------------------

    These same themes can also be stated for wages. In 1992, 
the average compensation per employee in the software industry 
was over $55,000. Compensation grew at an annual rate of 8.4 
percent from 1987 to 1992. Auto industry compensation grew at 
the annual rate of only 4.6 percent, while the motion picture 
industry wages grew at the rate of only .7 percent. Total 
software industry payroll grew at an annual rate of over 20 
percent from 1987 to 1992, going from little over $2 billion to 
over $5 billion. By contrast, the recorded music industry grew 
at the rate of only 4 percent, going from $266 million to $328 
million., The motion picture industry payroll grew at the 
relatively lackluster rate of 7.7 percent.
    Small Firm Competitiveness: The OSTP study summaries the 
way in which small firms enhance U.S. competitiveness in 
international markets.
    The importance of small high-tech firms to the U.S. economy 
cannot be overstated; competition in the global economy will 
inevitably mean that many of the most successful technology 
firms will eventually succumb to competitive pressure, and as a 
consequence, a viable pool of smaller firms must be available 
to replace these firms with newer, updated technology 
products.\73\
---------------------------------------------------------------------------
    \73\ A Profile, OSTP study, at 2.
---------------------------------------------------------------------------
    Foreign Acquisitions: However, American ownership of these 
high technology firms is an issue. The OSTP study found that 
outlays by foreign-owned firms to acquire U.S. high technology 
firms rose sharply from 1988-1992, with Japan buying 65% of the 
total including 40 advanced material companies, 19 aerospace 
companies, 25 chemical companies, 93 computer companies, 33 
electronics companies, 30 semiconductor equipment companies, 51 
semiconductor companies, 31 telecommunications companies, 17 
biotechnology companies, and 60 other high tech companies--a 
total acquisition of 399 companies in a four year period.\74\ 
The United Kingdom was second in acquisitions with 65, France 
acquired 41, Canada acquired 14, Germany acquired 17, 
Switzerland acquired 14, and Taiwan acquired 11.
---------------------------------------------------------------------------
    \74\ A Profile, OSTP study, at 24 (citing Economic Strategy 
Institute database).
---------------------------------------------------------------------------
      

                                

    Chairman Archer. Thank you, Mr. Wiggans.
    In order to determine whether to ask this panel to come 
back after lunch or whether to release them, are there Members 
who wish to inquire?
    I hate to ask you to come back after lunch in order to 
respond to one Member, but the Chair is constrained. I have to 
conduct a luncheon. So, what I will do is permit Mr. English to 
Chair the Committee so that he may inquire and, subsequent to 
his inquiry, release this panel. And then, the Committee will 
return for the next panel at 5 minutes after 1 p.m.
    Mr. English [presiding]. I thank the panel for staying. I 
will keep this relatively brief, and I will consider this a 
lesson to myself for inquiring. [Laughter.]
    First of all, I am going to briefly have, at this point, 
read into the record of the Committee a very thoughtful letter 
that I had received from the American Business Conference that 
speaks to some of the issues that we are addressing today, 
particularly the effect of changes in the Tax Code, instability 
in the Tax Code on capital gains, and the consequences it has 
for the economy in general, and at this point, I will, without 
objection. [Laughter.]
    [The information follows:]
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    Mr. English. Thank you.
    Mr. Wiggans, I very much appreciated your testimony and 
your reference also to the targeted capital gains bill that Mr. 
Matsui and I have been promoting. I wonder if you could amplify 
on your remarks and talk about how the capital gains tax 
affects entrepreneurs who are trying to enter capital markets, 
trying to finance innovations in the economy, and recognizing 
that their ventures involve a fair amount of risk, How does the 
capital gains tax affect people in your situation and your 
ability to attract investors?
    Mr. Wiggans. Well, first of all, let me thank you for your 
support of these bills, because as I mentioned, they do seem to 
be the solution to some of these issues. Let me simply say that 
the investments that investors need to make in companies like 
mine are unique. It requires patient capital; it requires 
locked-up capital. As you pointed out, it is high risk capital. 
So, it is a very unique type of investment that should 
correspond with a different tier or a different type of 
incentive.
    Investors who originally made an investment in my company 
or any biotechnology company for that matter must be willing to 
not only risk that capital but at a minimum, have it locked up 
for extended periods of time. There is no liquidity to venture 
investments. If you invest in General Motors today and decide 
you have changed your mind, you can sell it tomorrow. The 
founding investors, the founding venture capitalists in my 
company, cannot get their capital out. They are locked up for 
years and years. So, I hope that answers your question.
    Mr. English. That does, and I am grateful for that answer, 
because it speaks directly to one of my concerns about the 
capital gains tax, that it falls disproportionately on those 
parts of our economy and even those communities, such as 
depressed, inner-city areas that are least able to attract 
investment because of the risks associated with it.
    Mr. Bloomfield, I wonder, following through on this line of 
questioning, in your view, is a capital gains incentive more 
important to small businesses than to large businesses, and, in 
your view, why?
    Mr. Bloomfield. I do not think there is any doubt that 
companies like Mr. Wiggans' may have more difficulty attracting 
capital, but I think the extent to which we reduce overall 
capital costs has big macro impact, which helps the economy as 
a whole, in addition to certain segments. But if you talk about 
the concerns Mr. Wiggins has about finding scarce capital, I am 
not sure how many of you have seen this interesting article 
that appeared in the Wall Street Journal about 2 or 3 weeks ago 
called Found Money. When David Wyss refers to the fact that he 
would take a finder's fee for finding $50 billion, in other 
words, this is the true free lunch. What this article in the 
Wall Street Journal suggests is we really have a lot of locked 
up capital in the markets now that may not be reflected in a 
lot of the revenue estimates. Let me give you an example: In 
the period 1982 to 1985, realizations as a percentage of the 
total value of equities in the United States were between, 
let's say, 5 and 8 percent in that period. The stock market at 
that time, or the value of equities, was about $2.2 trillion.
    If you go a decade later, to 1995, you will find that 
realizations as a percentage of total value of equities was not 
between 5 and 8 percent but only 2 percent. If you apply that 
same ratio of realizations, and you say that realizations 
should have been at 7 percent, instead of revenues coming to 
the Treasury in the range of $40 billion, revenues would have 
been $70 billion. And when I am talking about the value of 
equities being, in 1995, about $7 trillion, they are now $9 
trillion.
    What I am basically saying is that there is a heck of a lot 
of locked up capital out there which might be unlocked which, I 
think, would change a lot of the equations about the revenue 
impact. That unlocking would provide capital for all Americans 
but in particular would help capital-starved, risky enterprises 
like Mr. Wiggans.
    Mr. English. I wonder: Directed to all of the panelists, 
and this will sound like, perhaps, an unusual question, Are any 
of you familiar with the tax treatment under the capital gains 
tax of dairy cows? Are any of you familiar with it? I must say, 
2 years ago I had a new conference with a dairy cow in my 
district named Bonnie, since deceased. No causal connection, I 
might add. [Laughter.]
    Mr. English. And I had discovered that dairy cows are taxed 
as a capital gain at sale unless they are slaughtered. And what 
typically happens in a situation like we are experiencing now 
in northwestern Pennsylvania, where a lot of dairymen are under 
enormous economic pressure, they are selling some of their 
stock, and on tax day, they are getting slaughtered. So, 
stipulating that the capital gains tax has, in many ways, 
unforeseen and unpredictable effects on different parts of the 
economy and given that, perhaps, the equity issues associated 
with capital gains are not as clear cut as they frequently seem 
to be in debate, I wonder if each of you could offer 
observations as to what types of individuals and businesses 
would most benefit from a capital gains tax reduction, starting 
perhaps with Mr. Wiggans.
    Mr. Wiggans. Well, I would point out that in the 
biotechnology industry, it is very common practice to give all 
employees stock options. Even the largest biotechnology 
company, Amgen, still gives stock options to every single 
employee. In many cases, that is in lieu of pension plans. So, 
your sweat equity and your stock option equity are your 
retirement plan. So, if I could focus, maybe, my answer on that 
specific segment, from top to bottom in the company, from the 
highest paid to the lowest paid, stock options are a tremendous 
incentive economically, and the capital gains changes that you 
have contemplated would have, I think, tremendous impact on 
these employees.
    Mr. English. Mr. Woodbury.
    Mr. Woodbury. In the real estate industry, there are 
several groups that might very well benefit. One is the most 
creative people, because they will be the ones who will create 
the projects that will end up with the most profit and the most 
gain. And I think you do, as a matter of public policy, want to 
reward those people who are creative and who produce value for 
your economy.
    Contrary to popular belief, our statistics show that there 
are a large number of middle-income tax payers who hold real 
estate capital assets, investment assets. Twenty percent, I 
think, of those who report adjusted gross incomes under $50,000 
a year hold real estate investment assets, and more than 30 
percent of those who report income between $50,000 and $100,000 
hold investment real estate assets. So, I think that it would 
be a broad-based application to middle-income tax payers.
    Last, it would help--and this is the locking effect that 
people are referring to--people, probably, who have held assets 
for a long time, who have run out of ideas; who are lazy. They 
are just holding them because they do not know what to do with 
them, and they do not want to pay the tax. By reducing the 
capital gains tax, having a broad-based cut, I think it would 
allow these people, motivate these people to sell, and it would 
put those assets, again, in the hands of people who would maybe 
renovate and improve the assets, which would increase the value 
to the whole economy.
    Thank you.
    Mr. English. Mr. Wyss.
    Mr. Wyss. I would divide it into three categories, 
beginning with corporations. On the corporate side, what the 
capital gains tax does is makes it more difficult to acquire 
capital. Therefore, it penalizes the companies that are growing 
the most rapidly and the companies that need the capital in 
order to expand. I do not think it is primarily big companies 
versus small companies; it is growing companies versus static 
companies.
    On the individual side, we do have to accept the fact that, 
on average, the rich have more capital than the poor. The tax 
cut is biased toward the high end of the income spectrum. That 
is reality. It does not mean the poor lose; it just means they 
do not gain as much as the wealthy. One exception to that is 
the housing deduction, and I think this is a critical point for 
the elimination of capital gains on housing, because you are 
now hitting that time when the baby boomers are getting rid of 
their kids. Maybe I am speaking too much as an individual, but 
all I know is that my kids are both gone; my wife and I share a 
bedroom; the cat does not need the other four bedrooms. But I 
am not going to sell the house because I do not want to pay 28 
percent on the sale value of that house, nor do I want to find 
a condo downtown that is worth as much as my current house is.
    That unlocking of capital is almost free. We are collecting 
almost no revenue on it now, because I am not selling the 
house. And why do we not use that capital a little more 
productively than having the empty bedrooms.
    Mr. English. Ms. Gravelle.
    Ms. Gravelle. Well, I think the data show that there are 
two kinds of assets that are responsible for virtually all the 
capital gains taxes: Corporate stock and real estate. Those 
shares fluctuate depending on how the stock market versus the 
real estate market is doing. Right now, I think the big 
fraction is in corporate stock. Most corporate stock is issued 
by large corporations; therefore, most of the capital gains tax 
cut would have to do with the owners of shares of large 
corporations.
    You mentioned earlier small businesses. A lot of small 
businesses are not incorporated, so they would not have an 
effect. And, of course, small businesses issuing new shares are 
already eligible for a 50-percent exclusion. So, I would say 
basically, large corporations, and although many middle-income 
people have shares in large corporations, the assets, 
particularly equity assets, are concentrated at the higher end 
of the scale.
    Mr. English. Mr. Bloomfield.
    Mr. Bloomfield. Mr. English, I would make four points. The 
first point is, Who owns capital assets. And, as I indicated, 
CBO points out that 31 percent of people with incomes of 
$20,000 or below actually have capital assets excluding their 
home. If you talk about from zero to $50,000, you get an even 
higher amount. So, a lot of middle-class people have capital 
assets.
    The second point I would make is, When the Joint Committee 
or CBO occasionally talks about income distribution, they may 
artificially inflate a person's income because he may have once 
or twice or three times in his lifetime have a capital gain.
    Mr. English. On that point, Mr. Bloomfield, I understand 
that roughly 44 percent of the people who pay the capital gains 
tax have had only one realization during the prior 5-year 
period. Does that suggest to you that many of the people who 
pay the capital gains tax in fact are not large investors but 
individuals who have a single asset, which they sell, that puts 
them temporarily in a different income category?
    Mr. Bloomfield. I think that data is true, and there is 
even more recent data by CBO which looked at people with an 
income of $50,000, and they only had a capital gain 3 out of 10 
years. So, people do occasionally have capital gains, and a lot 
of people have capital gains.
    The third point I would make is David Wyss' point about who 
benefits. In reference to Ms. Gravelle's comment about 
corporate stock, the Investment Co. Institute recently released 
data that indicated of those people with incomes of $50,000 or 
less, 60 percent of those families have mutual funds. So, we 
are talking about a growing percentage. Mutual funds as a 
percentage of capital gains realizations, quite frankly, is one 
sector that has grown dramatically, from 3 percent of all 
capital gains to 13 percent. So, individuals benefit from 
capital gains and capital gains reduction because of their 
pensions.
    Second, there are a lot of people who have dairy cows or 
other small businesses who benefit because of the tax treatment 
of their investment in small businesses. And finally, which is 
also very, very important, as Dr. Wyss pointed out, the average 
American benefits from the higher productivity of a lower tax 
on capital. Finally, Mr. English, unfortunately, I do not have 
any personal knowledge of dairy cows, but I did read in the 
paper the other day about a painter who said that he supported 
a capital gains tax cut because he had never been hired by a 
poor person. And so, I think both directly, in terms of what 
they own, or indirectly, because of its economic impact, all 
Americans benefit from a lower tax on capital or capital gains.
    Mr. English. Thank you. One final question I would like to 
pose to the entire panel, and it has to do with the fact that 
we are contemplating with limited revenue opportunity, perhaps, 
a capital gains reduction this year as part of an overall tax 
package. I wonder, starting again with Mr. Wiggans, in summary, 
in your view, What are the most important issues for the 
Committee to keep in mind in designing a capital gains 
reduction?
    Mr. Wiggans. I guess I would answer it two ways. I think 
the macroeconomic data on the productivity and the job creation 
and the benefits of a broad capital gains tax is clearly one 
set of issues. I would then focus on the specific issues 
associated with the capital required to fund small, emerging 
companies; the technology generated, and the innovation in 
those small companies; the new therapies, life-saving therapies 
in many cases, is the second category.
    So, clearly, there are macroeconomic benefits. I think 
those situations at least here seem to be well documented. The 
targeted gains for emerging companies where the innovation 
occurs, where biotechnology companies bring new therapies 
forward, there is also the human element of that, the very real 
human element of that in addition to the economic benefit.
    Mr. English. Mr. Woodbury, which issues would you like us 
to keep in the front of our minds as we consider capital gains 
tax reduction?
    Mr. Woodbury. As I said in my testimony, we feel there are 
two basic criteria. One is that, besides the principal 
residence proposal, which we think is a separate issue and is a 
simplification issue more than anything else, we believe the 
capital gains reduction should be broad based and apply equally 
to all industries and then, let the private sector determine, 
based on a risk-reward basis, where to put that capital. It 
should also have enough differential between the ordinary 
income tax rate to provide an incentive, and I think several of 
the bills, H.R. 14, the 50-percent reduction, is a broad enough 
basis to provide that, and those are the two criteria.
    Mr. English. Thank you, Mr. Woodbury.
    Dr. Wyss, what issues should we keep first and foremost?
    Mr. Wyss. Well, first of all, I am very much in favor of 
keeping the tax law simple. Getting rid of the capital gains on 
housing as much as possible is a good step in that direction, 
since that is a complication which yields no revenue. But on 
the rest of the capital gains, I would also tend to echo the 
same sentiments of the previous speaker: Keep it simple by 
keeping the same rate across the board, and let the market 
decide where the money should go rather than to try to target 
capital gains in a way that favors one sector over another.
    Mr. English. Ms. Gravelle.
    Ms. Gravelle. Well, I do think one thing the Committee 
ought to be very careful about is to pay attention to the 
revenue costs of these proposals. As I indicated at the 
beginning and ending of my testimony, the Joint Tax Committee 
already includes a very generous dynamic offset for capital 
gains, and there has been some recent evidence that suggests 
that even that offset may actually be too large. And if we add 
to the deficit, I think we are doing it in a way that is very 
costly for savings.
    The other important thing is to keep track of the cost over 
time, because even though you might have a realizations 
response or possibly even an asset response, that is a 
transitory effect, and these provisions will likely cost much 
more revenue in the future. I think it is very important to 
have a longtime horizon; look out beyond 5 years and to try to 
think about the future. That is particularly true if you talk 
about prospective capital gains tax cuts, such as indexing or 
exclusions for any new assets that tend to grow very fast.
    So, I think the revenue issue, as we all know, is a very 
important one to pay attention to, and I think there are lots 
of issues. There are issues of equity, efficiency, and 
simplicity. But I do urge you to not forget about simplicity 
along the way and, in particular, the efforts of some kinds of 
tax changes. For example, indexing would be much more 
complicated than an exclusion in terms of tax compliance. I 
think those are issues that tend to get swept aside sometimes, 
and they are sort of important to remember.
    Mr. English. Thank you.
    Mr. Bloomfield.
    Mr. Bloomfield. Mr. Chairman, let me suggest three areas 
that you ought to look at to make sure or to increase the odds 
that you will enact a sensible capital gains tax cut. The first 
issue is one of being fiscally responsible, and I do not think 
there is any doubt, none of us here or none of those on this 
Committee would want to do anything that would be fiscally 
irresponsible. I think David Wyss and others have indicated 
that this is one of those few tax cuts that is a free lunch.
    I would point out, with some disagreement with Ms. 
Gravelle, it is true that the Joint Committee does take into 
account the unlocking factor. It takes into account the 
reclassification of income from ordinary into capital gains. 
But it does not take into account the macroeconomic impact of a 
higher GDP, nor does it take into account the impact of higher 
asset values. If you look at a mainstream economic model like 
Alan Sinai's or DRI--take, for example, the Hatch-Lieberman 
bill--what you would find is a revenue gain in the range of 
between $8 billion under David Wyss' analysis and up to $40 
billion under Alan Sinai's.
    So, I think you need to look at that, and I think that is a 
fair way to look at capital gains. You need to be revenue 
responsible. I do not think you are going to lose money, and 
you might pick up money.
    Second, I think you need to be fair, and by being fair, I 
do not think you should favor one asset over another. I would 
encourage you to make sure the dairy cows of your congressional 
district are eligible assets, as well as the new biotech 
developments in Silicon Valley.
    And finally, a proposal needs to make economic sense, and 
to do so, it needs to meet only four criteria: You should 
reduce the capital costs, encourage the mobility of capital, 
prevent the taxation of inflationary gains, and you ought to 
encourage entrepreneurship. If you meet those four criteria, 
you are doing something worthwhile. I would caution, however, 
if you do not meet those criteria, or the tax cut is so small 
it is negligible, a capital gains tax cut in name may not be 
worth much in reality.
    Mr. English. Thank you, Mr. Bloomfield, and I want to thank 
the entire panel for providing this very enlightening, diverse, 
and extremely--in each case--thoughtful testimony. I 
appreciate, really, the responses you provided, because I think 
they point the way for this Committee to make some significant 
changes, hopefully this year, in the Tax Code that will create 
new incentives for investment back into the economy and 
hopefully unlock assets that could be more productively used 
elsewhere.
    In my view, this is a very important issue, and we very 
much appreciate the contribution this panel has made to our 
deliberations. With that, without objection, I am going to 
recess the panel until 1:05 p.m.
    Thank you.
    [Whereupon, at 12:32 p.m., the Committee recessed, to 
reconvene at 1:05 p.m., the same day.]
    Chairman Archer [presiding]. The Committee will come to 
order.
    The Chair apologizes to our witnesses for being 5 minutes 
late, but hopefully, that is good enough for government work.
    We are happy to have you with us today, and we look forward 
to the testimony from each one of you.
    Mr. Whelan, would you lead off, identify yourself for the 
record----
    Mr. Whelan. Yes, sir.
    Chairman Archer [continuing]. And then you may proceed.
    Hopefully, all of you will limit your oral testimony to 5 
minutes, and your entire printed statement will be inserted in 
the record.

STATEMENT OF MARTIN J. WHELAN, PRESIDENT, ETTLINE FOODS CORP., 
      YORK, PENNSYLVANIA; ON BEHALF OF FOOD DISTRIBUTORS 
             INTERNATIONAL, FALLS CHURCH, VIRGINIA

    Mr. Whelan. Good afternoon, Mr. Chairman and Members of the 
Committee. I am Martin Whelan, president of Ettline Foods 
Corp., a privately owned distributor of food service products 
located in York, Pennsylvania's, 19th District, and a member of 
Food Distributors International.
    At the request of the Committee, I will limit my testimony 
to a few short minutes. Food Distributors International has 
provided the Committee with my written comments, which we would 
like to appear in the official record of this hearing.
    Mr. Chairman, I am very pleased to have the opportunity to 
appear before you today to discuss estate taxes which the food 
distribution industry prefers to call death taxes. I commend 
you for holding these hearings on this very important subject 
matter.
    You may recall that one of my colleagues in the food 
distribution industry, William Eacho, had the opportunity to 
testify before this Committee during the 104th Congress on the 
same issue, and our message remains the same: The tax should be 
repealed.
    Ettline Foods Corp. is a privately owned distributor of 
food service products. Ettline was founded in 1889 by Oscar 
Ettline and was at that time a general store whose customers 
were farmers and local people. Today, 109 years later, the 
company is a broad-line food service distributor, serving over 
1,300 customers in three States. Our customers are restaurants, 
institutional food service users, and grocery and convenience 
stores.
    Over the years, Ettline has remained a family owned and 
operated company. My family purchased the company 8 years ago, 
following the retirement of Doyle Ankrum, and we became the 
fourth family to own this business. When I purchased Ettline in 
1989, the company employed 48 people. I am very proud to say 
today, we employ 105 people.
    My family has reinvested all of our aftertax profits into 
facilities, equipment, and working capital. Additionally, I 
have chosen to limit my compensation in order to support the 
growth of the business. Over the past 2 years, we have invested 
approximately $4.5 million in additional capital, and as a 
result of all these efforts, we have more than doubled the 
sales volume of our business and added more than 20 full-time 
employees to our payroll.
    Mr. Chairman, there is a very personal reason for my being 
interested in the death tax issue. I have a terminal illness 
that mandates constant planning for the managerial succession 
of my business and the financial security of my family after my 
death.
    As a result, I spend several thousand dollars each year to 
keep on retainer an estate tax lawyer and a tax accountant who 
assist in keeping me abreast of any changes in tax regulations, 
as well as reviewing changes in my company's assets.
    I cannot help but feel that this is a nonproductive use of 
assets. It could be used to continue to grow the business and 
create more jobs in York. Estate planning is a time-consuming 
and expensive process. However, in my case, it is a very 
necessary process.
    Yet, when all is said and done, I still worry knowing that, 
after all this money and effort, the continuity of my family's 
business continues to be at risk.
    I have four children, three of whom are still in college. 
One of my children has expressed an interest in working in the 
family business, and I want to ensure that if my daughter so 
chooses, she inherits a financially sound company.
    If at my death Congress has yet to act on this issue, my 
company's capital structure may very well be impaired, causing 
at best the stagnation of Ettline, and at worst, the demise of 
my family business and the loss of a significant number of 
jobs.
    Privately held independent businesses are the backbone of 
our free enterprise system. Small businesses, which for the 
most part are family owned, are where two-thirds of all new 
American jobs are currently being created.
    Therefore, it is ironic to me that the Federal Government 
would penalize family owned businesses with an unfair and 
confiscatory tax. If small businesses are so important to the 
growth of this Nation, then companies such as mine should be on 
a level playingfield with larger public companies that are not 
subject to estate or death tax burdens.
    President Clinton in his budget proposal provides estate 
and gift tax relief. However, in my opinion, his proposal falls 
short of ensuring that privately held family owned businesses, 
such as my own, will be able to survive being passed on to 
future generations.
    Earlier during this hearing, we heard arguments for 
reducing the capital gains tax rate. While the food 
distribution industry certainly supports reducing the capital 
gains tax rate, we point out that there is an even greater 
justification for lowering the death tax rate. I say that 
because capital gains are realized through the voluntary sale 
of a business or other asset. Whereas, estate transfers are the 
result of a death, which is involuntary.
    I am not a wealthy man. I sit before you today, a humble 
man from York. In my business, the days are long, the work is 
hard, the profits are slim.
    When I bought my company 8 years ago, I also bought a piece 
of the American dream. I would like to think I represent what 
is still good about this country of ours, the spirit of 
entrepreneurship and hard work. With the low profit margins in 
our industry, Ettline is simply not liquid enough to be able to 
pay this burdensome tax. At a top tax rate of 55 percent, my 
family and many others would simply be unable to maintain the 
continuity of the business.
    With the small amount of revenue that is generated by the 
tax, the economic devastation hardly seems worth it. The death 
tax costs the government and taxpayers almost as much in 
administrative and compliance fees as it raises in revenue.
    I am not only concerned for the well-being of Ettline and 
our employees, but also the hundreds of family owned 
restaurants and mom-and-pop grocery and convenience stores who 
are my customers. I would be remiss if I did not commend those 
lawmakers here in the House who have introduced legislation to 
repeal the Federal death tax.
    The food distribution industry applauds their tough stand 
against this onerous tax. It is my understanding that Members 
of this Committee are working together to craft bipartisan 
legislation that provides significant relief from death taxes 
by using a three-pronged approach: Increasing the unified 
credit, providing a special family business carve-out, and 
reducing the estate tax rates. Of these three approaches, it is 
obvious that rate reduction is the only true and viable 
approach that is on the path to full repeal.
    Therefore, short of repeal, the food distribution industry 
strongly urges this Committee to rally its support around this 
type of approach. I strongly believe it is incumbent upon this 
Congress to enact meaningful death tax relief legislation this 
year. To do otherwise is simply unconscionable. However, by 
doing so, this Congress would be sending a message to the 
American people that recognizes the importance of family owned 
business and the contributions that they make to this great 
Nation.
    The future of Ettline's employees and the millions of 
employees of other family owned businesses rest in your hands.
    Thank you for having me here, and I look forward to 
answering your questions.
    [The prepared statement and attachment follow:]

Statement of Martin J. Whelan, President, Ettline Foods Corp., York, 
Pennsylvania; On Behalf of Food Distributors International, Falls 
Church, Virginia

                              Introduction

    Good morning, Mr. Chairman and members of the Committee, I 
am Martin J. Whelan, President of Ettline Foods Corporation and 
a member of Food Distributors International. I am very pleased 
to have the opportunity to appear before you today to discuss 
estate taxes, which the food distribution industry prefers to 
call death taxes.
    I commend you, Mr. Chairman, for holding these hearings on 
death taxes, as well as the other savings and investment 
provisions included in the Clinton Administration's Fiscal Year 
1998 budget proposal. You may recall that one of my colleagues 
in the food distribution industry, William Eacho, III, had the 
opportunity to testify before this Committee last Spring, 
during the 104th Congress, on the same issue. Our message 
remains the same--the death tax should be repealed.

             Background on Food Distributors International

    Food Distributors International (FDI), the group that 
represents the interests of Ettline Foods Corporation in 
Washington, DC, is an international trade association comprised 
of food distribution companies which primarily supply and 
service independent grocers and foodservice operations 
throughout the United States, Canada and more than 20 other 
countries. FDI's 266 member companies operate 1139 distribution 
centers with a combined annual sales volume of $142 billion. 
Their members employ a work force of over 350,000 and, in 
combination with their independently owned customer firms, 
provide employment for several million more people.
    Roughly 30 percent of FDI's members are small, privately 
held family-owned businesses. They provide employment for over 
22,000 people, and have a combined annual sales volume of over 
$7.5 billion. These businesses, along with FDI's other member 
companies, supply and service thousands of family-owned grocery 
stores and restaurants across the country.
    FDI is also a member of the Family Business Estate Tax 
Coalition, which is made up of approximately 100 organizations 
who support the elimination of the estate tax. I have attached 
an ad on the death tax that FDI placed in the March 3rd edition 
of The Washington Times.

                Background on Ettline Foods Corporation

    Ettline Foods Corporation is a privately owned distributor 
of foodservice products, located in York, Pennsylvania. Ettline 
was founded in 1889 by Oscar Ettline, and was at that time a 
general store whose customers were farmers and local people. 
Today, 109 years later, the company is a broadline foodservice 
distributor serving over 1,300 customers in three states. Our 
customers are restaurants, institutional foodservice users, and 
grocery and convenience stores.
    Over the years, Ettline has remained a family-owned and 
operated company. The Whelan family purchased the company 8 
years ago, following the retirment of Doyle Ankrum, and became 
the fourth family to own the business. When I purchased Ettline 
in 1989, the company employed 48 individuals. I am proud to say 
that today we employ 105 people.
    My family has reinvested all of the after-tax profits into 
facilities, equipment, and working capital. Additionally, I 
have chosen to limit my compensation in order to support the 
growth of the business. Over the past two years, we have 
invested approximately $4.5 million in additional capital and, 
as a result of all of these efforts, have more than doubled the 
sales volume of our business and added more than 20 full-time 
employees to our payroll.
    Ettline's number one goal for 1997 is to give all of its 
employees the opportunity to exercise their skills, and to 
provide training and continuing education so that they are able 
to advance their careers. At Ettline, we strive to create a 
family-oriented environment, by holding such annual activities 
as an Easter egg hunt, a company-wide picnic, and an end-of-
the-year holiday party. All of our employees are encouraged to 
bring their entire families and to participate in these events.
    At Ettline, we also believe it is important to give 
something back to the community that has supported our business 
over the years. Therefore, we encourage our employees to become 
involved in community-based activities. Of the many things that 
Ettline quietly does within the community, I would like to 
mention that each week my company contributes its excess 
inventory to the York City Food Bank. I am also a board member 
of Our Daily Bread, a soup kitchen located in York.

                  The Need for Estate/Death Tax Relief

    Mr. Chairman, there is a very personal reason for my being 
interested in the death tax issue. I have a terminal illness 
that mandates constant planning for the managerial succession 
of my business, and the financial security of my family after 
my death. As a result, I spend several thousand dollars each 
year to keep on retainer an estate tax lawyer and a tax 
accountant, who assist in keeping me abreast of any changes in 
tax regulations, as well as reviewing changes in my company's 
assets.
    I cannot help but feel that this is a non-productive use of 
assets that could be used to continue to grow my business and 
create more jobs in York. Estate planning is a time-consuming 
and expensive, but--in my case--necessary process. Yet, when 
all is said and done, I still worry knowing that all of this 
prudent planning will not alleviate my heirs of a heavy tax 
burden, and that the continuity of my family's business is at 
risk.
    I have four children--ages 25, 22, 21 and 20, three of whom 
are still in college. One of these four children has expressed 
an interest in working in the family business, and I want to 
ensure that, if my daughter so chooses, she inherits a 
financially sound company.
    Unfortunately, if we do not act now to provide family-owned 
businesses substantive relief from the death tax, my daughter 
just might be unable to move our company forward in the next 
millineum. If, at my death, Congress has yet to act on this 
issue, my company's capital structure may very well be 
impaired, causing, at best, the stagnation of Ettline and at 
worst the demise of my family business and the loss of a 
significant number of jobs.
    We continue to hear that privately held, independent 
businesses are the backbone of our free enterprise system. 
Small businesses, which for the most part are family-owned, 
comprise 99 percent of the private sector, employ 60 percent of 
all working Americans, and are responsible for 50 percent of 
gross domestic product and 30 percent of U.S. exports. Finally, 
these small businesses are where two-thirds of all new American 
jobs are currently being created.
    Therefore, it is ironic to me that the federal government 
would penalize family-owned businesses with this unfair, 
confiscatory tax. It would seem to me that if small businesses 
are so important to the growth of this nation, then companies 
such as mine should be on a level playing field with larger 
public concerns--companies that are not subject to estate/death 
tax burdens.
    According to a letter Senator Phil Gramm sent to an FDI 
member, unless we achieve significant changes in the estate tax 
law, this nation ``will be put in the position where virtually 
every family farm and every family business would have to be 
sold or severely penalized to pay taxes on wealth that has been 
built up over the years with after-tax income.'' \1\
---------------------------------------------------------------------------
    \1\ Letter from Senator Gramm to member of Food Distributors 
International.
---------------------------------------------------------------------------

            The Disincentive Effects of the Estate/Death Tax

    Mr. Chairman, the food distribution industry agrees with 
your statement--in announcing these hearings--that an overhaul 
of the current tax system would provide ``a more lasting way to 
encourage savings and investment and produce a stronger 
economy, and that until that goal can be reached, we should 
enact changes to our tax system that reduce disincentives to 
save and invest.'' I am glad we agree that the death tax 
provides such a disincentive.
    President Clinton, in his Fiscal Year 1998 budget proposal, 
provides estate and gift tax relief by increasing the amount of 
property eligible for a favorable interest rate on deferred 
estate tax, and eliminating certain distinctions based on form 
of ownership. In my opinion, the President's proposal falls 
short of ensuring that privately held/family-owned businesses, 
such as mine, will be able to survive being passed on to future 
generations.
    I was raised to believe that hard work would be rewarded. 
How can--in good faith--instill that same message in my 
children, when I know that upon my death the government will, 
in effect, confiscate the value of my lifetime of work? Is that 
how I am to be rewarded? Is that really the message this 
Congress wants to send to America's aspiring entrepreneurs? 
Believe me, I am not searching for a ``hand out,'' I just want 
the ability to pass down to my heirs--unencumbered--what is 
rightfully theirs.
    Earlier during this hearing, we heard arguments for 
reducing the capital gains tax rate. And while the food 
distribution industry certainly supports reducing the capital 
gains tax rate, we point out that there is an even greater 
justification for lowering the death tax rate. I say that 
because capital gains are realized through the voluntary sale 
of a business or other asset, whereas estate transfers are a 
result of death, which is involuntary. Simply put, Mr. 
Chairman, death taxes steal from America's family-owned 
businesses.

            Impact of Estate/Death Taxes on Small Businesses

    Since last year, I believe we have made significant headway 
in dispelling the notion that death taxes affect only the 
wealthy. We cannot afford to let demagoguery and class warfare 
overshadow the merits of reducing a tax that kills. This issue 
is far too important to succomb to those sorts of attacks.
    I am not a wealthy man. I sit here before you today a 
humble man from York. In my business, the days are long, the 
work is hard, and the profits are slim. When I bought my 
company 8 years ago, I also bought a piece of the American 
dream. I would like to think that I represent what is still 
good about this country of ours--the spirit of entrepreneurship 
and hard work.
    The food distribution industry as a whole is not a 
particularly ``wealthy'' industry. It is important to note that 
in 1995, profits before tax as a percent of sales for 
foodservice distributors were only 2.2 percent--the highest 
level since 1987. This measure for wholesale grocers was 1.3 
percent--down from 1.6 percent in 1994.\2\ Similarly, the 
profit margin in the restaurant and grocery business is also 
narrow.
---------------------------------------------------------------------------
    \2\ 1996 Distributor Productivity Financial Report Falls Church, 
VA: Food Distributors International, 1996
---------------------------------------------------------------------------
    Again, as I stated earlier, my family has invested all of 
its after-tax profits into facilities, equipment, and working 
capital. It is commonplace for companies such as mine to 
reinvest their profits into the business, in order to grow that 
business. Most small businesses would be unable to survive 
without the reinvestment of profits.
    Therefore, it should become painfully clear that businesses 
such as Ettline are simply not liquid enough to be able to pay 
this burdensome tax. At a top tax rate of 55 percent, my 
family--and many others--would simply be unable to maintain the 
continuity of the business.
    For the small amount of revenue generated by the death tax 
(approximately one percent of all federal revenues), the 
economic devastation hardly seems worth it. Furthermore, the 
death tax costs the government and taxpayers almost as much in 
administrative and compliance fees as it raises in revenue. To 
be more precise, these fees account for 65 percent of every 
dollar collected.
    I would like to make it clear that I am not only concerned 
for the well-being of Ettline and our employees, but also the 
hundreds of family-owned restaurants and grocery and 
convenience stores who are my customers. These businesses rely 
upon Ettline to supply their needs, and their customers--the 
American people--rely on them for the food they eat everyday.

                               Conclusion

    I would be remiss if I did not commend Representatives 
Christopher Cox, Phil Crane, Wally Herger, Amo Houghton, Kenny 
Hulshof, Bob Livingston, Mike Pappas, Joseph Pitts, Gerald 
Solomon, Bob Stump, William Thomas, and William Thornberry \3\ 
for sponsoring legislation to repeal the federal death tax. The 
food distribution industry applauds their tough stand against 
this onerous tax.
---------------------------------------------------------------------------
    \3\ Various Estate/Gift Tax Legislation Introduced in the 105th 
Congress by the following Members of the U.S. House of Representatives: 
Representative Cox (R-CA)--H.R.902 Representative Crane (R-IL)--H.R.525 
Representative Herger (R-CA)--H.R. 64 Representative Houghton (R-NY)--
H.R. 195 Representative Hulshof (R-MO)--H.R. 525 Representative 
Livingston (R-LA)--H.R. 683 Representative Pappas (R-NJ)--H.R. 245 
Representative Pitts (R-PA)--H.R. 249 Representative Solomon (R-NY)--
H.R. 324 Representative Stump (R-AZ)--H.R. 348 and H.R. 736 
Representative Thomas (R-CA)--H.R.495 Representative Thornberry (R-
TX)--H.R. 802.
---------------------------------------------------------------------------
    It is my understanding that members of this Committee are 
working together to craft bipartisan legislation that provides 
significant relief from death taxes by using a three-pronged 
approach: increasing the unified credit, providing a special 
family-business carve-out, and reducing the estate tax rates. 
Of these three approaches, it is obvious that rate reduction is 
the only true, viable approach that is on the path to full 
repeal. Therefore, short of repeal, the food distribution 
industry strongly urges this Committee to rally its support 
around this type of approach.
    As I previously mentioned, a colleague of mine testified on 
this issue during the 104th Congress. On behalf of the food 
distribution industry, he urged lawmakers to enact some form of 
estate tax relief. As all of you are aware, that did not 
happen. It would be a shame if we let another year go by 
without addressing this problem.
    Again, short of repeal, I strongly believe it is incumbent 
upon this Congress to enact meaningful death tax relief 
legislation this year--to do otherwise is simply 
unconscionable. However, by doing so, this Congress would be 
sending a message to the American people that it recognizes the 
importance of family-owned businesses and the contributions 
that they make to this great Nation.
    The future of Ettline's employees and the millions of 
employees of other family-owned businesses rests in your hands.
    Thank you for having me. I look forward to answering your 
questions.
      

                                

[GRAPHIC] [TIFF OMITTED] T8616.023

      

                                

    Chairman Archer. Thank you, Mr. Whelan.
    Our next witness is Dan Danner. If you will identify 
yourself for the record, we will be pleased to have your 
testimony.

  STATEMENT OF DAN DANNER, VICE PRESIDENT, FEDERAL GOVERNMENT 
     RELATIONS, NATIONAL FEDERATION OF INDEPENDENT BUSINESS

    Mr. Danner. Thank you, Mr. Chairman.
    For the record, I am Dan Danner, vice president of Federal 
Government relations for NFIB, the National Federation of 
Independent Business.
    NFIB represents 600,000 small businessowners in all 50 
States. We thank you for the opportunity to testify here today. 
I will submit longer testimony, but in the brief time I have 
here, I would like to leave you with three points. First, 
providing small businessowners relief from the death tax is 
NFIB's top legislative priority. Second, the proposal in the 
President's budget is well intentioned but does not go far 
enough. Third, we encourage Congress to go well beyond the 
President's proposal in this Congress.
    Providing relief now is our top priority. Today, the death 
tax represents a huge disincentive for growth for family 
businesses. It means lost opportunities, lower productivity, 
and fewer jobs. Nearly 60 percent of businessowners report they 
would add more jobs in the year ahead if death taxes were 
eliminated. Three out of four family businessowners report that 
long-term growth is made significantly more difficult or 
impossible by the death tax.
    For those that do attempt to plan well for death taxes, the 
costs are staggering and often result in cash flow problems and 
ultimately failure. All of this is why elimination of the death 
tax was the number four recommendation out of 60 adopted by 
President Clinton's White House Conference on Small Business, 
but all of these are just numbers.
    Let me mention just two of the many NFIB member stories. 
Clarence Tart is the owner of a fourth generation farming and 
lumber business in Dunn, North Carolina. Tart & Tart employs 70 
people. He wonders why his family will have to buy back the 
business from the Federal Government for the fourth time and 
how his son will ever afford the estimated $1.5 million tax 
without eliminating many of the jobs when his son's salary is 
only $30,000 a year.
    Wayne Williams runs a business that makes fiberoptic 
equipment in Spokane, Washington. His parents started the 
business over 15 years ago with nothing and have grown the 
business to over 500 employees. Williams, who fights along with 
his parents to remain competitive against Japanese and German 
rivals, wonders how the astronautical cost of his legal and 
life insurance fees benefits this country when he sees the 
beneficiaries as his foreign competitors.
    And how do we help these families? The President's proposal 
does not go far enough. The President's proposal to modify the 
existing 14-year loan program by lowering the interest rate for 
closely held businesses is a very small Band-Aid for a very 
large problem.
    Small businesses will still be left with massive debt and 
huge cash flow problems to pay the death taxes of up to 55 
percent.
    With the children in a family business who are struggling 
to buy back half of their own business from the Government, 
this proposal is like throwing a life raft to a sinking ship 
after shooting a hole in its bow. It still results in lower 
productivity and often failure of the business. That is why 
family businesses are becoming an endangered species. More than 
70 percent do not survive the second generation, and 87 percent 
do not make it to the third generation. Death taxes are 
increasingly becoming a death sentence for their businesses.
    Finally, Congress should address the death tax in a 
significant way in this Congress. Certainly, our first choice 
would be elimination of the death tax. It is the fairest and 
the simplest method. A tax doesn't make sense, and we should 
eliminate it.
    Short of repeal, we want the most relief possible for 
family businesses, farmers, and ranchers in this Congress. We 
need to at least begin the transition toward eliminating the 
death tax in a meaningful way. Short of repeal, we support 
increasing the unified credit and reducing death tax rates. We 
further propose that the value of a closely held business, 
farm, or ranch, should be exempted from death taxes altogether.
    Mr. Chairman, on behalf of the NFIB's 600,000 members, I 
want to thank you again for the opportunity to testify. There 
isn't any issue that NFIB members feel stronger about than the 
death tax and the devastating impact it has on their 
businesses, the jobs they provide, and the communities they 
support.
    We urge you and the Committee to take real steps now toward 
elimination of the death tax on family businesses, and we urge 
the President to consider expanding on his proposal to provide 
real relief now.
    Thank you, and I look forward to your questions.
    [The prepared statement follows:]

Statement of Dan Danner, Vice President, Federal Governmental 
Relations, National Federation of Independent Business

    The National Federation of Independent Business appreciates 
the opportunity to testify on the Administration's 1998 Budget 
Proposal, and, specifically, the issue of federal death taxes 
and their impact on small businesses. NFIB is the nation's 
largest small business organization representing 600,000 small 
business owners from all fifty states. NFIB sets its public 
policy positions through regular polling of the membership.
    The process the Committee and the Congress is now engaged 
in presents an historic opportunity to relieve America's small 
business owners from government-imposed burdens and open the 
door to economic expansion and job creation in the small 
business sector. The federal death tax represents perhaps the 
greatest burden today on our nation's most successful small 
businesses.
    At roughly one percent of annual revenues, this tax is 
hardly worth the devastation it causes to family businesses and 
farms, incentives for entrepreneurship, and our nation's 
international competitiveness. The costs of such damage to 
small businesses and our nation's economy is unquestionably 
high.

        Small Business: America's Path to Jobs and Independence

    Evidence continues to suggest clearly that small business plays a 
rather remarkable role as a job creator and provider of personal 
opportunity, security and independence for millions of Americans. 
Consider the following:
    Jobs. Since the early 1970s, small firms have created two of every 
three net new jobs in this country (created jobs minus lost jobs). The 
nation's small business job machine has shown a capacity to produce in 
either good or tough times. From 1989 to 1991, a period of minimal 
economic growth, firms with fewer than 20 employees created all net new 
jobs in the country. Firms of all other sizes lost employment during 
that period.
    Demographics. Almost all businesses are small businesses. There are 
approximately five and one half million employers in the United States. 
About 99 percent of them are small employers (with under 500 
employees), and almost 90 percent employing fewer than 20 employees. 
Small business as a whole employs more than half of the private sector 
workforce. Most small firms are not set up as C corps, but as 
proprietorships, partnerships, and subchapter's corporations.
    Values. Small business holds out to our citizens' great hope. Small 
business offers a road map to the American dream that allows any 
American with a good idea and talent to follow it to economic freedom 
and security by starting their own business and working hard to make it 
a success. And possibly the ultimate American dream is to be able to 
pass that successful business on to one's children.
    Evidence indicates that the vast majority of America's small 
closely-held businesses are family businesses. Although it is difficult 
to precisely define a family business, there are clear characteristics 
of the family business which distinguish it from others. While other 
businesses are usually driven entirely by return on investment, the 
family business is most often driven first by other priorities--like 
relationships and longevity. Family businesses are generally much 
smaller than publicly-traded corporations, but possess certain 
advantages over these larger businesses. For instance, being private, 
family businesses do not have to worry about quarterly earnings reports 
for stock analysis, and can instead focus on long-term value 
enhancement, even if it means losing money in the short-term in some 
cases. Additionally, family businesses operate without a rigid 
bureaucracy, consequently, they can respond quickly and intuitively to 
changes in business environments. On the other hand, because of 
personal considerations, such as a desire to pass the business on to 
one's children, a family business may not always make purely rational 
decisions in a market-driven sense. Family businesses play a far 
greater role in this nation's economy than many might think--estimates 
indicate that they produce roughly half of our nation's gross domestic 
product.

                     The Need for Death Tax Reform

    NFIB considers death tax reform to be crucial to the continued 
survival of the small American family business. Current death tax rates 
cripple a small business passed on to heirs, and often force them to 
liquidate a business they have worked in their whole lives. High death 
taxes may provide government revenue in the short run, but the long-run 
losses far outweigh the gains--a productive business is extinguished, 
many jobs are lost, and the American dream of growing a business and 
preserving it beyond one's lifetime by passing it on to heirs becomes 
impossible to achieve.
    Because all assets are included in determining death taxes, such as 
the decedent's home and other personal assets, many productive 
businesses worth far less than the current exemption level become 
victims of the death tax. Because so many small businesses operate on 
cash flow, often with extremely small or negative profit margins, 
current law allowing small businesses to spread their tax liability 
over fourteen years does not provide adequate relief. The 1995 White 
House Conference on Small Business voted death taxes as the fourth 
greatest problem to small business needing reform.
    Small businesses are also particularly vulnerable to the 
intricacies of death tax law. Although some owners can ensure a 
successful transfer to heirs by purchasing life insurance and through 
other methods, many cannot afford this kind of planning or do not have 
the time to meet with estate planners because most of their energies 
are directed toward keeping the business running. Unfortunately, unlike 
a publicly traded corporation, which continues operation regardless of 
how shareholders plan for their death, a closely held business, unless 
there has been careful planning, is usually devastated by the death of 
an owner.

                        Impact on Small Business

    Current death tax rates range from 37 to 55 percent. Faced with the 
tremendous burden imposed by this tax upon their death, a business 
owner will react in several of the following ways:
    The business owner will not expand the business. Especially in 
later years of the business owner's life, large capital expenditures 
for long term growth make little sense when the family will soon be 
forced to sell or liquidate the business. This disincentive to growth 
means lost opportunities, lower productivity, and lost jobs. In fact, 
the existence of death taxes can deter many potential entrepreneurs 
from starting a business at all.
    2) The children will not participate in the business. Knowing that 
taxes will prevent children from continuing operation of a family 
business, the business owner will often discourage their children from 
working in the business and encourage them to gain experience 
elsewhere. If the children do actively participate in the business, 
their experience and knowledge will often go to waste when the business 
is forced to be sold off. A survey of family businesses by Mass Mutual 
Life Insurance showed that in 1995 only 57 percent of owners planned on 
keeping the business in the family, down from 65 percent a year prior; 
taxes were cited as one of the prime reasons for plans to sell out.
    3) The business owner will pay dearly in death planning costs. Even 
if the business owner has the foresight to plan early for their death, 
the expense of this planning, in insurance, legal and accounting costs, 
can be enough to eliminate a business' small profit margin. These extra 
insurance, legal and accounting costs are especially burdensome because 
small businesses survive on cash flow, not profit. In an NFIB survey of 
Small Business Problems and Priorities of NFIB members, cash flow 
ranked as one of the top ten highest problems for small business. 
Coming up with the cash to pay bills and make payroll is a constant 
challenge in a small firm. Money left in the business--cash flow--is 
the difference between life and death for most new businesses. The 
costs to small business and society as a whole are high--instead of 
using these funds to expand, create new jobs, and become more 
productive and competitive in the international marketplace, small 
businesses must spend the money on death planning costs.
    4) Heirs may not be able to afford tax payments.Despite some 
planning, heirs are often still imposed with some significant tax 
burden. Even paid out over time, taxes may be too much of a burden to 
survive in an internationally competitive marketplace.

                    Fire-Sale of the Family Business

    What this means is that all too often the family business is sold-
off, either before the owner's death or by the estate. Most often, a 
ready market does not exist for the sale of a small family run 
business. Consequently, the business is subject to a fire-sale--either 
liquidated entirely or sold intact for a price far below its true 
value. Additionally, much of the value of a family business often comes 
from the experience and know-how of those who run it--the family 
members. Their stewardship often makes the difference between a 
profitable, successful business enterprise, and a dying one.
    All too often, the family business or farm will be bought-up by a 
large business such as a corporate conglomerate, at a price that's a 
fraction of the real value of the business. While the large business 
may gain some of the assets of the small business, most of the real 
value of the former business is lost--the entrepreneurial spirit, know-
how and ingenuity, the small business' flexibility, and, usually, most 
if not all of the jobs. What might have become an Apple Computer 
instead becomes another division of a large cash register sales 
company.
    Contrast this with what happens when a shareholder in a corporation 
traded on the New York Stock Exchange dies. Because there is a ready 
market for the stock, the estate can easily sell off enough to pay 
taxes. The value of that stock does not decline because of the death. 
Although the stock may have new owners, the operation of the 
corporation continues completely unaffected by the shareholder's death.

           Public Policy Reasons for the Death (Estate) Tax?

    The philosophy behind the death tax started with early Americans 
who were trying to prevent the pooling of too much wealth in too few 
families, as had occurred in Europe. Today, however, this philosophy is 
fundamentally flawed. When applied to closely-held business assets, 
ironically, the tax produces just the opposite result--often forcing 
family-owned businesses to sell-off to larger public corporations, 
further concentrating the wealth and power of this country, and 
encouraging monopolistic controls on markets. This philosophy also 
ignores the tax's impact on communities that are dependent on these 
businesses, and its deleterious impact on our nation's international 
competitiveness against foreign countries like Japan and Germany who do 
not impose this kind of death tax burden, and who encourage the 
continuation of family-run enterprises.

             The Administration's Death Tax Reform Proposal

    NFIB appreciates the President's acknowledgment, through his 
proposal to expand the Section 6166 loan program, that family 
businesses need relief from death taxes. What our members tell us, 
however, is that loans to pay exorbitant death taxes do not deliver the 
kind of relief needed.
    The President's proposal would modify existing law, which allows 
death taxes to be paid over up to a 14 year period and grants a four 
percent interest rate for taxes attributable up to $1 million of a 
qualified closely held business. The 1998 Budget Proposal drops the 
interest rate to 2 percent and raises the attributable amount to $2.5 
million, but would make the interest paid on the 14 year loan non-
deductible against income taxes. Unfortunately, for the children in a 
family business who are struggling to buy back half of their own 
business from the government, this proposal is like throwing a life 
raft to a sinking ship after shooting a hole in its bow.
    We urge the President to work with the Congress to significantly 
enhance the relief from this tax for America's employers and employees. 
We believe that this tax should be eliminated altogether. If budget 
constraints do not allow for that to happen right away, however, it is 
important to emphasize that America's family businesses and the people 
they employ need relief from this confiscatory tax now. To this end, 
short of repealing the tax we have supported increasing the unified 
credit and reducing death tax rates. We further propose that the value 
of a closely-held family business, farm or ranch be exempted from death 
taxes altogether.
    Exempting closely-held business, farm and ranch assets from death 
taxes would ensure that the business will continue and that the jobs of 
its employees will be protected. Moreover, this exemption would 
eliminate the strong disincentive that now exists for business owners 
to continue to develop their business and create jobs as they reach 
their later years in life. A recent study by the Tax Foundation found 
that today's death tax rates have the same disincentive effect on 
entrepreneurs as a doubling of current income tax rates.
    Total federal death tax revenue represents only about $15 billion 
annually. Business assets represent roughly 12 percent of this $15 
billion--about $1.8 billion a year. In other words, for $1.8 billion 
annually, every closely-held farm, ranch, and small business in America 
could be exempt from the federal tax collector's axe.
    By restoring incentives to continue operation of closely-held 
businesses in the family, this proposal would fuel economic growth in 
the sector which produces more than half of our nation's gross domestic 
product. Any loss of revenue by static analysis would likely be more 
than compensated by a greater tax base in the small business sector.

                               Conclusion

    Current death tax rates impose an often overwhelming burden on our 
nation's small family-run businesses. The small amount of revenue this 
tax generates is hardly worth the long term damage impacted on these 
enterprises--in the long run the tax means less economic activity, job 
loss, and prevention of the continuation and fulfillment of the 
American dream of operating one's own business and passing it on to 
one's children.
    Eliminating the death tax for family businesses would remove the 
single greatest government burden imposed upon small family businesses, 
setting national priorities where they should be: encouraging the 
continued operation and expansion of family businesses through 
generations.
      

                                

    Chairman Archer. Thank you, Mr. Danner.
    Our next witness is Wayne Nelson. If you will identify 
yourself for the record, we will be pleased to hear your 
testimony.

    STATEMENT OF WAYNE NELSON, PRESIDENT, COMMUNICATING FOR 
              AGRICULTURE, FERGUS FALLS, MINNESOTA

    Mr. Nelson. Thank you, Mr. Chairman, Members of the 
Committee.
    My name is Wayne Nelson. I am a farmer from Winner, South 
Dakota. I am also president of Communicating for Agriculture, a 
membership association representing farmers, ranchers, and 
rural small business people in all 50 States.
    The estate tax reform is very important to all our members, 
and especially to me. For years, Communicating for Agriculture 
has considered meaningful estate tax reform one of our highest 
priorities. As you well know, heirs wanting to carry on family 
businesses all too often have to sell land or other assets to 
pay for Federal estate taxes.
    To eliminate or reduce the impact of the estate tax, we 
have been an active member of the Family Business Estate Tax 
Coalition for the past 2 years. The coalition represents 
approximately 80 groups representing more than 6 million owners 
of family businesses, including farmers, ranchers, and business 
people. We are very familiar with the various approaches which 
have been put forth during this time.
    Although we salute the President for his initiative in 
addressing the problem, the solution only extends to the amount 
of time heirs have to pay the tax. It doesn't address the basic 
unfairness of the estate tax, which as you know quickly becomes 
confiscatory.
    Delaying the inevitable is not the answer. Repealing or 
implementing broad-based, meaningful reform is desperately 
needed.
    Just as in urban areas, small family owned businesses are 
integral to the health of their local economies. We supply 
jobs. We pay the taxes which support our schools and other 
public services. We provide the opportunities which help 
prevent the flight of our children because they can't find work 
at home. Because our communities are small, every business that 
shuts its doors sends shockwaves through the area.
    We also have to face the issue of age. In my area of South 
Dakota, the average age of our farmers is 59. This generally 
holds true across the Nation where the farm population is 
considerably older than our urban counterparts. What happens 
when this generation is gone? Who will be there to take over 
the job of feeding our Nation and much of the world, if not our 
children?
    The estate tax is a slap in the face to a farmer or small 
business person who devotes every waking hour to building a 
business and paying taxes, only to have their life's work 
severely downsized or in some cases even eliminated because of 
a death tax which quickly reaches 55 percent. It isn't even 
index for inflation.
    Adding insult to injury is that it taxes assets which have 
already been taxed at least once, and in some cases, twice. Our 
system layers taxes on top of taxes so we have the highest cost 
of dying in the world for the farmer and the small business 
person.
    Unfortunately, my own experience is typical. I farmed with 
my father until his death in 1993. He was confident that his 
estate plan was adequate to keep the farm operation going and 
to reduce the estate tax upon his death. Unfortunately, the 
plan proved inadequate, and the estate owed a great more tax 
than what we had prepared for. We had to sell several parcels 
of land to pay the Federal estate taxes.
    As most farmers, my father also had existing debt against 
the land, which meant that more land had to be sold to generate 
enough cash to help pay this tax.
    Consequently, after all this, I consider myself very 
fortunate to be able to continue farming, even if it is on a 
more limited scale. Many farmers and small businesses are not 
so fortunate, and their heirs are forced to cease operations 
after selling assets to pay these estate taxes. The old saying 
that farmers live poor and die rich speaks to the great 
investment we have in the land and the burden of higher values 
in our estates at the death of owner.
    As you know, Congress last addressed the estate tax issue 
in 1981, raising the exemption to $600,000. This might have 
been enough to cover most small- and mid-sized farms and 
ranches. That was then and this is now, and now inflation has 
taken its toll to where $600,000 today is not what it was 15 
years ago.
    In many areas of the country, medium-sized and even smaller 
farms have equity exceeding the $600,000 exemption. Estate 
planning can help limit our tax liability, but is very costly 
and complicated in its own right. Even the best plans are not 
easily changed if circumstances warrant it.
    The added cost of this planning diverts money which should 
be reinvested in capital improvements and job growth. Many 
farmers and small business people look to life insurance to pay 
their estate tax, but this is an expensive option which further 
diverts money which could have been reinvested in the business.
    The irony is that more planning money is spent to prevent 
family businesses from being destroyed by the estate tax than 
is actually collected under the law.
    The impact of the estate tax has prompted bipartisan 
support in Congress to remedy the situation. We appreciate the 
fact that a dozen bills have been introduced in the House and 
eight in the Senate, which address either repealing or 
reforming the estate tax.
    Mr. Chairman, we in Communicating for Agriculture are 
hopeful that Congress and the administration can finally 
address this barrier to America's future prosperity during this 
session. Please correct this misguided tax policy which has 
forced many family farms and businesses to cease operation 
after lifetimes of work, job creation, and support for our 
communities and Nation through the taxes that we have paid. It 
isn't fair to our children. It isn't fair to America.
    Thank you very much, and we look forward to your questions.
    [The prepared statement follows:]

Statement of Wayne Nelson, President, Communicating for Agriculture

    Mr. Chairman and members of the Committee. Thank you for 
asking me to testify today. My name is Wayne Nelson and I am a 
farmer from Winner, South Dakota. I am also President of 
Communicating for Agriculture, a membership association 
representing farmers, ranchers and rural business people in all 
50 states. Estate tax reform is very important to all our 
members and especially to me. For years, Communicating for 
Agriculture has considered meaningful estate tax reform one of 
our highest priorities. As you well know, heirs wanting to 
carry on family businesses all too often have to sell land or 
other assets to pay for Federal estate and state inheritance 
taxes. To eliminate or reduce the impact of the estate tax, we 
have been an active member of the Family Business Estate Tax 
Coalition for the past two years. The Coalition represents 
approximately 80 groups representing more than six million 
owners of family-businesses including farmers, ranchers and 
rural business people. We are very familiar with the various 
approaches which have been put forth during this time. Although 
we salute the President for his initiative in addressing the 
problem, his solution only extends the amount of time heirs 
have to pay the tax. It doesn't address the basic unfairness of 
the estate tax, which as you know quickly becomes confiscatory. 
Delaying the inevitable is not the answer. Repealing or 
implementing broad-based, meaningful reform is desperately 
needed.
    Just as in urban areas, small family-owned businesses are 
integral to the health of their local economies. We supply 
jobs. We pay the taxes which support our schools and other 
public services. We provide the opportunities which help 
prevent the flight of our children because they can't find work 
at home. Because our communities are so small, every business 
that shuts its doors sends shock waves throughout the area.
    We also have to face the issue of age. In my area of South 
Dakota, the average age of our farmers is 59. The generally 
holds true across the nation where the farm population is 
considerably older than our urban counterparts. What happens 
when this generation is gone? Who will be able to take over the 
job of feeding our nation and much of the world if not our 
children. This is not an intellectual exercise for us. It's a 
real issue which we face today.
    The estate tax is a slap in the face to a farmer or small 
business person who devotes every waking hour to building a 
business and paying taxes only to have their life's work 
severely downsized or even eliminated because of a death tax 
which quickly reaches 55%. It isn't even indexed for inflation. 
Adding insult to injury is that it taxes assets which have 
already been taxed at least once and in many cases twice. Our 
system layers taxes on top of taxes so we have the highest cost 
of dying in the world for the farmer and small business person.
    Unfortunately, my own experience is typical. I farmed with 
my father until his death in 1993. He was confident that his 
estate plan was adequate to keep the farm operating and reduce 
the estate taxes due upon his death. Unfortunately, the plan 
proved inadequate and the estate owed a great deal more tax 
than we had prepared for. We had to sell several parcels of 
land to pay the federal estate and state inheritances taxes. As 
most farmers, my father had existing debt against the land 
which meant more land had to be sold to generate enough cash to 
pay this death tax. Consequently, after all this, I consider 
myself very fortunate to be able to continue farming, even if 
it is on a more limited scale. Many farmers and small 
businesses are not so fortunate and their heirs are forced to 
cease operations after selling assets to pay estate and 
inheritance taxes.
    The old saying that ``farmers live poor and die rich'' 
speaks to the great investment we have in the land and the 
burden of higher valued estates at the death of the owner.
    As you know, Congress last addressed the estate tax in 
1981, raising the exemption to $600,000. This was enough to 
cover most small and mid-size farms and ranches. That was then. 
This is now. Inflation has taken its toll. $600,000 today isn't 
what it was 15 years ago. In many areas of the country, medium 
size and even smaller farms have equity exceeding the $600,000 
exemption.
    Estate planning can help limit our tax liability but it is 
very costly and complicated in its own right. My father 
invested in a plan which he thought would work. Even the best 
plans are not easily changed if circumstances warrant. The 
added cost of this planning diverts money which should be 
reinvested in capital improvements and job growth. Many farmers 
and small business people look to life insurance to pay their 
estate tax but this is an expensive option which further 
diverts money which could have been reinvested in the business.
    The irony is that more planning money is being spent to 
prevent family businesses from being destroyed by the estate 
tax than is actually collected under the law. This makes no 
sense at all.
    The impact of the estate tax has prompted bi-partisan 
support in Congress to remedy the situation. We appreciate the 
fact that a dozen bills and have been introduced in the House 
and eight in the Senate which address either repealing or 
reforming the estate tax.
    Mr. Chairman, we in Communicating for Agriculture are 
hopeful that Congress and the Administration can finally 
address this barrier to America's future prosperity during this 
session. Please correct this misguided tax policy which has 
forced many family farms and businesses to cease operation 
after lifetimes of work, job creation and support for our 
communities and nation through the taxes we've paid. It isn't 
fair to our children. It isn't fair to America.
    Thank you.
      

                                

    Chairman Archer. Thank you, Mr. Nelson.
    Our next witness is Harold Apolinsky. Mr. Apolinsky has 
been before the Committee before. We welcome you back again. If 
you will officially identify yourself for the record, we will 
be pleased to receive your testimony.

     STATEMENT OF HAROLD I. APOLINSKY, VICE PRESIDENT FOR 
  LEGISLATION, SMALL BUSINESS COUNCIL OF AMERICA; AND GENERAL 
          COUNSEL, AMERICAN FAMILY BUSINESS INSTITUTE

    Mr. Apolinsky. Thank you, Mr. Chairman.
    Harold Apolinsky. I am an estate tax lawyer from 
Birmingham, Alabama. I present my testimony on behalf of the 
American Family Business Institute and its Committee To 
Preserve the American Family Business and the Small Business 
Council of America. Our groups come together because of our 
desire to help family businesses continue within a family.
    As I mentioned, I am an estate tax lawyer, an estate 
planning lawyer. That is what I have been doing for over 30 
years. I also teach estate planning and estate gift tax at both 
the University of Alabama School of Law and the Cumberland 
School of Law. I have been teaching there for 26 years. Thank 
you for having me back.
    As the Chairman knows, since January 1995, when I first 
came and appeared before the Small Business Committee and urge 
that they repeal this estate tax, I have been trying to put 
myself out of business; close down my estate planning practice. 
I am running into resistance, however, which either reflects a 
love of lawyers, which would be nice, because we don't have 
that back home as much as we should, or a lack of 
understanding. I think there has been a real awakening which 
makes me very proud. In the last 2 years I have a better 
understanding of how this tax works.
    I guess we could not have heard a more chilling discussion 
than what Mr. Whelan just said and how he reviewed the 
situation. You have heard this morning from Mr. Whelan and 
others of the damage this tax does. So I really won't dwell on 
that.
    What I would urge, however, is that--and I believe what 
your Committee does is truly the most important as the 
constitutionally charged Committee for taxation--that you not 
enact again a family business carve-out; that you not enact 
another 2033A as happened in the 1995 Balanced Budget Act. From 
an estate tax perspective, it was good the bill was vetoed. I 
am afraid it would have made people feel they had done 
something really beneficial for family businesses and family 
farms.
    I know people are well meaning. They want family businesses 
and family farms to continue. They understand this tax keeps 
them from continuing. I have tried to work for years with 203A 
which is a farm carve-out that you recall became into the law 
in 1976. It is the underpinning of 2033A they proposed. In 
fact, 2033A, as it was originally introduced and made it 
through the process, incorporates some 12 provisions from the 
farm carve-out, 2032A. I have devoted quite a bit of my written 
testimony to an analysis of 2033A. I would urge that you not 
spend the amount of human capital and resources to work to make 
something like that useful because it will not ever be useful. 
It just will not be useful, irrespective of the changes made.
    When proposed 2032A was first introduced, one national 
accounting firm estimated it would benefit some 400 family 
businesses. I think there are about 100,000 family businesses 
worth between, say, $5 and $100 million nationwide. That would 
be less than half of 1 percent.
    Look at 2032A. The Internal Revenue Service has attacked it 
often. There have been 134 reported court cases which I have 
listed in my testimony. The IRS has won most of them. The 
Commerce Clearinghouse says, appropriately, lawyers are scared 
to death of this section because of malpractice. I mention it 
to my students. I do not teach it. I tell them to be on the 
lookout for it. It would take an entire semester to teach it.
    Passage of 2033A or a similar provision would be great for 
my business. We looked at the number of family businesses and 
farms my firm represents. We have eight trust and estate 
lawyers. We have some 200-such family businesses. For us to 
explain it, test it, document participation and monitor, we 
would have to charge about $15,000 apiece. It would create $3 
million of legal fees for us, which would be great. I think it 
would probably help me send my grandchildren through 
professional school, and I am just one firm.
    You could easily extrapolate that to 1,000 lawyers. There 
are 2,600 senior trust and estate lawyers in the American 
College of Trust and Estate Counsel. I believe you could have 
$3 billion of legal fees testing this for less than half of 1 
percent of the family businesses and farms.
    My hope would be, first, if you could find the money, that 
you move forward and repeal the death tax. It is the kind of 
thing you have to hurry. You cannot put it off because someone 
dies, and that is when the tax is due. If the money is not 
available, you reduce the tax rate and you raise the tax-free 
amount. What a great opportunity for simplification. If you 
could repeal it, you could get the IRS off the back of 
families. I appreciate it, Mr. Chairman, and applaud your 
desire to do that.
    I have attached a complete report from the Family Business 
Institute in Kennesaw State. They did a study of equipment 
distributors and minority owned businesses. They said this 
thing was counterproductive, significantly limiting economic 
growth, development, and job creation. They said minority 
businesses will never grow because they get sliced 55 percent. 
They will never get to be of any size.
    I know probably some Members are concerned that it will be 
perceived as prorich instead of profamilies and projobs. 
Representative Cox was telling me that in California, as you 
may know, they had a referendum someone put on the ballot and 
repealed their inheritance tax. Massachusetts repealed their 
death tax 3 years ago because people were moving to Las Vegas, 
Nevada, and to Florida. They put it on the ballot in 
California. They voted to repeal the inheritance tax in 
California. That, to me, is a cross-section of the country. It 
shows that people really believe you should tax money once and 
not twice or three times.
    Thanks for letting me share my views with you, and I look 
forward to some questions.
    [The prepared statement and attachments follow:]

Statement of Harold I. Apolinsky, Vice President for Legislation, Small 
Business Council of America; and General Counsel, American Family 
Business Institute

    Mr. Chairman and Members of the Committee, I am Harold I. 
Apolinsky, General Counsel of the American Family Business 
Institute and Past Chair of the Small Business Council of 
America (SBCA) and currently Vice President-Legislation. I am 
also a practicing tax attorney (over 30 years) who specializes 
in estate planning and probate. For over 20 years, I have 
taught estate planning and estate, gift and generation-skipping 
taxation as my avocation to law school seniors at both the 
University of Alabama School of Law in Tuscaloosa, Alabama and 
the Cumberland School of Law in Birmingham, Alabama. I am here 
to present our views on meaningful estate, gift and generation-
skipping relief.
    SBCA is a national nonprofit organization which represents 
the interests of privately-held and family-owned businesses on 
federal tax, health care and employee benefit matters. The 
SBCA, through its members, represents well over 20,000 
enterprises in retail, manufacturing and service industries, 
which enterprises represent or sponsor over two hundred 
thousand qualified retirement and welfare plans, and employ 
over 1,500,000 employees.
    The American Family Business Institute is a recently formed 
non-profit organization and a successor to the Committee to 
Preserve the American Family Business. The Committee for a 
number of years has been working for estate tax relief. Our 
members are family businesses throughout the United States 
facing forced sale or liquidation because of the 55% death tax.
    Throughout the first two months of the 105th Congress, 
numerous members have introduced legislation that seeks to 
address the very serious problems that the federal estate tax 
laws cause family-owned businesses, farms and capital. Many of 
the Bills introduced have a significant number of co-sponsors. 
The legislation drafted by your Committee on Ways and Means 
will be the most important in securing meaningful estate, gift 
and generation skipping tax relief.
    We are delighted and heartened by the overwhelming response 
that this issue has evoked from Members of Congress and their 
staffs. It is indeed refreshing to observe the level of 
understanding and commitment that individual Members have 
demonstrated. In the past, the existence and harm of the 55% 
death tax has not been generally known other than to estate tax 
lawyers and families who have suffered the loss of a loved one 
owning more that $600,000 of assets.
    We submit that the time has come for Congress to repeal the 
estate, gift, and generation-skipping taxes. If this is not 
possible because of budgetary constraints, then the exemption 
at which assets are not subject to any estate taxes should be 
increased dramatically as some bills suggest to $1 Million to 
$2 Million. We also submit that not only should the exemption 
be increased, but that the tax rates be significantly reduced 
and the tax brackets expanded.
    An estate tax due nine months after death is imposed on the 
transfer to children or other heirs of the taxable estate of 
every decedent who is a citizen or resident of the United 
States ($600,000 of assets are exempt). The graduated estate 
tax rates begin effectively at 37% and increase to a maximum 
rate of 55% (see Exhibit A for how the tax is calculated). 
Taxes on bequests to spouses may be deferred until the last-to-
die of husband and wife.
    A gift tax is levied on taxable gifts (excluding $10,000 
per donee per year) as a back-stop to the estate taxes. The 
graduated rates are the same. (The $600,000 exempt amount may 
be used during life for gifts or at death.)
    An extra, flat 55% generation-skipping tax is imposed on 
gifts or bequests to grandchildren ($1,000,000 is exempt).
    Combined income and estate taxes frequently consume 75% or 
better of retirement plan accounts at death (see chart attached 
as Exhibit B).
    The 1995 White House Conference on Small Business 
recommended repeal of estate and gift taxes. In fact, ranked by 
votes, this was the number four (out of sixty) recommendation 
to come out of the Conference.
    President Clinton has expressed the desire to retain and 
increase jobs. Repeal or a significant cut back and phase out 
of this deadly tax would accomplish this. AFBI and SBCA contend 
that any suggestion to solve the problem by simply extending 
the time period by which payment of the estate taxes is due is 
no solution at all. If a farm owes $5,000,000 in estate taxes, 
does it really matter if the payment of this amount can be 
spread over a period of time slightly longer than before? We 
submit that it is not the time period that is critical, it is 
the exorbitant amount of the tax that is critical.
    Only 30% of family business and farms make it through the 
second generation. Seventy percent (70%) do not. Only 13% make 
it through the third generation. Eighty-seven (87%) do not. The 
primary cause of the demise of family businesses and farms, 
after the death of the founder and the founder's spouse, is the 
55% estate tax. It is hard for the successful business to 
afford enough life insurance. (Premiums are not deductible and 
deplete working capital.)
    A recent study by the research company, Prince and 
Associates, for National Life of Vermont reviewed the history 
of 749 family businesses which failed within three years after 
the death of the founder. The Prince study reinforced and 
supported the conclusion of the deadly effect of estate taxes. 
The businesses could not continue as a result of the tax drain 
on working capital needed to effectively compete and cover 
errors in judgment made by new and younger management. Jobs 
were lost in the communities. Key families in the community 
lost the family business as their base of power and faded away 
as leaders in that community.
    The estate tax took its present form primarily in the early 
30's. The express purpose was to break-up wealth. One must 
question whether this is consistent with a free enterprise 
economic system and a very competitive world economy? Also, is 
it consistent at a time when the projected standard of living 
for our children will be worse than it is for their parents? 
The estate and gift tax cannot be justified as playing an 
important role in financing the federal government; it now 
brings in less than 1.2 percent of total federal revenues. The 
expense of administering this system probably offset 75% or 
more of the revenue.
    The estate tax system certainly cannot be justified when it 
is breaking up family farms and family businesses. Years ago, a 
family working hard on their farms or in their businesses 
making a modest income would probably not have run into this 
tax. Now with inflation rich assets, such as that owned by 
farmers, ranchers, timber companies, even small Mom and Pop 
stores, it is commonplace for people that few would think of as 
wealthy to be hit hard by the estate tax. These people who pay 
a lot of income tax year in and year out, now for the privilege 
of transferring these assets to their children will be subject 
to estate tax rates of 37% and higher--as high as 55%. This is 
a combined tax of over 80%.
    If the estate tax were repealed, we believe based upon 
studies conducted by Professor Richard Wagner of George Mason 
University, by the Heritage Foundation and by Kennesaw State 
College (portions of which are attached as Exhibit C) that the 
beneficial effect on the economy would be significant. 
According to the study conducted by Professor Richard Wagner of 
George Mason University, the effect of the estate tax on the 
cost of capital is so great that within eight years, a U.S. 
economy without an estate tax would be producing $80 billion 
more in annual output and would have created 250,000 additional 
jobs and a $640 billion larger capital stock.
    The Heritage Foundation study utilizing two leading 
econometric models also found that repealing the estate tax 
would have a beneficial effect on the economy. The Heritage 
analysis found that if the tax were repealed in 1996, over the 
next nine years: The nation's economy would average as much as 
$11 billion per year in extra output; An average of 145,000 
additional new jobs could be created; Personal income could 
rise by an average of $8 billion per year above current 
projections; and The deficit actually would decline, since 
revenues generated by extra growth would more than compensate 
for the meager revenues currently raised by the inefficient 
estate tax.
    We submit if repealing estate taxes accomplished only half 
of these things, even a third or a fourth of them, then the 
country would be significantly better off than staying under 
the current draconian estate tax system. The estate tax system 
raises very little revenue at a heavy cost to the economy. It 
generates complex tax avoidance schemes, it promotes spending 
instead of saving and it promotes people giving up on the 
family business or farm.
    The hardest hit by the tax are small business people who 
work hard to pass on their farm or business to their children. 
To this end, a complex family business carve out has been 
introduced into legislation, S. 2. It is similar to the 2033A 
which was in the Balance Budget Tax Act of 1995. The problem is 
that this carve-out is much too complicated. Optimistic 
estimates are that it will not help more than 10% of the family 
businesses or farms hurt by estate taxes and will not save many 
of the jobs lost when a company dies. There are several hoops a 
business or farm must jump through before this carve out can 
help it. First, the business must comprise at least 50% of the 
estate. Sometimes this is the case, but often it is not. 
Second, the decedent must have materially participated in the 
business for a specified number of years prior to death. Just 
think of the litigation resulting from the words, materially 
participated.... Third, the business must be left to one or 
more qualified heirs, these are designated family members and 
long time employees and those people must continue to actively 
participate in the business for at least ten years after 
receiving the stock from the decedent. Again, imagine the 
litigation resulting from the words--active participation .... 
Surely, there must be a better way to protect our country's 
family farms and businesses.
    Overall, a carve-out will have very limited application but 
will definitely create the need for spending many more dollars 
on estate tax attorneys and accountants. Small businesses have 
already spent more than enough on this problem. They need their 
working capital to keep their businesses viable and to continue 
to provide jobs.
    The tax services list 133 cases where the IRS has denied 
relief under the last carve-out for family farms--2032A (which 
has not worked to save these farms). The new suggested 
provision 2033A incorporating 12 provisions of 2032A will send 
my grandchildren through professional school. I am grateful but 
urge that funds available be spent toward a total phase out of 
the death tax over time, not to a gift to tax lawyers and 
accountants. A more extended study of 2033A is attached as 
Exhibit D.
    The Kennesaw State College Study on the Impact of the 
Federal Estate Tax, prepared by Astrachan and Aronoff, studied 
in detail the impact of the estate tax on members of the 
Associated Equipment Distributors (AED), an association 
composed of capital-intensive family-owned distribution 
businesses and on newly-emerging, minority-owned family 
enterprises selected from lists published by Black Enterprise 
Magazine. The study showed that for the AED group:
     Nearly $5 million is spent annually in life 
insurance premiums in order to have proceeds available to meet 
their estate tax liability. The survey shows an average of 
$27,000 per year expended by distributors on such insurance.
     $6.6 million has been spent on lawyers, 
accountants and other advisors for estate tax planning 
purposes. On average companies spent nearly:
     $20,000 in legal fees
     $11,900 in accounting fees
     $11,200 for other advisors
     In addition to the protection provided by life 
insurance premiums, roughly 12% of the AED respondents reserved 
over $51 million in liquid assets for the purpose of having 
cash available for the payment of the estate tax.
    I do not think we need to be an expert in anything to 
realize this is an awful lot of money not being spent in a 
particularly useful fashion when viewed through the eyes of our 
society. Probably worse, this same study found that 71% of the 
AED respondents would not have taken the actions they did but 
for the estate tax--in other words, actions were being taken 
that served no business purpose, they only served to alleviate 
the draconian effect of the estate tax. 46% of this group 
restructured the ownership of the company because of estate tax 
considerations (this statistic could be read to mean that 46% 
of them had restructured themselves right out of the so-called 
family business carve out which is one more problem with that 
solution). 11% have actually slowed down the business to limit 
estate tax burdens. Worse, the study showed that 57% of the 
businesses felt that the imposition of the estate tax would 
make long term survival of the business after the death of the 
current owner significantly more difficult and 9% thought it 
would make it impossible. They are not wrong--the statistics 
show it is extraordinarily difficult to have the family 
business survive the death of the first generation.
    Congress should repeal the estate tax in 1997. It will 
greatly assist family capital and family businesses of all 
kinds. If dollar constraints and the need to balance the budget 
limit what Congress can do at this point, then increasing the 
tax free amount (the exemption amount), while bringing the 
rates down and expanding the brackets is the best solution. For 
instance, the estate tax system could call for a 15% tax rate 
on all estates between the exemption level and ten million and 
then impose a 20% rate on all estates between 10 and 20 million 
and have a tax rate of 30% on all estates over that amount. We 
submit this kind of change will save the family farms and 
businesses and keep the jobs that all of these businesses 
provide. It will also prevent massive wealth from being 
transferred without any taxation at all. It should also bring 
the capital gains and estate tax system into a neutral stance 
so that desired actions are not postponed until death.
    The transfer tax provisions represent 82 pages of the 
Internal Revenue Code and 289 pages of Regulations issued by 
the Internal Revenue. The transfer tax system forces many 
estates, the Internal Revenue Service, and the Department of 
Justice to expend funds in court. The number of transfer tax 
cases now total 10,247 representing some 13,050 pages of the 
Commerce Clearing House Tax Publication.
    Australia repealed their estate and gift tax laws in the 
mid-1970's. It was felt that these transfer taxes were an 
inhibitor on the growth of family businesses. The legislative 
body of Australia sought more jobs which they believed would 
come if family businesses grew larger and were not caused to 
sell, downsize, or liquidate at the death of the founder to pay 
estate taxes. More recently, Canada has also repealed estate 
taxes for the same reasons.
    The SBCA has a legal and advisory board comprised of the 
top legal, accounting, insurance, pension and actuarial 
advisors to small business in the country. It is contrary to 
the financial interests of these board members in their tax 
practice and advisory businesses to urge repeal of these 
transfer taxes. We stand firmly behind repeal or significant 
reform, however, because it is the right thing to do to help 
grow family businesses, provide jobs and encourage the 
entrepreneurial spirit needed for small businesses to become 
large businesses.
    We applaud the bills introduced by Congressman Cox (HR 902) 
AND Senators Kyl (S-75) and Lugar (S-30) to repeal these taxes. 
The country will be far better off if any of them become law. 
As a country, we cannot stand by and see one more farm or one 
more small business get torn apart because of an obsolete tax 
supposedly in place to redistribute massive wealth. Part of the 
problem with estate taxes is that many of the families who are 
ultimately destroyed by the estate tax are not even aware that 
it exists. Many times no one in the family has ever been 
subjected to it.
    The 55% death tax (the highest in the world) does the most 
harm to capital of any tax we have. Once it leaves the family 
at death and goes to Washington, it never seems to come back to 
provide jobs back home.
      

                                

Exhibit A, Calculation of Estate Taxes

    Gross Estate (fair market value at death of all assets, including 
real estate, stock, cash, life insurance, retirement accounts, etc.).
    Deductions:
    1. Debts and expenses.
    2. Marital (assets left to spouse if citizen).
    3. Charitable.
    C. Taxable Estate.
    D. Add Prior Taxable Gifts.
    E. Total transfer to heirs (life and death).
    F. Apply Rates: 18% to 55%.
    G. Less credit ($192,800*)
    H. Net tax (effective 37% to 55% [plus 5% for larger estates] due 9 
months after death.
    I. Extra 55% tax for bequests to grandchildren in excess of $1 
million.

    *This is tax on $600,000 taxable estate.

    The complexity for filing the estate tax return is demonstrated by 
the 35 hours and 83 minutes estimated pursuant to the Paperwork 
Reduction Act Notice.
      

                                

Exhibit D, American Family Business Institute, Small Business Council 
of America

 Concerns With Existing Code Section 2032A and Any Business Carve Out 
                             Based Thereon

    The family-owned business provisions of S.2 (i.e., the 
proposed Section 2033A) mirror the statutory scheme that 
currently exists in Section 2032A of the tax code. In fact, the 
proposal repeatedly refers to various subsections of the 
existing provision to resolve various details relating to 
definitions, the treatment of different types of taxpayers, 
etc.
    The technical experts and practitioners that AFBI met with 
expressed serious reservations about basing estate tax reform 
on the existing Section 2032A. It is believed that the Section 
is much too complex and restrictive to ever be of significant 
benefit to the family farms that it originally was designed to 
help. Its applicability also has proven to be subject to 
relentless attacks from the Internal Revenue Service. Commerce 
Clearing House tax publications describe Section 2032A as 
follows:
    Code Sec. 2032A is a very technically complex statute that 
is generally interpreted with nit-picking narrowness by the 
IRS. The possible exposure to malpractice liability for failure 
to perfect a Code Sec. 2032A election or the giving of 
incorrect advice regarding recapture tax is a serious concern.
    The same publishers have described the IRS' unrelenting 
attacks on Section 2032A as follows:
    Congress has expressed concern that the IRS is interpreting 
2032A in a more restrictive manner than contemplated by 
Congress. See Estate of Davis v. Commissioner [Dec. 43, 105], 
86 T.C. 1156, 1164 (1986). United States Senator Alan J. Dixon 
of Illinois noted the tension between Congress' purpose in 
enacting 2032A and the IRS' administrative policy under that 
section in a Senator floor amendment in which he proposed the 
perfection provision contained in Code 2032A(d)(3).
    Congress wants to continue the family farm and small 
family-owned enterprises. Congress does not want the death of 
one owner of a family farm or a small family-operated business 
to force the sale of that farm or business if the family wants 
to stay in farming or the small business. The idea was to not 
permit the federal estate tax to destroy the farms or small 
businesses.
    There seems to be people at the IRS, however, who are not 
interested in preserving the family farms and small business, 
and who want to use the slightest technically to prevent an 
estate from being valued under the provisions of Section 2032A.
    The practitioners summarized their principal concerns about 
using the existing Section 2032A as the basis for estate tax 
reform as follows:
    1. Benefits may be outweighed by heavy costs. Because of 
the unusual complexity in Section 2032A, family-owned 
businesses could incur substantial additional legal and 
accounting costs (easily an average increase of $15,000 in 
professional fees for each such business) for every estate plan 
for or to determine applicability of the proposed Section 
2033A.
    2. Constant litigation could result. Section 2032A (from 
which Section 2033A has been cloned), though rarely elected, 
has been the subject of more than 130 litigated cases between 
taxpayers undertaking to elect the intended benefits of the 
section and the Internal Revenue Service which, contrary to the 
remedial nature of the statute, is continuously and 
successfully undertaking to limit its applicability and 
restrict its remedial benefits. A listing of the cases is 
attached as Exhibit 1. There may be an equal number not yet 
concluded and reported.
    3. Family planning could be more difficult and costly. Not 
only could estates attempting to utilize Section 2033A become 
involved with costly disputes with the IRS, heirs could 
likewise become entangled in various personal traps and 
disputes. For example,
    a. If the value of business interests declined during the 
ten-year estate tax recapture period, heirs could owe more in 
recaptured estate taxes than the gross proceeds realized upon 
disposition of such business interests.
    b. Heirs could unwittingly bear disproportionately large 
percentages of the overall estate tax in situations in which 
all heirs bore the initial tax on non-excluded estate assets 
proportionately, but qualified heirs who received excluded 
business interests would alone share the entire burden of an 
recapture tax.
    4. Qualification is unduly complex and uncertain. The 
qualification computation itself is unreasonably complex and 
cumbersome, requiring at least five obscure variables in the 
numerator (e.g., liquid assets in excess of reasonably expected 
day-to-day working capital needs) and at least six obscure 
variables in the denominator of a fraction which must exceed 
50% of the A.G.E., so that the miscalculation of one of such 
eleven factors could have devastingly adverse consequences of 
the estate. See Exhibit 2, attached.
    5. Benefits could be too limited. In 1995, the proposed 
Section 2033A was severely restricted by Congress as it worked 
its way through the legislative process. The benefits were 
reduced so much in 1995 (valuation reductions were limited to a 
maximum of $1,750,000) that the planning costs, complexities, 
uncertainties, and continuous predictable attacks from the IRS 
were far too great to justify such a limited benefit.
    6. Non-elective mandate forces unwilling participation and 
costs. Proposed section 2033A's application is mandated, and is 
not, like even section 2032A, elective. As written, compliance 
costs and fees can easily exceed any benefit from section 
2033A, yet businesses would be forced even against their will 
to deal with the statute's complexities and bear such added 
out-of-pocket expenses.
    7. Planning is uncertain and inflexible. Unlike most family 
farms, business interests are more likely to be the subject of 
complex transactions such as incorporations, mergers and other 
forms of reorganizations and recapitalizations effecting subtle 
shifts in financial interests, etc. The ramifications of these 
complex transactions would be difficult to deal with under 
section 2033A.

                   Proposed Changes to Section 2033A

    As noted above, we asked the group of practitioners and tax 
experts what changes would be required to simplify the proposed 
Section 2033A to make it at least arguably workable in the 
field. Numerous suggestions were made, but it was agreed that 
at least the following would be required to correct the 
legislative text:
    1. Expand definition of trade or business. Whether or not 
an activity and related estate assets constitute a trade or 
business is necessarily a question of fact and could be a 
source of constant litigation. For example, based on IRS 
interpretation of Section 2033A, tree farming encompassing the 
planting, ownership and maintenance of forest lands in 
anticipation of future harvesting would not constitute a trade 
or business whereas professional gambling would be a trade or 
business. In order to qualify their forestry activities for 
traded or business purposes, tree farmers would be required to 
initiate timber cutting activities, even if such cutting was 
premature and ill-advised for both business and environmental 
purposes. Similar problems exist for other nature resource-
based businesses, and businesses developing, owning and 
managing intangibles and other tangible property. The proposed 
statute must greatly expand the traditional definition of a 
trade or business to specifically incorporate such activities 
by utilizing a more relaxed active asset management test. We 
recognize that administrators have legitimate concerns 
regarding an overly broad definition, but the current approach 
is unworkable.
    2. Exclude Recapture on Ordinary Asset Sales. Sale of 
business assets, including inventory, plant and equipment, 
timber, crops, minerals, etc. in the ordinary course of a trade 
or business during the recapture period must not trigger 
recapture of estate tax. Recapture under such circumstances 
eliminates intended benefits, and would cause continuous 
filings and massive professional fees clearly providing a net 
negative impact on the small business.
    3. Eliminate Material Participation. The material 
participation requirement should be eliminated. Businesses, 
even more so than family farms, need competent professional 
management. It should be contrary to public policy to impose 
tax penalties for replacing aged, inform or incompetent family 
management with competent, professional non-family managers if 
necessary to maintain the economic health and viability of the 
business. So long as the family continues to own, operate and 
invest in the business, society continues to benefit from the 
stability and commitment inherent in such ownership.
    4. Expand the Definition of Family. After the second 
generation, it would be difficult for any family to qualify for 
the heirship or for material participation purposes as family 
is currently defined. Expand the definition of family by at 
least adopting the 447(e)(1) definition.
    5. A qualified heir should be permitted to receive his or 
her interest through a trust.
    6. Eliminate 50% of A.G.E. Test. There are numerous 
complexities and unfair results arising from this very high-
percentage cliff approach. It's easy to see the unfairness that 
would result comparing the family that owns 49% with the family 
that owns 51% particularly when valuation of such qualifying 
interests is so subjective and the source of continuous 
litigation. The cliff approach assures constant litigation with 
the IRS. There is also concern that a business suddenly may be 
worth much less due to the loss of its driving force, while the 
values of the non-business assets may be unaffected by the 
death.
    7. If any A.G.E. cliff test remains, a number of experts 
suggested that it be changed from a 50% to a 10% test.
    8. If any A.G.E. test remains the value of the principle 
residence should be eliminated from the computation of the 
adjusted gross estate. For small businesses, the value of the 
residence could be a significant factor in determining 
eligibility under any percentage of adjusted gross estate test.
    9. If any A.G.E. test remains, then language should be 
provided to ensure that the creation of ESOPs for gifts of 
qualifying business interests or gifts to charity do not 
prevent families from availing themselves of the provisions of 
this legislation. There are two sections where you might 
consider taking transfers to ESOPs and charities into 
consideration. First, is the section relating to eligibility 
for the exclusion, i.e., the 50%-of-adjusted-gross-estate test. 
Language should be added to apply any such test only to that 
portion of the ownership interests not held by a qualified ESOP 
or charity. Second, in the section dealing with disqualifying 
dispositions, transfer of ownership interests to a qualified 
ESOP or charity should not trigger the recapture provisions.
    10. If any A.G.E. test remains, include the gifts of the 
spouse in determining the adjusted taxable gift component in 
the 50%-of-adjusted-gross-estate test. Many married couples 
make separate, lifetime gifts of business interests (or they 
utilize the gift-splitting provisions under which they are 
deemed to have made separate gifts). If only the decedent's 
gifts of family business interests are counted in determining 
adjusted taxable gifts, many family businesses will fail to 
qualify under section 2033A simply because of the form chosen 
for lifetime gifting.
    11. If any A.G.E. test remains, then modify the calculation 
of the adjusted-gross-estate test to ensure that the 
determination of the denominator does not count certain assets 
twice. An example helps demonstrate how this could happen: 
Assume the spouse receiving the gifted assets (donee) is the 
first to die and all of the assets are placed into a QTIP trust 
for the benefit of the surviving donor spouse to take advantage 
of the marital deduction. Upon the death of the second spouse, 
the assets of that spouse plus the QTIP assets will be included 
in the estate tax return of the second spouse. Apparently, in 
determining the adjusted gross estate under Section 2033A, the 
previously gifted assets themselves must again be included in 
the calculation, even though the value of the assets themselves 
already is included in the gross estate of the second spouse by 
way of inclusion of the QTIP assets. At a minimum, this 
provision should be modified to somehow exclude those assets 
that were gifted and subsequently added back to the estate of 
the donor because of the workings of the marital deduction. An 
even better result would be to eliminate the spousal gift 
portion of the calculation altogether.
    12. If any A.G.E. test remains, then clarify that various 
family-owned business interests may be aggregated for purposes 
of meeting the percentage of adjusted-gross-estate test. It is 
common for various components of family-owned businesses to be 
held in different forms of entities (including entities that 
are unrelated). Any one of the companies may not constitute the 
necessary percentage of the adjusted gross estate. Provisions 
similar to those in Code Section 6166(c) would have to be 
considered.
    13. Redraft restrictions on working capital. The current 
language will produce litigation and unfairness. The tree 
farming business provides a useful illustration. The expansion 
of one's timber holdings requires significant amounts of cash 
and companies and requires many years to accumulate sufficient 
funds to effect their next purchase (the unanticipated 
withdrawal of federal timberlands from the Northwest timber 
base has created a need for companies to more aggressively 
acquire private lands to insure adequate timber supply). Any 
impartial observer, probably even the IRS, would agree that 
cash being accumulated for such appropriate business purposes 
was acceptable. But such accumulations would not necessarily 
meet the day-to-day test in the bill. Some commenters suggested 
flat percentage tests, but that would allow for no flexibility 
to reflect the very different capital needs of differing 
businesses. It appears that ``reasonable business needs'' test 
would provide more flexibility, but would still be a source of 
continuing uncertainty and litigation.
    14. Integrate the proposed Section 2033A general exclusion 
with the generation-skipping transfer tax.
    15. Integrate the proposed Section 2033A general exclusion 
with the gift tax credit provisions. One can envision a 
situation where a gift tax has been paid in certain years on 
amounts that (although above the annual gift tax exclusion) 
would not have been subject to tax had the assets been retained 
in the estate. The estate should get credit for the gift taxes 
already paid (or a refund if they exceed the estate tax owed). 
In the absence of this clarification, passage of proposed 
Section 2033A would create an incentive not to begin the 
transfer of the business to the next generation during the life 
of the deceased. That would seem to defeat our desire to 
facilitate the smooth transfer of family business ownership to 
the next generation.
    16. Redraft sections to clarify which persons are 
responsible for payment of any recapture tax. Under the current 
draft language, the experts envision planning costs and 
difficulties as well as family disputes over efforts to fairly 
distribute the overall estate tax burden where qualifying 
business interests do not pass proportionately to all family 
members. At this point, it remains unclear how best to redraft 
this section.
    17. Minimize the family-owned tests. Reducing ownership 
percentages to as little as 10% would still limit applicability 
to only intended circumstances. Utilizing ownership tests 
involving ownership by other families can create severe 
complications for planning purposes.
    18. Ease strict prohibition on public ownership of 
securities. Growing family businesses should not be penalized 
for seeking essential capital in public financial markets. 
Public ownership of 30% of a company's stock in no way removes 
the liquidity needs or provides a reasonable market for 70% of 
the business still held by the family.

                         Preferred Alternatives

    As discussed above, there are significant problems with the 
current draft of Section 2033A. Significant changes would have 
to be made to make it workable for the estate planning 
professionals in the field. Rather than spend time and effort 
to fix or draft something which will not help a significant 
number of family businesses and farms (but will enrich tax 
lawyers and accountants) we suggest:
    1. Increase the unified credit (tax free amount) 
significantly. Consider a phase in (as occurred in 1982 Tax 
Act--ERTA) to $5,000,000.
    2. A phased reduction in the Estate Tax Rates. Target zero 
as soon as affordable.
    3. Expansion of the Existing Rate Brackets. Broaden the 
brackets so that the highest rates would not kick in as soon.
      

                                

Exhibit 1

    1. C.I.R. v. McCoy, 484 U.S. 3, 108 S.Ct. 217, 98 L.Ed.2d 2, 60 
A.F.T.R.2d 87-6150, 87-2 USTC P 13,736 (U.S., Oct 19, 1987) (NO. 87-75)
    2. Ernzen v. Ernzen, 105 F.3d 669 (Table, Text in WESTLAW), 
Unpublished Disposition, 1997 WL 7276, 97 CJ C.A.R. 115 (10th 
Cir.(Kan.), Jan 09, 1997) (NO. 95-3145)
    3. LeFever v. C.I.R., 100 F.3d 778, 78 A.F.T.R.2d 96-7335 (10th 
Cir., Nov 13, 1996) (NO. 95-9022)
    4. In re Estate of Lucas, 97 F.3d 1401, 78 A.F.T.R.2d 96-6911 (11th 
Cir.(Fla.), Oct 23, 1996) (NO. 95-2370)
    5. Estate of Hoover v. C.I.R., 69 F.3d 1044, 76 A.F.T.R.2d 95-7305, 
95-2 USTC P 60,217 (10th Cir., Nov 01, 1995) (NO. 94-9018)
    6. Estate of Hudgins v. C.I.R., 57 F.3d 1393, 64 USLW 2044, 76 
A.F.T.R.2d 95-5401, 95-2 USTC P 60,202 (5th Cir., Jun 28, 1995) (NO. 
94-40211)
    7. Estate of Klosterman v. C.I.R., 32 F.3d 402, 74 A.F.T.R.2d 94-
5193, 74 A.F.T.R.2d 94-7453, 94-2 USTC P 60,172 (9th Cir., Jul 05, 
1994) (NO. 93-70349)
    8. Minter v. U.S., 19 F.3d 426, 73 A.F.T.R.2d 94-1721, 73 
A.F.T.R.2d 94-2365, 94-1 USTC P 60,160 (8th Cir.(N.D.), Mar 23, 1994) 
(NO. 92-3745ND)
    9. Estate of Doherty v. C.I.R., 982 F.2d 450, 61 USLW 2429, 71 
A.F.T.R.2d 93-2155, 93-1 USTC P 60,125 (10th Cir., Dec 31, 1992) (NO. 
919013)
    10. Poisl v. C.I.R., 978 F.2d 1261 (Table, Text in WESTLAW), 
Unpublished Disposition, 1992 WL 321001 (7th Cir., Nov 04, 1992) (NO. 
92-1080)
    11. Williamson v. C.I.R., 974 F.2d 1525, 61 USLW 2201, 70 
A.F.T.R.2d 92-6244, 92-2 USTC P 60,115 (9th Cir., Sep 14, 1992) (NO. 
89-70506)
    12. McAlpine v. C.I.R., 968 F.2d 459, 70 A.F.T.R.2d 92-6216, 92-2 
USTC P 60,109 (5th Cir., Aug 04, 1992) (NO. 91-4699)
    13. Estate of Wallace v. C.I.R., 965 F.2d 1038, 70 A.F.T.R.2d 92-
5349, 92-2 USTC P 50,387 (11th Cir., Jul 13, 1992) (NO. 91-7318)
    14. Bartlett v. C.I.R., 937 F.2d 316, 68 A.F.T.R.2d 91-6015, 91-2 
USTC P 60,078 (7th Cir., Jul 12, 1991) (NO. 89-2237)
    15. Estate of Wood v. C.I.R., 909 F.2d 1155, 59 USLW 2097, 66 
A.F.T.R.2d 90-5987, 90-2 USTC P 50,488, 90-2 USTC P 60,031 (8th Cir., 
Jul 26, 1990) (NO. 89-2366)
    16. Brockman v. C.I.R., 903 F.2d 518, 65 A.F.T.R.2d 90-1249, 90-1 
USTC P 60,026 (7th Cir., Jun 05, 1990) (NO. 89-1559)
    17. Prussner v. U.S., 896 F.2d 218, 65 A.F.T.R.2d 90-1222, 90-1 
USTC P 60,007 (7th Cir.(Ill.), Feb 15, 1990) (NO. 88-1933)
    18. Smoot v. U.S., 892 F.2d 597, 58 USLW 2401, 65 A.F.T.R.2d 90-
1177, 90-1 USTC P 60,002 (7th Cir.(Ill.), Dec 27, 1989) (NO. 88-2058)
    19. Heffley v. C.I.R., 884 F.2d 279, 64 A.F.T.R.2d 89-5909, 89-2 
USTC P 13,812 (7th Cir., Aug 17, 1989) (NO. 88-1929)
    20. Foss v. U.S., 865 F.2d 178, 63 A.F.T.R.2d 89-1524, 89-1 USTC P 
13,793 (8th Cir.(Minn.), Jan 09, 1989) (NO. 88-5152)
    21. Estate of Thompson v. C.I.R., 864 F.2d 1128, 63 A.F.T.R.2d 89-
1515, 89-1 USTC P 13,792 (4th Cir., Jan 03, 1989) (NO. 88-3981)
    22. McDonald v. C.I.R., 853 F.2d 1494, 62 A.F.T.R.2d 88-5995, 88-2 
USTC P 13,778 (8th Cir., Aug 17, 1988) (NO. 87-2389)
    23. Mangels v. U.S., 828 F.2d 1324, 60 A.F.T.R.2d 87-6145, 87-2 
USTC P 13,734 (8th Cir.(Iowa), Sep 16, 1987) (NO. 86-1647)
    24. Whalen v. U.S., 826 F.2d 668, 60 A.F.T.R.2d 87-6127, 87-2 USTC 
P 13,729 (7th Cir.(Ill.), Aug 13, 1987) (NO. 86-2997)
    25. Estate of McCoy v. C.I.R., 809 F..R.2d 87-1207, 87-1 USTC P 
13,707 (6th Cir., Jan 23, 1987) (NO. 86-1008)
    26. Schuneman v. U.S., 783 F.2d 694, 54 USLW 2439, 89 A.L.R. Fed. 
85, 57 A.F.T.R.2d 86-1530, 86-1 USTC P 13,660 (7th Cir.(Ill.), Feb 10, 
1986) (NO. 84-2651, 84-2888)
    27. Martin v. C.I.R., 783 F.2d 81, 54 USLW 2440, 57 A.F.T.R.2d 86-
1527, 86-1 USTC P 13,659 (7th Cir.(Ind.), Feb 03, 1986) (NO. 85-2077, 
85-2088)
    28. Estate of Sherrod v. C.I.R., 774 F.2d 1057, 56 A.F.T.R.2d 85-
6594, 85-2 USTC P 13,644 (11th Cir., Oct 25, 1985) (NO. 84-7682)
    29. Estate of Cowser v. C.I.R., 736 F.2d 1168, 84-2 USTC P 13,579 
(7th Cir., Jun 13, 1984) (NO. 83-2329)
    30. Rath v. U.S., 733 F.2d 594, 84-1 USTC P 13,573 (8th Cir.(Neb.), 
May 09, 1984) (NO. 83-2552)
    31. Ernzen v. Ernzen, 1995 WL 261131 (D.Kan., Apr 03, 1995) (NO. 
CIV. A. 94-2265-EEO)
    32. Ernzen v. Ernzen, 878 F.Supp. 190 (D.Kan., Feb 28, 1995) (NO. 
CIV. A. 94-2265-EEO)
    33. Gettysburg Nat. Bank v. U.S., 806 F.Supp. 511, 72 A.F.T.R.2d 
93-6769 (M.D.Pa., Nov 19, 1992) (NO. CIV.A.1:CV-90-1607)
    34. Simpson v. U.S., 1992 WL 472023, 92-2 USTC P 60,118 (D.N.M., 
Aug 31, 1992) (NO. CIV-90-827 SC)
    35. Gettysburg Nat. Bank v. U.S., 1992 WL 472022, 70 A.F.T.R.2d 92-
6229, 92-2 USTC P 60,108 (M.D.Pa., Jul 17, 1992) (NO. 1:CV-90-1607)
    36. Parker v. U.S., 1991 WL 338264, 68 A.F.T.R.2d 91-6056, 91-2 
USTC P 60,082 (E.D.Ark., Jul 31, 1991) (NO. CIV. J-C-89-91)
    37. Collins v. U.S., 1991 WL 496861, 91-1 USTC P 60,060 (W.D.Okla., 
Jan 31, 1991) (NO. CIV-90-324-P)
    38. Parker v. U.S., 1990 WL 300672, 90-2 USTC P 60,038 (E.D.Ark., 
Aug 17, 1990) (NO. J-89-91)
    39. Parker v. U.S., 1990 WL 300673, 90-2 USTC P 60,028 (E.D.Ark., 
May 30, 1990) (NO. J-89-91)
    40. Miller v. U.S., 680 F.Supp. 1269, 61 A.F.T.R.2d 88-1370, 88-1 
USTC P 13,757 (C.D.Ill., Mar 09, 1988) (NO. 86-3245)
    41. Foss v. U.S., 1987 WL 49368, 63 A.F.T.R.2d 89-1503, 88-1 USTC P 
13,762 (D.Minn., Dec 21, 1987) (NO. 6-86-711)
    42. Voorhis v. U.S., 1987 WL 49370, 88-1 USTC P 13,749 (C.D.Ill., 
Nov 20, 1987) (NO. 86-3150)
    43. Smoot v. C.I.R., 1987 WL 49387, 63 A.F.T.R.2d 89-1533,TC P 
13,748 (C.D.Ill., Nov 16, 1987) (NO. 85-2431)
    44. Prussner v. U.S., 1987 WL 47915, 87-2 USTC P 13,739 (C.D.Ill., 
Oct 13, 1987) (NO. 85-2442)
    45. Bruch v. U.S., 1986 WL 83454, 58 A.F.T.R.2d 86-6383, 86-2 USTC 
P 13,692 (N.D.Ind., Sep 03, 1986) (NO. CIV. A. F 83-410)
    46. Mangels v. U.S., 632 F.Supp. 1555, 58 A.F.T.R.2d 86-6361, 86-2 
USTC P 13,682 (S.D.Iowa, Apr 22, 1986) (NO. CIV. 84-10-D-2)
    47. Whalen v. U.S., 1985 WL 6355, 86-1 USTC P 13,661 (C.D.Ill., Nov 
14, 1985) (NO. 84-3020)
    48. Bixler v. U.S., 616 F.Supp. 177, 56 A.F.T.R.2d 85-6532, 85-2 
USTC P 13,623 (D.S.D., May 31, 1985) (NO. CIV. 84-1059)
    49. Schuneman v. U.S., 1984 WL 2810, 57 A.F.T.R.2d 86-1545, 84-1 
USTC P 13,561 (C.D.Ill., Jan 31, 1984) (NO. 82-4027)
    50. Schuneman v. U.S., 570 F.Supp. 1327, 83-2 USTC P 13,540 
(C.D.Ill., Sep 14, 1983) (NO. 82-4027)
    51. Teubert v. U.S.A., 1983 WL 1615, 83-1 USTC P 13,513 (D.Minn., 
Jan 31, 1983) (NO. 3-82-43)
    52. In re Morgan, 1990 WL 208790 (Bankr.E.D.Okla., Jan 22, 1990) 
(NO. 89-70816)
    53. Matter of Moellenbeck, 83 B.R. 630, Bankr. L. Rep P 72,144 
(Bankr.S.D.Iowa, Mar 01, 1988) (NO. 87-1258-D)
    54. Matter of C.R. Druse, Sr., Ltd., 82 B.R. 1013 (Bankr.D.Neb., 
Feb 05, 1988) (NO. BK87-346)
    55. Estate of Trueman v. U.S., 6 Cl.Ct. 380, 54 A.F.T.R.2d 84-6514, 
84-2 USTC P 13,590 (Cl.Ct., Oct 04, 1984) (NO. 309-82T)
    56. Carmean v. U.S., 4 Cl.Ct. 181, 84-1 USTC P 13,551 (Cl.Ct., Dec 
23, 1983) (NO. 328-82T)
    57. Hohenstein v. C.I.R., T.C. Memo. 1997-56, 1997 WL 34996, 73 
T.C.M. (CCH) 1886, T.C.M. (RIA) 97,056 (U.S. Tax Ct., Jan 30, 1997) 
(NO. 22282-94)
    58. Estate of Neumann v. C.I.R., 106 T.C. No. 10, 106 T.C. 216, Tax 
Ct. Rep. (CCH) 51,280, Tax Ct. Rep. Dec. (P-H) 106.10 (U.S. Tax Ct., 
Apr 09, 1996) (NO. 11060-94)
    59. Estate of Kokernot v. C.I.R., T.C. Memo. 1995-590, 1995 WL 
735295.M. (CCH) 1559, T.C.M. (P-H) 95,590 (U.S. Tax Ct., Dec 13, 1995) 
(NO. 16088-94)
    60. Ripley v. C.I.R., 105 T.C. No. 23, 105 T.C. 358, Tax Ct. Rep. 
(CCH) 50,986, Tax Ct. Rep. Dec. (P-H) 105.23 (U.S. Tax Ct., Nov 08, 
1995) (NO. 26209-93)
    61. Estate of Sequeira v. C.I.R., T.C. Memo. 1995-450, 1995 WL 
558728, 70 T.C.M. (CCH) 761, T.C.M. (P-H) 95,450 (U.S. Tax Ct., Sep 21, 
1995) (NO. 16264-91)
    62. LeFever v. C.I.R., T.C. Memo. 1995-321, 1995 WL 422679, 70 
T.C.M. (CCH) 98, T.C.M. (P-H) 95,321 (U.S. Tax Ct., Jul 19, 1995) (NO. 
19915-92)
    63. Estate of Monroe v. C.I.R., 104 T.C. No. 16, 104 T.C. 352, Tax 
Ct. Rep. (CCH) 50,539, Tax Ct. Rep. Dec. (P-H) 104.16 (U.S. Tax Ct., 
Mar 27, 1995) (NO. 9819-93)
    64. Tate; Lyle, Inc. v. C.I.R., 103 T.C. 656, Tax Ct. Rep. (CCH) 
50,241, Tax Ct. Rep. Dec. (P-H) 103.37 (U.S. Tax Ct., Nov 15, 1994) 
(NO. 740-92)
    65. LeFever v. C.I.R., 103 T.C. No. 31, 103 T.C. 525, Tax Ct. Rep. 
(CCH) 50,206, Tax Ct. Rep. Dec. (P-H) 103.31 (U.S. Tax Ct., Oct 26, 
1994) (NO. 19915-92)
    66. Estate of Hoover v. C.I.R., 102 T.C. No. 36, 102 T.C. 777, Tax 
Ct. Rep. (CCH) 49,919, Tax Ct. Rep. Dec. (P-H) 102.36 (U.S. Tax Ct., 
Jun 21, 1994) (NO. 18464-92)
    67. Estate of Einsiedler v. C.I.R., T.C. Memo. 1994-155, 1994 WL 
125924, 67 T.C.M. (CCH) 2647, T.C.M. (P-H) 94,155 (U.S. Tax Ct., Apr 
13, 1994) (NO. 4461-91)
    68. Estate of Climer v. C.I.R., T.C. Memo. 1994-29, 1994 WL 17919, 
67 T.C.M. (CCH) 2017, T.C.M. (P-H) 94,029 (U.S. Tax Ct., Jan 24, 1994) 
(NO. 21678-91)
    69. Stovall v. C.I.R., 101 T.C. No. 9, 101 T.C. 140, Tax Ct. Rep. 
(CCH) 49,183, Tax Ct. Rep. Dec. (P-H) 1019 (U.S. Tax Ct., Jul 29, 1993) 
(NO. 19432-91, 19434-91, 19436-91, 19438-91, 19433-91, 19437-91, 19435-
91)
    70. Rockwell Inn, Ltd. v. C.I.R., T.C. Memo. 1993-158, 1993 WL 
112452, 65 T.C.M. (CCH) 2374, T.C.M. (P-H) 93,158 (U.S. Tax Ct., Apr 
13, 1993) (NO. 21842-91)
    71. Fisher v. C.I.R., T.C. Memo. 1993-139, 1993 WL 9 T.C.M. (CCH) 
2284, T.C.M. (P-H) 93,139 (U.S. Tax Ct., Apr 05, 1993) (NO. 9383-90, 
9416-90, 9417-90)
    72. Estate of Mapes v. C.I.R., 99 T.C. No. 27, 99 T.C. 511, Tax Ct. 
Rep. (CCH) 48,609, Tax Ct. Rep. Dec. (P-H) 99.7 (U.S. Tax Ct., Oct 29, 
1992) (NO. 1038-89)
    73. Estate of Dooley v. C.I.R., T.C. Memo. 1992-557, 1992 WL 
231695, 64 T.C.M. (CCH) 824, T.C.M. (P-H) 92,557 (U.S. Tax Ct., Sep 22, 
1992) (NO. 11131-88, 23026-88, 23027-88)
    74. Estate of Klosterman v. C. I. R., 99 T.C. No. 16, 99 T.C. 313, 
Tax Ct. Rep. (CCH) 48,496, Tax Ct. Rep. Dec. (P-H) 99.16 (U.S. Tax Ct., 
Sep 10, 1992) (NO. 27652-89)
    75. Ann Jackson Family Foundation v. C. I. R., 97 T.C. No. 35, 97 
T.C. 534, Tax Ct. Rep. (CCH) 47,736, Tax Ct. Rep. Dec. (P-H) 97.35 
(U.S. Tax Ct., Nov 12, 1991) (NO. 28883-89)
    76. Estate of Holmes v. C. I. R., T.C. Memo. 1991-477, 1991 WL 
188869, 62 T.C.M. (CCH) 839, T.C.M. (P-H) 91,477 (U.S. Tax Ct., Sep 26, 
1991) (NO. 27129-89)
    77. Shaw v. C. I. R., T.C. Memo. 1991-372, 1991 WL 148902, 62 
T.C.M. (CCH) 396, T.C.M. (P-H) 91,372 (U.S. Tax Ct., Aug 08, 1991) (NO. 
5219-89)
    78. Estate of Hughan v. C. I. R., T.C. Memo. 1991-275, 1991 WL 
102698, 61 T.C.M. (CCH) 2932, T.C.M. (P-H) 91,275 (U.S. Tax Ct., Jun 
17, 1991) (NO. 23221-88)
    79. Estate of McAlpine v. C. I. R., 96 T.C. No. 6, 96 T.C. 134, Tax 
Ct. Rep. (CCH) 3963, Tax Ct. Rep. Dec. (P-H) 96.6 (U.S. Tax Ct., Jan 
24, 1991) (NO. 28298-87)
    80. Estate of Wallace v. C. I. R., 95 T.C. No. 37, 95 T.C. 525, Tax 
Ct. Rep. (CCH) 46,977, Tax Ct. Rep. Dec. (P-H) 95.37 (U.S. Tax Ct., Nov 
14, 1990) (NO. 22960-88)
    81. Estate of Doherty v. C. I. R., 95 T.C. No. 32, 95 T.C. 446, Tax 
Ct. Rep. (CCH) 46,929, Tax Ct. Rep. Dec. (P-H) 95.32 (U.S. Tax Ct., Oct 
18, 1990) (NO. 5568-88)
    82. Estate of Merwin v. C. I. R., 95 T.C. No. 13, 95 T.C. 168, Tax 
Ct. Rep. (CCH) 46,817, Tax Ct. Rep. Dec. (P-H) 95.13 (U.S. Tax Ct., Aug 
21, 1990) (NO. 23398-88)
    83. Estate of Pattison v. C. I. R., T.C. Memo. 1990-428, 1990 WL 
112409, 60 T.C.M. (CCH) 471, T.C.M. (P-H) 90,428 (U.S. Tax Ct., Aug 08, 
1990) (NO. 26805-87)
    84. EsC. I. R., T.C. Memo. 1990-359, 1990 WL 96986, 60 T.C.M. (CCH) 
137, T.C.M. (P-H) 90,359 (U.S. Tax Ct., Jul 16, 1990) (NO. 37390-87)
    85. Hight v. C. I. R., T.C. Memo. 1990-81, 1990 WL 14579, 58 T.C.M. 
(CCH) 1457, T.C.M. (P-H) 90,081 (U.S. Tax Ct., Feb 21, 1990) (NO. 
21390-88)
    86. Estate of Slater v. C.I.R., 93 T.C. No. 41, 93 T.C. 513, Tax 
Ct. Rep. (CCH) 46,114, Tax Ct. Rep. Dec. (P-H) 93.41 (U.S. Tax Ct., Oct 
30, 1989) (NO. 7844-88)
    87. Bank of West v. C.I.R., 93 T.C. No. 37, 93 T.C. 462, Tax Ct. 
Rep. (CCH) 46,084, Tax Ct. Rep. Dec. (P-H) 93.37 (U.S. Tax Ct., Oct 11, 
1989) (NO. 23220-88)
    88. Williamson v. C.I.R., 93 T.C. No. 23, 93 T.C. 242, Tax Ct. Rep. 
(CCH) 45,954, Tax Ct. Rep. Dec. (P-H) 93.23 (U.S. Tax Ct., Aug 21, 
1989) (NO. 33059-87)
    89. Estate of Maddox v. C.I.R., 93 T.C. No. 21, 93 T.C. 228, Tax 
Ct. Rep. (CCH) 45,924, Tax Ct. Rep. Dec. (P-H) 93.21 (U.S. Tax Ct., Aug 
10, 1989) (NO. 9134-87)
    90. Estate of Headrick v. C.I.R., 93 T.C. No. 18, 93 T.C. 171, Tax 
Ct. Rep. (CCH) 45,914, Tax Ct. Rep. Dec. (P-H) 93.18 (U.S. Tax Ct., Aug 
07, 1989) (NO. 21659-86)
    91. Estate of Evers v. C. I. R., T.C. Memo. 1989-292, 1989 WL 
63156, 57 T.C.M. (CCH) 718, T.C.M. (P-H) 89,292 (U.S. Tax Ct., Jun 15, 
1989) (NO. 33808-86)
    92. Estate of Wood v. C.I.R., 92 T.C. No. 46, 92 T.C. 793, Tax Ct. 
Rep. (CCH) 9246, Tax Ct. Rep. (CCH) 45,604 (U.S. Tax Ct., Apr 12, 1989) 
(NO. 48020-86)
    93. Estate of Strickland v. C.I.R., 92 T.C. No. 3, 92 T.C. 16, Tax 
Ct. Rep. (CCH) 45,412, Tax Ct. Rep. Dec. (P-H) 92.3 (U.S. Tax Ct., Jan 
10, 1989) (NO. 41553-85)
    94. Estate of Grimes v. C.I.R., T.C. Memo. 1988-576, 1988 WL 
135011, 56 T.C.M. (CCH) 890, T.C.M. (P-H) 88,576 (U.S. Tax Ct., Dec 20, 
1988) (NO. 33429-84)
    95. Estate of Nesselrodt v. C.I.R., T.C. Memo. 1988-489, 1988 WL 
98625, 56 T.C.M. (CCH) 452, T.C.M. (P-H) 88,489 (U.S. Tax Ct., Oct 11, 
1988) (NO. 38921-84)
    96. Estate of Christmas v. C.I.R., 91 T.C. No. 49, 91 T.C. 769, Tax 
Ct. Rep. (CCH) 45,118, Tax Ct. Rep. Dec. (P-H) 91.49 (U.S. Tax Ct., Oct 
06, 1988) (NO. 12926-86)
    97. Estate of Donahoe v. C.I1988-453, 1988 WL 96218, 56 T.C.M. 
(CCH) 271, T.C.M. (P-H) 88,453 (U.S. Tax Ct., Sep 21, 1988) (NO. 28311-
85)
    98. Cokes v. C.I.R., 91 T.C. No. 19, 91 T.C. 222, Tax Ct. Rep. 
(CCH) 44,972, Tax Ct. Rep. Dec. (P-H) 91.19 (U.S. Tax Ct., Aug 15, 
1988) (NO. 7435-84)
    99. Estate of Killion v. C.I.R., T.C. Memo. 1988-244, 1988 WL 
52652, 55 T.C.M. (CCH) 1004, T.C.M. (P-H) 88,244 (U.S. Tax Ct., May 31, 
1988) (NO. 38967-84)
    100. Estate of Bartberger v. C.I.R., T.C. Memo. 1988-21, 1988 WL 
1958, 54 T.C.M. (CCH) 1550, T.C.M. (P-H) 88,021 (U.S. Tax Ct., Jan 19, 
1988) (NO. 36710-85)
    101. Estate of Di Fiore v. C.I.R., T.C. Memo. 1987-588, 1987 WL 
49178, 54 T.C.M. (CCH) 1168, T.C.M. (P-H) 87,588 (U.S. Tax Ct., Nov 25, 
1987) (NO. 3340-85)
    102. Estate of Thompson (James U.), Taylor (Susan T.) v. 
Commissioner of Internal Revenue, 89 T.C. No. 43, 89 T.C. 619, Tax Ct. 
Rep. (CCH) 44,200 (U.S. Tax Ct., Sep 17, 1987) (NO. 9879-86)
    103. McDonald (Gladys L.) v. Commissioner of Internal Revenue; 
Estate of McDonald (John), Cornelius (C.F.) v. Commissioner of Internal 
Revenue 89 T.C. No. 26, 89 T.C. 293, Tax Ct. Rep. (CCH) 44,118 (U.S. 
Tax Ct., Aug 18, 1987) (NO. 37673-84, 37694-84)
    104. Estate of Heffley (Opal P.), Heffley (Timothy S.) v. 
Commissioner of Internal Revenue, 89 T.C. No. 23, 89 T.C. 265, Tax Ct. 
Rep. (CCH) 44,103 (U.S. Tax Ct., Aug 11, 1987) (NO. 3201-85)
    105. Estate of Johnson (Curtis H.), Johnson (Kirby) v. Commissioner 
of Internal Revenue, 89 T.C. No. 13, 89 T.C. 127, Tax Ct. Rep. (CCH) 
44,048 (U.S. Tax Ct., Jul 20, 1987) (NO. 37085-85)
    106. Estate of Coffing v. C.I.R., T.C. Memo. 1987-336, 1987 WL 
40391, 53 T.C.M. (CCH) 1314, T.C.M. (P-H) 87,336 (U.S. Tax Ct., Jul 08, 
1987) (NO. 20452-81)
    107. Estate of Ward (Rebecca), Emerson (Floral), Harris (Reba) v. 
Commissioner of Internal Revenue, 89 T.C. No. 6, 89 T.C. 54, Tax Ct. 
Rep. (CCH) 44,031 (U.S. Tax Ct., Jul 08, 1987) (NO. 20600-80)
    108. Estate of Rothpletz v. C.I.R., T.C. Memo. 1987-310, 1987 WL 
49207, 53 T.C.M. (CCH) 1214, T.C.M. (P-H) 87,310 (U.S. Tax Ct., Jun 24, 
1987) (NO. 38934-84)
    109. Estate of Gunland (Carl C.), Gunland Commissioner of Internal 
Revenue, 88 T.C. No. 81, 88 T.C. 1453, Tax Ct. Rep. (CCH) 43,955 (U.S. 
Tax Ct., Jun 04, 1987) (NO. 968-85)
    110. Estate of Brandes v. C.I.R., 87 T.C. No. 33, 87 T.C. 592, Tax 
Ct. Rep. (CCH) 43,330 (U.S. Tax Ct., Sep 08, 1986) (NO. 27513-84)
    111. Estate of Gardner v. C.I.R., T.C. Memo. 1986-380, 1986 WL 
21590, 52 T.C.M. (CCH) 202, T.C.M. (P-H) 86,380 (U.S. Tax Ct., Aug 18, 
1986) (NO. 28332-83)
    112. Estate of Pliske v. C.I.R., T.C. Memo. 1986-311, 1986 WL 
21519, 51 T.C.M. (CCH) 1543, T.C.M. (P-H) 86,311 (U.S. Tax Ct., Jul 24, 
1986) (NO. 35008-04)
    113. Estate of Nesselrodt v. C.I.R., T.C. Memo. 1986-286, 1986 WL 
21992, 51 T.C.M. (CCH) 1406, T.C.M. (P-H) 86,286 (U.S. Tax Ct., Jul 14, 
1986) (NO. 24902-82)
    114. Estate of Davis v. C.I.R., 86 T.C. No. 67, 86 T.C. 1156, Tax 
Ct. Rep. (CCH) 43,105 (U.S. Tax Ct., Jun 11, 1986) (NO. 2383-82)
    115. Estate of Clinard v. C.I.R., 86 T.C. No. 68, 86 T.C. 1180, Tax 
Ct. Rep. (CCH) 43,106 (U.S. Tax Ct., Jun 11, 1986) (NO. 6345-84)
    116. Estate of Bettenhausen v. C.I.R., T.C. Memo. 1986-73, 1986 WL 
21472, 51 T.C.M. (CCH) 488, T.C.M. (P-H) 86,073 (U.S. Tax Ct., Feb 18, 
1986) (NO. 24133-82)
    117. McCoy v. C.I.R., T.C. Memo. 1985-509, 1985 WL 15131, 50 T.C.M. 
(CCH) 1194, T.C.M. (P-H) 85,509 (U.S. Tax Ct., Sep 26, 1985) (NO. 
19540-83)
    118. Estate of Rubish v. C.I.R., T.C. Memo. 1985-406, 1985 WL 
15027, 50 T.C.M. (CCH) 685, T.C.M. (P-H) 85,406 (U.S. Tax Ct., Aug 12, 
1985) (NO. 15051-81)
    119. Estate of Pullin , Black v. Commissioner of Internal Revenue, 
84 T.C. No. 52, 84 T.C. 789, Tax Ct. Rep. (CCH) 42,060 (U.S. Tax Ct., 
May 01, 1985) (NO. 18606-82)
    120. Martin by Martin v. Commissioner of Internal Revenue, 84 T.C. 
No. 40, 84 T.C. 620, Tax Ct. Rep. (CCH) 41,998 (U.S. Tax Ct., Apr 02, 
1985) (NO. 10122-82, 10740-82)
    121. Estate of Raab v. C.I.R., T.C. Memo. 1985-52, 1985 WL 14685, 
49 T.C.M. (CCH) 662, T.C.M. (P-H) 85,052 (U.S. Tax Ct., Feb 04, 1985) 
(NO. 7327-83)
    122. Estate of Flora J. Abell, Deceased, Juanita Abell Pyle, 
Executrix, Harry A. Waite, Executor, Petitioner v. Commissioner of 
Internal Revenue, Respondent, 83 T.C. No. 39, 83 T.C. 696 (U.S. Tax 
Ct., Nov 19, 1984) (NO. 24370-81)
    123. Estate of Gardner v. Commissioner of Internal Revenue, 82 T.C 
82 T.C. 989, Tax Ct. Rep. (CCH) 41,293 (U.S. Tax Ct., Jun 25, 1984) 
(NO. 28332-83)
    124. Estate of Williams v. C.I.R., T.C. Memo. 1984-178, 1984 WL 
15498, 47 T.C.M. (CCH) 1479, T.C.M. (P-H) 84,178 (U.S. Tax Ct., Apr 10, 
1984) (NO. 25089-82)
    125. Estate of Sherrod v. Commissioner of Internal Revenue, 82 T.C. 
No. 40, 82 T.C. 523, Tax Ct. Rep. (CCH) 41,084 (U.S. Tax Ct., Mar 26, 
1984) (NO. 5531-82)
    126. Estate of Young v. C.I.R., T.C. Memo. 1983-686, 1983 WL 14674, 
47 T.C.M. (CCH) 324, T.C.M. (P-H) 83,686 (U.S. Tax Ct., Nov 17, 1983) 
(NO. 29433-81)
    127. Estate of Coon v. Commissioner of Internal Revenue, 81 T.C. 
No. 32, 81 T.C. 602, Tax Ct. Rep. (CCH) 40,478 (U.S. Tax Ct., Sep 22, 
1983) (NO. 5758-81)
    128. Estate of Boyd v. C.I.R., T.C. Memo. 1983-316, 1983 WL 14302, 
46 T.C.M. (CCH) 328, T.C.M. (P-H) 83,316 (U.S. Tax Ct., Jun 06, 1983) 
(NO. 28651-81)
    129. Estate of Cowser v. Commissioner of Internal Revenue, 80 T.C. 
783, Tax Ct. Rep. (CCH) 40,054 (U.S. Tax Ct., Apr 25, 1983) (NO. 14699-
82)
    130. Estate of Geiger v. Commissioner of Internal Revenue, 80 T.C. 
484, Tax Ct. Rep. (CCH) 39,936 (U.S. Tax Ct., Mar 07, 1983) (NO. 7354-
81)
    131. Estate of Gill v. Commissioner of Internal Revenue, 79 T.C. 
437, Tax Ct. Rep. (CCH) 39,318 (U.S. Tax Ct., Sep 09, 1982) (NO. 21286-
80)
    132. Morris v. C.I.R., T.C. Memo. 1982-508, 1982 WL 10800, 44 
T.C.M. (CCH) 1036, T.C.M. (P-H) 82,508 (U.S. Tax Ct., Sep 08, 1982) 
(NO. 1144-77)
    133. Estate of Smith v. Commissioner of Internal Revenue, 77 T.C. 
326 (U.S. Tax Ct., Aug 11, 1981) (NO. 16500-79)
    134. Estate of Hankins v. C.I.R., T.C. Memo. 1981-326, 1981 WL 
10627, 42 T.C.M. (CCH) 229, T.C.M. (P-H) 81,326 (U.S. Tax Ct., Jun 24, 
1981) (NO. 8448-78)
      

                                

Exhibit 2, An Example of How To Qualify Under Section 2033A

    Aggregate Value of all qualified family owned business 
interests that are included in the gross estate and are 
acquired by or passed to a qualified heir from decedent (AV) = 
$11,000,000
    Adjusted Taxable Gifts of qualified family owned business 
interests to family members if still held by family member 
(ATG) = $2,000,000
    Gifts Not covered by Annual gift tax Exclusions made within 
3 years of death (GNAE) = $3,000,000
    Cash or marketable securities that exceed reasonably 
expected day-to-day working capital needs, i.e., Excess 
Liquidity (EL) = $1,000,000
    Total Indebtedness of decedent (TI) = $5,000,000
    Qualified acquisition indebtedness for personal residence, 
i.e. Personal residence Mortgage (Mort) = $2,000,000
    Debt to pay Education or Medical expenses (EdMed) = 
$200,000
    Other Debt up to $10,000 (OD) = $10,000
    Decedent's Gross Estate without regard to Section 2033A 
(GE) = $15,000,000
    Gifts to Spouse within 10 years of death (other than GNAE 
above) (GSP) = $1,000,000
    Nontaxable Gifts within 3 years of death (NTG) = $500,000
      

                                

[GRAPHIC] [TIFF OMITTED] T8616.052

      

                                

    Chairman Archer. Thank you, Mr. Apolinsky, for some very, 
very incisive testimony.
    Our last witness on this panel is Charles Kruse, and if you 
will identify yourself for the record, we would be pleased to 
receive your testimony.

STATEMENT OF CHARLES E. KRUSE, PRESIDENT, MISSOURI FARM BUREAU 
 FEDERATION; AND MEMBER, BOARD OF DIRECTORS,  AMERICAN  FARM  
                       BUREAU  FEDERATION

    Mr. Kruse. Thank you very much, Mr. Chairman.
    My name is Charlie Kruse. I am a fourth generation farmer 
and operate a corn, cotton, soybean, and wheat farm in Stoddard 
County, Missouri. I serve on the board of directors of American 
Farm Bureau Federation and as president of Missouri Farm Bureau 
Federation. My statement today is made on behalf of the 4.7 
million families who belong to the American Farm Bureau 
Federation.
    Production agriculture is a capital intensive industry with 
total assets of more than $1 trillion. Yet, despite its size, 
it is an industry dominated by family businesses, many of which 
are multigenerational.
    As I attend farm meetings across Missouri and the United 
States, I realize that many others like me are concerned about 
transferring our farm businesses to our sons and daughters when 
we die. Like me, they worry about the negative impact of estate 
taxes.
    When you consider that 47 percent of farm and ranch 
operators today are 55 years or older, you realize that 
agriculture is fast approaching a transformation.
    The Farm Bureau's position on estate taxes is very 
straightforward. We recommend repeal. Until repeal is possible, 
we support increasing the exemption to $2 million and indexing 
it for inflation. For assets over $2 million, the tax rate 
should be cut in half.
    Farmers and ranchers work long, hard hours over a lifetime 
to build their businesses. Along the way, they paid income 
taxes on their earnings, and it is wrong to tax those earnings 
again at death.
    Two million dollars may seem like a lot of money, but for 
many farmers and ranchers, it is simply a family business. A 
typical example of this would be a California family farm that 
may involve 1,000 or 2,000 acres. When you combine $2,400 an 
acre farmland with the value of the other business assets, the 
total worth of a farm supporting one or two families can easily 
top $2 million.
    Failure to increase the exemption discourages the 
continuation of family farms in this country. Often, farm heirs 
must sell business assets to pay estate taxes. When taxes drain 
too much capital from a farm business, the profitmaking ability 
of the farm is destroyed, and the farm business dies.
    A Missouri Farm Bureau member recently shared his story 
with me. His family's farm was purchased in 1919 for $3.50 an 
acre. Today, the farm has an appraised value of $1.7 million. 
The land, now planted with trees, happens to be located near 
the city of Branson, with its value based not on agriculture 
use but on commercial value. This family can donate the 
property to a church or even to a university with little or no 
tax liability. However, if the land is passed onto their 
children, the estate tax has been estimated at more than $\1/2\ 
million. Their heirs would be forced to sell a large portion of 
the farm just to pay the tax, bringing into question the 
economic viability of the smaller farm operation.
    The estate tax has essentially precluded this farm from 
being passed onto a fourth generation and will simply 
accelerate its transition into development and out of 
agriculture.
    While the focus of this panel is estate taxes, I would also 
like to make a comment or two regarding the capital gains tax 
because cutting this tax is also a priority for the Farm 
Bureau.
    The Farm Bureau supports repeal of capital gains taxes. 
Until repeal is possible, we support cutting the rate to no 
more than 15 percent. Also, capital gains should be indexed for 
inflation.
    Capital gains taxes result in the double taxation of income 
from capital assets. I don't know any farmers who have bought 
farmland, buildings, equipment, or livestock with untaxed 
dollars. It is wrong to tax earnings twice. The practice 
interferes with the sale of farm assets and causes asset 
allocation decisions to be made for tax reasons rather than 
business reasons.
    Capital gains taxes affect the ability of new farmers and 
ranchers to enter the industry and expand their operations. 
While many think of the capital gains tax as a tax on the 
seller, in reality, it is a tax on the buyer. Older farmers and 
ranchers are often reluctant to sell assets because they don't 
want to pay the capital gains taxes. Therefore, buyers must pay 
a premium to acquire assets in order to cover the taxes 
assessed on the seller.
    American farmers and ranchers are the most productive in 
the world, producing 16 percent of the world's food on just 7 
percent of the land. Farm and ranch productivity allows U.S. 
citizens to spend only 9.3 percent of their income on food, the 
lowest percentage in the world.
    Agriculture and related industries provide jobs for more 
than 21 million people in this country. In order for farmers 
and ranchers to continue this high level of productivity, 
reforms must be made in capital gains and estate taxes. These 
changes will benefit farmers, consumers, and the economy.
    Mr. Chairman, I thank you for the opportunity to testify 
before the Committee today and look forward to answering any 
questions you might have.
    [The prepared statement

Statement of Charles E. Kruse, President, Missouri Farm Bureau 
Federation; and Member, Board of Directors, American Farm Bureau 
Federation

    My name is Charlie Kruse. I am a fourth generation farmer 
who operates a 600-acre corn, wheat, cotton and soybean farm in 
Stoddard County, Missouri. I serve on the Board of Directors of 
the American Farm Bureau Federation and as president of the 
Missouri Farm Bureau Federation. My statement today is made on 
behalf of the 4.7 million families who belong to the American 
Farm Bureau Federation.
    Production agriculture is a capital intensive industry with 
total assets of more than $1 trillion. Yet, despite its size, 
it is an industry dominated by family businesses, many of which 
are multi-generational. Like so many of my fellow farmers, the 
operation of my business involves family members. My wife, Pam, 
and children, Scott and Ben, are my partners and, in fact, keep 
things going when I am away on Farm Bureau business.
    As I attend farm meetings across Missouri and the United 
States, I realize how many others, like me, are concerned about 
transferring our farm businesses to our sons and daughters when 
we die. Like me, they worry about the negative impact the 
capital gains tax has on the operation of our businesses. When 
you consider that 47 percent of farm and ranch operators are 55 
years or older, you realize that agriculture is fast 
approaching a transformation.
    The timing of this hearing on estate and capital gains 
taxes could not be better. The Administration's budget proposes 
expanding the exclusion of capital gains on the sale of an 
individual's principal residence and expanding the estate tax 
extension provisions for closely held businesses. While we are 
encouraged that the President raises the capital gains and 
estate tax issue, the changes he proposes are inadequate to 
address the needs of production agriculture. Narrowly targeted 
changes will not provide the relief needed by farmers, ranchers 
and other rural agricultural businesses.
    Estate and capital gains taxes greatly impact the efficient 
use of farm capital and the transfer of assets from one 
generation to another. Estate and capital gains tax reform is 
long overdue. Thank you for providing this forum where the 
reasons for reform can be put forward and for allowing me to 
speak today.

                              Estate Taxes

    Farm Bureau's position on estate taxes is straightforward. 
We recommend repeal. Farmers and ranchers work long, hard hours 
over a lifetime to build their businesses. Along the way they 
paid income taxes on their earnings and it is wrong to tax 
those earning again at death. Farmers and ranchers should be 
able to save for the future without having to worry about 
sharing the outcome of their efforts with the federal 
government after already paying a lifetime of income taxes. 
Family farms and other family businesses should be passed from 
generation to generation without complex and costly estate 
planning.
    Until repeal is possible, Farm Bureau supports increasing 
the exemption to $2 million and cutting the tax rate by half 
for assets over $2 million. The gift tax should be increased 
from $10,000 to $50,000 per year. These changes would lift the 
burden of estate taxes for thousands of farmers and ranchers. 
Internal Revenue Service figures show that by increasing the 
estate tax exemption to $1 million, over 37,000 estates, 54 
percent of the returns filed, would no longer have to file 
estate tax forms.
    A $2 million exemption would eliminate the tax on most 
farms and ranches. Failure to increase the exemption 
discourages the continuation of family farms. Often, farm heirs 
must sell business assets to pay estate taxes. When taxes drain 
capital from a farm business, the profit-making ability of the 
farm is destroyed and the farm business dies.
    The story of a Fauquier County, Virginia, farmer makes 
clear the need for estate tax reform. His wife inherited an 85-
acre beef farm that he now operates with his family. Through 
extensive estate planning and use of Section 2032A special use 
valuation, a portion of the farm was passed from father to 
daughter. The family wants to continue to farm but will be 
unable to pay the estate taxes on the mother's portion because 
the tax due will exceed their ability to pay. When asked if 
selling a part of the farm to obtain cash was an option, he 
said, There won't be much left.
    The estate tax exemption hasn't been increased since 1987. 
Since then, average prices in the U.S. economy have increased 
by 35 percent. Farm Bureau believes that the exemption should 
be increased to $2 million and indexed for inflation. This 
would provide the same protection from inflation as is provided 
by the adjusting of income tax brackets, personal exemptions 
and the standard deduction.
    Two million dollars may seem like a lot of money to some. 
But for many farmers and ranchers, it is simply a family 
business. According to USDA estimates, average farmland  in  
California  in  1996  was  valued  at  about  $2,400  an  acre. 
 A  multi-generation family farm may involve 1,000-2,000 acres. 
One thousand acres of land at $2,400 per acre is worth $2.4 
million. That doesn't include buildings, livestock, farm 
equipment and other assets whose value would easily be worth 
another third of a million dollars on a 1,000-acre farm.
    Some people argue that estate taxes do not impact small 
business if estate planning is effectively used. While 
sometimes effective at protecting farm businesses from estate 
taxes, estate planning tools and life insurance are costly and 
constantly drain resources that could be better used by farmers 
and ranchers to upgrade and expand their operations.
    The situation of an orchard and farm market operation in 
Allegheny County, Pennsylvania, illustrates this point. Knowing 
that the estate tax burden will be great, this family operation 
of a mother, father and four children has developed an estate 
plan requiring money to be set aside for estate taxes. The 
amount of money that the business puts into a trust each year 
is almost as great as the individual earnings of each of the 
children. According to the family, this significantly reduces 
funds for things that the farm could use to operate more 
efficiently, like equipment purchases and building 
improvements.
    The Virginia and Pennsylvania examples show that the estate 
tax is not a tax on the rich, as opponents of estate tax cuts 
argue, but rather a penalty on middle-class men and women who 
chose to make their living by operating their own businesses. 
Internal Revenue Service data from 1995 clearly shows that 
those with the greatest worth are also the best at using estate 
tax planning to reduce or eliminate taxes at the time of death.
    While farmers spend hundreds of hours and thousands of 
dollars for estate plans and life insurance, relatively little 
revenue is generated for the federal government. In fact, 
Internal Revenue Service figures for 1995 show 54 percent of 
returns (37,000 estates) had assets of less than $1 million and 
generated only $650 million. The estate tax raised a total of 
about $17.2 billion in fiscal year 1996, as reported by the 
Office of Management and Budget. But, the estate tax can also 
cause huge revenue losses. People who believe they will be 
subject to the estate tax seek ways to transfer assets to avoid 
the tax. That often includes investing in less productive 
assets that reduce taxable income in the short term.
    It follows that one of the reasons that revenue collected 
from the estate tax is low is that not very many people pay the 
tax. During 1995, 31,565 estates paid estate taxes. This is 
roughly 1.4 percent of the estimated 2.3 million adults who 
died that year. Opponents of estate tax reform say there is no 
reason to change a tax that affects so few middle-income 
Americans. But each death affects children,  grandchildren  and 
 other  close  family  members.  The  impact  is  greatest  for 
 multi-generation family farms and ranches and other family 
businesses.
    Farm Bureau supports changes in Section 2032A of the tax 
code that allows land to be appraised at its agricultural value 
for estate tax purposes. While beneficial to farms that operate 
near towns and parks, the amount that land value can be reduced 
is limited to $750,000. Use valuation is sound public policy 
and the limit should be removed so that the program can be 
applied to all farm and ranch land.
    In addition, Section 2032A requires that the land be kept 
in agricultural production and operated by the heirs for 10 
years. The rules have become so complex that some choose not to 
use the program because they fear they may not be able to 
comply with all the rules. Farm Bureau recommends improvements 
in the law so that cash leasing to family members and the 
harvest of timber does not trigger the recapture of estate 
taxes.
    Farm Bureau also supports the deferral of estate taxes 
until a farm is sold outside the family. In addition, land 
protected by a conservation easement or participating in a 
farmland preservation program should not be subject to estate 
taxes.

                          Capital Gains Taxes

    Farm Bureau supports repeal of capital gains taxes. Until 
repeal is possible, Farm Bureau supports cutting the rate to no 
more than 15 percent. Capital gains taxes result in the double 
taxation of income from capital assets. I don't know any 
farmers who have bought farmland, buildings, equipment or 
livestock with untaxed dollars. It is wrong to tax earnings 
twice. In addition, the tax interferes with the sale of farm 
assets and causes asset allocation decisions to be made for tax 
reasons rather than business reasons. The result is the 
inefficient allocation of scarce capital resources, less net 
income for farmers and reduced competitiveness in international 
markets.
    Farmers need capital gains tax relief in order to ensure 
the cost and availability of investment capital. Access to 
affordable capital influences agriculture's ability to compete 
with overseas production. Most farmers and ranchers have 
limited sources of outside capital. It must come from 
internally-generated funds or from borrowing from financial 
institutions. The capital gains tax reduces the amount of money 
available for reinvestment by farmers and ranchers. Financial 
institutions look closely at financial performance, including 
the impact of the capital gains tax on the profit-making 
ability of a business.
    Capital gains taxes affect the ability of new farmers and 
ranchers to enter the industry and expand their operations. 
While many think of the capital gains tax as a tax on the 
seller, in reality it is a penalty on the buyer. Older farmers 
and ranchers are often reluctant to sell assets because they do 
not want to pay the capital gains taxes. Buyers must pay a 
premium to acquire assets in order to cover the taxes assessed 
on the seller. These higher costs for asset acquisition 
negatively impact the ability of new and expanding farmers and 
ranchers to make a profit and compete in international markets.
    Farm Bureau supports adjusting capital gains for inflation 
so that only real gains in the value of assets would be taxed. 
Under current law, many farmers and ranchers pay an effective 
tax rate that is extreme and sometimes end up paying more in 
capital gains taxes than the increase in the real value of the 
assets. Farmers and ranchers are reluctant to sell land and 
farm assets and reinvest in other assets, even when that may 
make the best business sense. For assets held for long periods 
of time, adjusting their value for inflation is a matter of 
fairness.
    Farmland provides a good example. Farmers and ranchers on 
average hold farmland for about 30 years. In 1966, farmland in 
Missouri was selling for an average of $142 per acre. In 1996, 
the average was $948. A farmer who bought 300 acres of land in 
1966 for $42,600 and sold it in 1996 would have a taxable gain 
of $241,800 and owe $67,704 at a 28 percent tax rate. Average 
prices in the U.S. economy are now 4.26 times what they were 30 
years ago. This means that the real increase of value on those 
300 acres was $102,924, making the effective tax rate on the 
real capital gain 66 percent.
    Farm Bureau supports allowing receipts from the sale of 
farm and ranch assets to be placed directly into a pre-tax 
individual retirement savings account (IRA). Withdrawals would 
be taxed at the regular applicable income tax rate. Farm and 
ranch assets accumulated over a lifetime are often the 
``retirement plan'' for farmers and ranchers. Allowing these 
funds to be placed into a pre-tax account would treat farmers 
and ranchers in the same manner as other taxpayers who 
contribute to IRAs throughout their working life.
    A similar result for yearly income could be achieved by 
allowing farmers and ranchers to establish individual risk 
management accounts. Taxes on money placed in these accounts 
would be deferred, as with IRAs. Farmers and ranchers could 
manage risk by saving during profitable years for those years 
that are not. Funds would be taxed at the holder's regular tax 
rate at withdrawal. Because farmers and ranchers could save 
money before taxes in high-income years and draw that money out 
in low-income years, they would pay taxes at a rate similar to 
people earning the same aggregate amount with more stable 
incomes.
    Farm Bureau also believes that the current once-in-a 
lifetime exclusion of $125,000 on the sale of a primary 
residence by a taxpayer over 55 years of age should be 
increased to $500,000 and expanded to include farms and 
ranches. The exclusion should not be limited to a single use by 
a taxpayer over age 55 and, if not used, should be added to an 
individual's estate tax exemption.

                               Tax Reform

    Farm and ranch concerns over capital gains taxes and estate 
taxes raise many questions about the need to fundamentally 
reform the current tax system. Consideration should be given to 
a new and different taxing systems that encourage savings, 
investment and entrepreneurship. Changes are needed to simplify 
tax laws, reform Internal Revenue Service rules and regulations 
and simplify tax forms. Fundamental tax reform which completely 
replaces the current personal income tax and corporate income 
tax should eliminate estate taxes and capital gains taxes.

                               Conclusion

    American farmers and ranchers are the most productive in 
the world, producing 16 percent of the world's food on just 7 
percent of the land. Farm and ranch productivity allows U.S. 
citizens to spend only 9.3 percent of their income on food, the 
lowest percentage in the world.
    Agriculture and related industries provide jobs for more 
than 21 million people. Nearly 3.5 million people operate farms 
or work on farms. Another 3.6 million produce the machinery and 
inputs used on the farm or process and market what farmers 
produce. More than 14 million work in wholesale or retail 
businesses helping get farm products from the farm to 
consumers.
    In order for farmers to continue this high level of 
productivity, reform of estate tax and capital gains tax laws 
is needed without delay. The results will benefit farmers, 
consumers and the economy.
      

                                

    Chairman Archer. Thank you, Mr. Kruse.
    I compliment each of you for your testimony. We would 
prefer to go on to the questioning, but I want it to be clear 
in the record that when I came to Congress in 1971, I had the 
goal of repeal of the estate tax, now the death tax, which is 
what we should all call it today because that is what it is, 
and the repeal of the capital gains tax, completely and 
totally. We haven't gotten that done in the 26 years that I 
have been in the Congress, but I think we are closer today than 
we have ever been toward that ultimate goal.
    I fear that we will not get it by incremental changes in 
the current Income Tax Code, and that is one of the reasons why 
I have made the decision that the only way to go is to abolish 
the income tax and abolish the death tax, completely and 
totally, and replace it with a tax on consumption.
    This country should not have any taxes on capital savings 
anywhere on the books if we want to prosper and create jobs and 
a better opportunity for Americans in the years to come.
    In one fell swoop, we could eliminate all of it by 
eliminating the corporate income tax, the individual income 
tax, and the death tax. We are in a tax trap in the United 
States today. The longer you work, the harder you work, the 
more you pay to the Government; and the more you pay to the 
Federal Government, the more the Congress spends, and then the 
sequence continues, and the more they spend, the more you have 
to work and the longer you have to work and the more you have 
to pay. It shouldn't be that way. It should be that the more 
you spend, the more you pay, which is a far fairer system. But 
my goal is to completely get rid of the capital gains tax, the 
death tax, and to get the IRS completely and totally out of the 
lives of every individual American.
    I particularly applaud Mr. Apolinsky because it takes a 
true patriot to come before this Committee and argue against 
his own personal best financial interest. That is very rare, 
indeed, in this country, and I compliment you for that.
    I don't have any questions of you because we are in 
harmony. It is just a question of how much we can get done, but 
I am sure there are other Members of the Committee that would 
like to inquire.
    Mr. Hulshof.
    Mr. Hulshof. Thank you, Mr. Chairman.
    First of all, we appreciate your testimony. Mr. Kruse, in 
particular, you and I have known one another for years, and I 
see that you have got a strong contingent from the show-me 
State that are here to support your efforts, and it is great to 
see some constituents and others from the show-me State here.
    As you know, Charlie, as the only son of a Missouri farm 
family, I know firsthand some of the effects of the death tax, 
and particularly as those of us who have worked for the 
American dream, suddenly that American dream turning into a 
nightmare as we wake up to the fact of whether it is small 
business or having to liquidate its assets or having to sell 
off a piece of farm and having it auctioned on the auction 
block just to pay the Federal Government.
    I know our family, as well as many other hard-working men 
and women across this country, have invested not only our 
money, but our hearts and souls into something that we would 
like to pass on as a legacy to our descendants. We have taken 
the risks. We have navigated those treacherous straits of 
regulations, and then, just as we see open seas and hopefully 
calmer waters ahead of us, then the Federal Government sends a 
tidal wave crashing over our bows, and there we go.
    So I appreciate, Mr. Kruse, all you and the Farm Bureau are 
doing to help us get that message out across the country, and 
the rest of you as well.
    Mr. Danner, I also note from your testimony you mentioned 
section 6166 and the loan program. I am a bit disappointed with 
the administration's proposal just to expand this loan program. 
I have spoken personally to members of the administration that 
this does not nearly provide the tax relief we need in this 
area. Each of us, I think, probably brings horror stories to 
bear, but just this past weekend, when I was back home in the 
District, an individual, a 64-year-old man, told me about the 
fact he was in his 10th year of an installment loan that he had 
to take out just to pay the tax, and he is disabled and now is 
looking to pass on that small business to his son, and that he 
was trying to create some innovative way so that his son would 
not have to rely upon taking out a loan to pay the tax bill.
    As a final comment, maybe a couple of questions, Mr. 
Apolinsky, and this is the kind of information I have been 
looking for as far as the actual amount of moneys. You 
mentioned the Kennesaw State College study regarding the 
Associated Equipment Distributors, and I note that--is it just 
for that AED group, that about $5 million was spent in life 
insurance premiums and another $6.5 million on lawyers and 
accountants and other services?
    Mr. Apolinsky. Yes.
    Mr. Hulshof. Any data or survey information? Can we 
extrapolate that number out across the United States in some 
sort of an estimate? Do any of you have that information as to 
how much money hard-working families either spend on insurance 
policies or that hire your services, Mr. Apolinsky, or others 
in an effort to legally try to avoid the estate tax? Do we have 
a figure or an estimate as to how much money we have to expend 
in that regard?
    Mr. Apolinsky. I have never seen that number quantified. It 
is, as you anticipate, a huge industry today. If you combine 
the accounting fees, the legal fees, the financial planning 
fees, the last-to-die life insurance, which is only sold for 
estate taxes--I have got a client. He told me I could share 
with you his story.
    He is a bottler in Birmingham. In order to try to get the 
business through the third generation, they have purchased $180 
million of last-to-die life insurance. The premium is $1.5 
million after tax. Now, that business has stopped expansion.
    It used to expand, provide more jobs, but that was the seed 
money that they use for leverage to expand, and they are no 
longer able to expand.
    I see it as they did in Australia. In Australia, they 
repealed the estate tax in 1977 because they wanted family 
businesses, farms, capital to grow larger to provide jobs. I 
really see that as businesses are sold and liquidated and farms 
are sold, jobs are lost. We are not redistributing wealth, but 
concentrating ownership in some large multinational companies 
that are not affected by this tax. This tax is costing a lot of 
jobs. It will be amazing over the next 20 years how many jobs 
will be lost from this tax if we don't grab it now. I certainly 
applaud what the Chairman said. Hopefully, we are so close to 
getting it repealed. It is an exciting time from my 
perspective.
    Mr. Crane. Mr. Hulshof, would you yield for just a second?
    Mr. Hulshof. I would be happy to yield.
    Mr. Crane. I think it was Investors Business Daily, in a 
January publication, that indicated that estate tax compliance 
costs are estimated to be 65 cents for every dollar of revenue 
in.
    Mr. Hulshof. If the Chairman would yield just for a final 
comment.
    Mr. Crane, I appreciate the opportunity to join with you as 
a new Member as we have introduced our own bills to completely 
repeal the death tax.
    Mr. Chairman, this is, of course, my first term, and I 
certainly hope it doesn't take as long to get to that final 
result as it has from your first term. I appreciate the 
opportunity.
    Thank you, panelists.
    Chairman Archer. Does any other Member wish to inquire?
    Mr. Ramstad.
    Mr. Ramstad. Very briefly, Mr. Chairman.
    I want to thank the witness from Missouri for sending us 
our newest Member who is doing an outstanding job on the Ways 
and Means Committee, and also, I want to thank you, Wayne 
Nelson, for being here today from Minnesota and for all the 
excellent work you do back home. I appreciate your contribution 
to this effort.
    I think working together in a collaborative way as we are, 
we can get it done this year. So, we really appreciate your 
being here and your help in this regard.
    Thank you, Mr. Chairman.
    Chairman Archer. I might say that Mr. Crane, who just 
commented briefly, has been here slightly longer than I have, 
and he has been trying even longer than I have to repeal the 
death tax and the capital gains tax.
    Mr. Crane. You have from the beginning.
    Chairman Archer. Gentlemen, thank you very much for your 
testimony. It has been exceedingly helpful. We wish you a good 
day, and we hope we don't have to see you back here again.
    Mr. Whelan. Thank you, Mr. Chairman.
    Mr. Danner. Thank you.
    Chairman Archer. Our next panel will prepare to take seats 
at the witness table; James Higgins, Paul Yakoboski, Bennie 
Thayer, and William Gale.
    Welcome, gentlemen. As I said earlier, if you will make 
every effort to limit your verbal testimony to 5 minutes, your 
entire written statement will be printed in the record.
    Mr. Thayer, would you like to lead off? Identify yourself 
for the record, and then we will be pleased to receive your 
testimony.

STATEMENT OF BENNIE L. THAYER, PRESIDENT, NATIONAL ASSOCIATION 
   FOR THE SELF-EMPLOYED; ON BEHALF OF SAVINGS COALITION OF 
                            AMERICA

    Mr. Thayer. Thank you very much, Chairman Archer. I am 
Bennie L. Thayer. I am president of NASE, the National 
Association for the Self-Employed. The NASE represents more 
than 325,000 very small businesses, and these businesses 
generally have between zero to four employees. The rest are 
self-employed individuals that run their own businesses. They 
reside in all 435 of the congressional districts.
    I also appear here today on behalf of the Savings Coalition 
of America. This is a coalition of 65 member organizations 
supporting incentives to increase personal savings.
    The NASE and the Savings Coalition, Mr. Chairman, are 
committed to expanding individual retirement accounts. We 
strongly support the features of H.R. 446, the Savings and 
Investment Incentive Act of 1997.
    As you are all aware, and especially you, Mr. Chairman, the 
rate of personal saving in the United States has significantly 
decreased in the past three decades, from 8 percent in the 
sixties to about 4 percent to date. This is the lowest it has 
been in the United States since World War II.
    When compared to the other industrialized nations, the rate 
of personal savings in the United States is one of the lowest.
    Saving is also a key component of the National Economic 
Policy. Increased personal saving rates not only benefit 
individual Americans, but also provide the economy with the 
investment capital it needs to grow. More saving equals more 
funds available for lending, and for those of us in small 
business, that represents more money for loans.
    Let us talk about small business and retirement for the 
moment. Retirement income comes from three source: First of 
all, Social Security; second, pensions; and third, personal 
savings.
    We don't know what Social Security will be like in 20 
years, that is for sure, but it is very unlikely that today's 
structure of benefits and tax levels can be maintained.
    What about the pensions? Despite the good work of this 
Committee, Mr. Chairman, and the others in Congress last year, 
when you passed the SIMPLE plan, the plain truth is that the 
kind of entrepreneurs we represent within the NASE typically do 
not have pensions. And that is a fact. Our members just don't 
have pensions, nor do a great many of other small businesses in 
America.
    That leaves personal savings as the third category for 
retirement. We have surveyed our NASE members on retirement 
plans. Over 60 percent--60 percent of these typical smallest of 
small business people have put away less than $50,000 for their 
retirement, and 40 percent have saved less than $20,000. This 
is even true for people who are now in their fifties. Yet, a 
typical length of retirement today is about 15 years. Now, it 
doesn't take a lot of higher mathematics to see that many small 
business people are going to be in big trouble if we don't get 
them to save more and to save more soon.
    Due to the income limits on IRAs and the Tax Reform Act of 
1986, IRA contributions have dropped by more than 40 percent 
among those who continue to be eligible for tax-deductible 
IRAs, largely because aggressive IRA marketing has declined. 
IRAs have declined and have been restricted since 1986.
    Before 1986 when tax-advantaged IRAs were available to 
everyone, banks, mutual funds, brokerage houses, and insurance 
companies all competed to sell savings. We need to have this 
happen again in America. We really need to have this happen 
again. An IRA that is available to all Americans will make it 
happen again, and we firmly believe that.
    The Savings Coalition and the NASE urges lawmakers to keep 
IRAs simple and easy to understand. Therefore, we firmly 
support H.R. 446.
    Mr. Chairman, in conclusion, let me simply say this to you. 
Regarding the tax benefits from the $2,000 cap that presently 
exists for IRAs, you will hear that it is really there for the 
rich. We say to you here today that for many Americans, that 
$2,000 represents their only chance to save. It is for that 
reason we support and ask you and this Committee to firmly get 
behind H.R. 446 and assert to you today that we will do 
everything within our power to support you.
    Thank you.
    [The prepared statement and attachment follow:]

Statement of Bennie L. Thayer, President, National Association for the 
Self-Employed; On Behalf of Savings Coalition of America

    Good Morning. My name is Bennie L. Thayer, and I am the 
President of the National Association for the Self-Employed. I 
submit this testimony on behalf of the Savings Coalition of 
America. The Savings Coalition consists of 65 member 
organizations representing the interests of tens of millions of 
American savers. Established in 1991, the Savings Coalition 
membership includes a wide variety of interests including 
consumer, health care, education and business groups, 
engineers, home-builders, realtors, trust companies, banks, 
securities firms, insurance, and financial service companies. 
The Savings Coalition supports incentives to increase the rate 
of personal saving in the United States.

                Expanded Individual Retirement Accounts

    When Americans retire they rely on three sources of 
income--Social Security, pensions and personal savings. 
Individual Retirement Accounts (IRAs) fall in the category of 
personal savings. The Savings Coalition is committed to seeking 
the enactment of expanded IRA legislation and strongly supports 
the features of H.R. 446, The Savings and Investment Incentive 
Act of 1997. The Savings Coalition believes that tax and 
economic policy should provide more opportunity and incentive 
for Americans to save and invest for their futures. The Savings 
and Investment Incentive Act of 1997 has features that provide 
incentives and opportunities to save for all Americans. It also 
provides the intangible values of responsibility and self-
reliance for people through those provisions.

   Council for Economic Development Findings of Americas Retirement 
                               Situation

    In May 1995, the Council for Economic Development (CED) 
released its report entitled, Who Will Pay For Your Retirement? 
The Looming Crisis. In its findings, the CED found that this 
countrys retirement system is in dire straits and unless 
corrective action is taken soon, America will be confronting a 
major economic crisis. The CED report concluded that Americas 
retirement system is underfunded, overregulated, and soon to be 
challenged by unprecedented growth in the retirement-age 
population. Consequently, our nation will confront a major 
crisis in financing the needs of the elderly at the beginning 
of the twenty-first century unless policies are reformed to 
make retirement saving a top priority. One of the 
recommendations of the CED is the implementation of tax 
incentives and regulatory reform to encourage individual 
retirement saving and to achieve increased funding of, and 
coverage by, private pensions. H.R. 446 provides all Americans 
with the savings incentives for retirement which are critical 
when one considers the problems illuminated by the CED in its 
report.

                Low Rate of Saving in the United States

    Saving is a key component of economic policy. Increased 
personal saving rates not only benefit individual Americans, 
but also provide the economy with the investment capital it 
needs to grow. Improving the saving rate increases the nations 
store of funds available for lending that helps small 
businesses when they need loans.
    The rate of personal saving in the United States has 
significantly decreased in the past three decades--from 8% in 
the 1960s to hovering around 4% today. This current rate is the 
lowest it has been in the United States since World War II. 
When compared to other industrialized nations, the rate of 
personal saving in the US is one of the lowest. Americans are 
saving less than one-half as much as the Germans and one-third 
as much as the Japanese. We can do something about the low rate 
of saving by taking a bite out of our federal deficit. But, we 
must also do something to change peoples attitudes towards 
savings. The universally available IRA is the best vehicle we 
currently have to get that done.
    Over the past several years, a significant amount of 
academic research on the effectiveness of IRAs has been 
published. Top academic economists have found that IRAs 
increase saving. The list includes Martin Feldstein (Harvard), 
David Wise (Harvard), Treasury Deputy Secretary Lawrence 
Summers (former Harvard economist), James Poterba (MIT), Steven 
Venti (Dartmouth), Jonathan Skinner (University of Virginia), 
Richard Thaler (Cornell) and Glenn Hubbard (Columbia).
    It is less well-known that, because of the low personal 
saving rate in the US, America has become increasingly 
dependent on foreign investors to finance the US debt. 
Regardless of the progress made toward balancing the budget, 
the US must still finance an outstanding debt of more than $5 
trillion by selling Treasury securities. In the past few years, 
foreign investors have become the dominant force in the market 
for these Treasury securities.
    According to an analysis conducted by the Securities 
Industry Association, in 1995, for instance, net purchases of 
US Treasury notes and bonds by foreigners reached $134 billion. 
The analysis further revealed that in 1996 the pace of foreign 
acquisitions of Treasury securities accelerated. According to 
the US Department of Treasurys Office of Market Finance, at the 
end of 1996, foreigners owned 31.6% of the total private 
holdings of US Treasury securities, up from 21.7% at the end of 
1994.
    This trend means that the favorable interest rate 
environment that we have enjoyed in the US is vulnerable to the 
vagaries of investing by foreigners. If they substantially 
reduced their purchases of US Treasury securities, the interest 
rate on such securities would probably rise and accordingly so 
would interest rates on corporate bonds as well as mortgages 
and bank loans. In other words, a key component of economic 
health in the US is heavily influenced by the investment 
decisions of foreign savers.

               IRAs Should be Available to All Americans

    An interesting effect of the implementation of income 
limits on universally available IRAs in the Tax Reform Act of 
1986 is that IRA contributions have dropped by more that 40% 
for those who continued to be eligible for deductible IRAs. The 
decline in IRA contributions is partially attributed to 
misunderstanding on the part of Americans as to their 
eligibility for IRAs and a decline in marketing of IRAs by 
financial institutions. Before 1986, the IRA worked to increase 
savings because we had banks, mutual funds, brokerage houses 
and insurance companies competing to sell savings. Instead of 
selling goods, Madison Avenue was selling investment. Universal 
availability of IRAs--a savings incentive available to 
everyone--is what led to the advertising of IRAs in the mid-
80s. This is the kind of advertising we need again if we are to 
get people refocused on the importance of saving. An IRA that 
is available to all Americans will reduce confusion on the part 
of individuals and increase the marketing of IRAs on the part 
of financial institutions. The Savings Coalition urges 
lawmakers to keep IRAs simple and easy to understand. Limiting 
IRA eligibility confuses people and scares them away from 
establishing a pattern of savings that IRAs would otherwise 
promote.
    The Savings and Investment Incentive Act of 1997 benefits 
all Americans--it gives an incentive to everyone who wants to 
take advantage of it. The first home withdrawal features and 
the IRA Plus account are very attractive to the young, even if 
they do not have children. The education expansion provides a 
strong incentive for people with children. The expanded 
retirement savings vehicles in both the traditional IRA and the 
IRA Plus are popular with people in their 50s and early 60s who 
see retirement just around the corner.

    Expanded IRAs Enjoy Broad Support and are Popular with Americans

    Expansion of IRAs is not only an area of agreement on both 
sides of the aisle in Congress, but also down Pennsylvania 
Avenue between Congress and the White House. The 1996 
Republican and Democratic National Platforms included expanded 
IRAs.
    In December 1995 and May 1996, the Savings Coalition 
commissioned polls of registered voters regarding their 
preference of items included in the tax cut proposals. In the 
December 1995 poll conducted by Lake Research, 7 out of 10 
registered voters said they would increase their rate of 
personal saving if IRAs were expanded to allow Americans to 
save. Also, middle class Americans choose expanded IRAs above a 
child tax credit and the capital gains tax cut as the tax 
proposal the country should adopt first. In May 1996 a 
bipartisan poll was conducted by Lake Research and the Luntz 
Research Companies. The results of the poll indicated that more 
than 6 out of 10 American voters (64%) claimed that they would 
increase their rate of personal saving if IRAs were expanded to 
allow more Americans to save. In addition, the heart of the 
American workforce, voters aged 30 to 64 favored the expansion 
of IRAs (35%) to a cut in capital gains or a child tax cut.
    In February 1997, the NASDAQ Stock Market, a member of the 
Savings Coalition, surveyed investors and potential investors. 
An interesting finding of the survey is that those who are 
investing their money are relying on their personal investments 
to fund their retirement. Forty-one percent of investors say 
that most of the money for their retirement will come from 
savings and investments, while just twenty-nine percent say it 
will come from a retirement plan (25%) or Social Security (4%). 
Americans plan to save and invest more for their retirement and 
the provisions in H.R. 446 will provide them with an incentive 
to do that.
    In a 1995 poll conducted by Dr. Frank Luntz of Luntz 
Research Companies for Merrill Lynch, one of the members of the 
Savings Coalition, it was revealed that an overwhelming 
majority of Americans do not believe that Social Security or 
Medicare will provide them with peace of mind in retirement. 
The poll also found that a majority of Americans feel that 
government policies do not encourage retirement saving. Similar 
to the results of the polls conducted by the Savings Coalition, 
this poll found that among the various proposed forms of tax 
relief, Americans believe that expanding the IRA should be the 
highest priority.
    Other members of the Savings Coalition have conducted polls 
with similar results. In August 1995, Dean Witter, Discover; 
Company conducted a survey of its clients on their attitudes 
and behaviors towards savings, preparing for retirement and 
opinions towards the IRA legislation being considered. Most of 
the clients felt that the current tax laws do not encourage 
enough savings and that the expansion of IRAs proposed by 
Congress would encourage them to save more for retirement. 
Another interesting finding in the survey is that the primary 
reason cited by Dean Witter clients for not contributing to an 
IRA is the lack of tax advantages for doing so. In a poll 
conducted by the Institute of Electrical and Electronic 
Engineers (United States) of its members, the majority of the 
respondents favored expanded IRA provisions. In one day, 
through an 1-800 number sponsored by USA Today and manned by 
the International Association for Financial Planning, a member 
of the Savings Coalition, 73,000 phone calls were made 
requesting help with retirement planning. This is from a total 
circulation of 2 million. These results reveal that Americans 
are very concerned about their retirement. Provisions in H.R. 
446 give them the incentive to help themselves.
    By making the IRA available to all income levels, H.R. 446, 
The Savings and Investment Incentive Act of 1997, encourages 
all Americans to save. For those who claim that the benefits of 
expanded IRAs should be directed to Americans at certain income 
levels, the members of the Savings Coalition would like to 
point out that (1) the saving rate in this country is low and 
all Americans should be provided with incentives to save, and 
(2) the IRA contribution is limited to $2000. The tax benefits 
from this $2000 cap may not mean much to a high-income person--
it is a small tax break for them. However, the benefits for 
everyone else that flow from universal availability (and the 
resultant advertising) will more than offset the small tax 
break for higher income individuals. Increasing the eligibility 
of IRAs for Americans is a good public policy that is popular 
with the American people, Congress and the White House.
      

                                

[GRAPHIC] [TIFF OMITTED] T8616.020

      

                                

    Chairman Archer. Thank you, Mr. Thayer.
    Our next witness is James Higgins. If you will identify 
yourself for the record, we would be pleased to receive your 
testimony.

 STATEMENT OF JAMES F. HIGGINS, PRESIDENT AND CHIEF OPERATING 
    OFFICER, DEAN WITTER FINANCIAL, NEW YORK, NEW YORK; AND 
 CHAIRMAN, BOARD OF DIRECTORS, SECURITIES INDUSTRY ASSOCIATION

    Mr. Higgins. Thank you, Mr. Chairman.
    I am Jim Higgins, president and chief operating officer of 
Dean Witter Financial, a unit of Dean Witter Discover Card. Mr. 
Chairman, thank you for inviting me here to testify today on 
the savings and investment provisions in President Clinton's 
1998 budget.
    I am testifying before you today in my capacity as chairman 
of the board of directors of the Securities Industry 
Association.
    Before I summarize SIA's position, I respectfully ask that 
you include my full written statement, along with a copy of an 
SIA-sponsored study on IRAs in the record of this hearing.
    Chairman Archer. That will occur.
    Mr. Higgins. Thank you.
    Mr. Chairman, SIA commends you for holding this hearing. 
The securities industry shares your commitment for a balanced 
budget, sooner rather than later. We believe there is room in a 
balanced budget, however, for incentives to help all Americans 
save and invest for retirement security.
    Congress will consider few issues that are more important 
than helping Americans repair for their retirements, especially 
when you consider the following. The U.S. savings rate is at an 
all time low. There are legitimate questions about Social 
Security and employer sponsored pension plans as the primary 
source of retirement income in the not too distant future. The 
baby boom generation is not saving enough for a secure 
retirement, even though the oldest among them will turn 65 in 
just 15 years. The next generation of retirees will spend as 
many years in retirement as they did working.
    In light of these trends, Congress has a tremendous 
opportunity to make a difference in every American's life by 
giving them tools they can use to save enough to retire without 
worry. IRAs are a savings incentive with a proven record of 
success.
    Mr. Chairman, I have spent my entire year, more than 25 
years, at Dean Witter. My firm's client base is primarily 
individual investors, the people who stand to benefit the most 
from an enhanced IRA.
    I served as a branch office manager during the eighties and 
can attest firsthand to the popularity of IRAs among our 
clients. According to industry statistics, one in six families, 
many with incomes under $50,000, contributed annually to IRAs 
when they were widely available. IRAs worked because they were 
simple. Anyone could make a tax deductible contribution up to 
$2,000 into an account that grew tax free until retirement.
    In 1986 the Tax Reform Act transformed IRAs from a simple, 
easy-to-understand investment to a more complex, less 
accessible account. IRAs are not an attractive investment 
option for many individuals because they have very low income 
caps for deductible contributions. Eligibility is tied to an 
individual or their spouses belongs to another plan, and there 
are high penalties for withdrawals, for whatever reason. 
Research shows, however, that people would contribute to an IRA 
if they were widely available again.
    In a survey of Dean Witter clients, we found that nearly 
two-thirds are worried about their household's future financial 
condition and whether they will outlive their retirement 
savings. A large number of our clients have IRAs and many of 
them still make contributions. But among those who no longer do 
so, the overwhelming majority cited either the lack of tax 
advantage or participation in other 401(k) type plans as their 
primary reasons for stopping. When asked what would make them 
start again, two-thirds answered ``restoring universal 
availability on a fully tax deductible IRA, regardless of 
income.''
    Recent experience has shown that our clients respond to 
positive changes in IRA. Last year, after Congress increased 
the amount, a nonworking spouse could contribute to the full 
$2,000. The industry has experienced a notable increase in new 
IRA applications. We thank you for making this positive change 
in the law. SIA encourages you to build on this accomplishment 
with further enhancements to IRAs this year.
    We are encouraged that the President included an expanded 
IRA in his budget. His proposal addresses some of the 
shortcomings of the current law by raising the income cap, 
indexing the contribution limit to inflation, and creating a 
flexible back-end IRA account. In our opinion, his proposal 
falls short of restoring the IRA to a simple, universally 
acceptable investment option. In addition, with its 5-year 
sunset, it cannot possibly stimulate enough savings to provide 
Americans with a secure retirement.
    Instead, Mr. Chairman, SIA is pleased to support the 
Thomas-Neal Super IRA Proposal. It brings the universal 
availability, fully deductible IRA ``out of retirement.''
    The Super IRA will do a number of things. It will restore 
simplicity to the process. It will take inflation into account 
by indexing the $2,000 annual contribution. It will add 
flexibility by creating a back-end IRA that allows savers to 
make nondeductible contributions up front in exchange for tax-
free withdrawals after retirement.
    It will also appeal to younger people that will benefit by 
being allowed withdrawals for major life events, like buying a 
new home and college tuition.
    SIA commends the sponsors, Mr. Thomas and Mr. Neal, for 
their leadership. The bill has broad bipartisan support, with 
over 100 cosponsors. The Super IRA is the type of savings 
incentive that Americans want and need.
    In conclusion, Mr. Chairman, I want to thank you for 
holding this hearing and calling attention to the importance of 
savings and investment as an integral part of the balanced 
budget process.
    I appreciate the opportunity to share SIA's views with you. 
We stand ready to work with you to restore the IRA as an 
investment option for all Americans, and I would be happy to 
answer questions you may have.
    [The prepared statement follows. The article, ``Journal of 
Economic Perspectives,'' is being retained in the Committee 
files.]

Statement of James F. Higgins, President and Chief Operating Officer, 
Dean Witter Financial; and Chairman, Board of Directors, Securities 
Industry Association

    Chairman Archer, Mr. Rangel, members of the Committee, good 
morning. I am James Higgins, Chairman of the Board of Directors 
of the Securities Industry Association,\1\ and President and 
Chief Operating Officer of Dean Witter Financial, a business 
unit of Dean Witter, Discover; Co. Thank you for inviting me 
here today to talk about the savings and investment incentives 
in President Clinton's fiscal 1998 budget. SIA commends you for 
holding this hearing. Congress will consider few issues of 
greater importance than helping Americans save for a secure 
retirement.
---------------------------------------------------------------------------
    \1\ The Securities Industry Association brings together the shared 
interests of more than 760 securities firms throughout North America to 
accomplish common goals. SIA members--including investment banks, 
broker-dealers, specialists, and mutual fund companies--are active in 
all markets and in all phases of corporate and public finance. In the 
U.S., SIA members collectively account for approximately 90 percent, or 
$100 billion, of securities firms' revenues and employ about 350,000 
individuals. They manage the accounts of more than 50-million investors 
directly and tens of millions of investors indirectly through 
corporate, thrift, and pension plans. (More information about SIA is 
available on its home page: http://www.sia.com.)
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    We are not saving enough to remain globally competitive in 
the long-term as a nation or financially secure as individuals. 
The Clinton Administration's budget contains proposals to 
encourage savings and investment through improved Individual 
Retirement Accounts (IRAs) and narrowly targeted capital gains 
tax cuts. SIA believes the Administration is on the right track 
with these proposals, but ultimately that they will not 
encourage the levels of savings and investment needed for 
national economic growth and personal retirement income 
security.
    Mr. Chairman, your colleagues on the Committee have 
introduced legislation, H.R. 446, that would help all Americans 
save for retirement. SIA commends the sponsors--Mr. Thomas and 
Mr. Neal--for their leadership. Similarly, we salute 
Representative English, who, together with Representatives 
Dreier, Hall, Moran and McCarthy, introduced H.R. 14--a broad-
based capital gains tax cut that treats all assets equally. 
Both bills have attracted bipartisan support, with many co-
sponsors lined up across both sides of the aisle. SIA fully 
supports these measures and urges Congress to enact them as 
part of an overall plan to balance the budget by 2002.

                        The U.S. Savings Crisis

    The United States faces a saving crisis. Americans today 
are saving less than at almost any time since World War II. The 
personal savings rate has plummeted from 8 percent of 
disposable income in 1970 to only about 4.9 percent in 1996. In 
fact, American households currently save less than half as much 
as those in Britain and Germany and a third as much as those in 
Japan and France.
    This drop in personal savings has driven the decline in 
U.S. national savings (defined as the sum of all savings by 
households, businesses, and government), a fact some have 
failed to recognize. Many policy makers believe that the fall 
in national savings can be attributed to federal budget 
deficits. To the contrary, statistics reveal that the fall in 
personal savings has been a larger contributor to the drop in 
national savings during the last 25 years than has been the 
increase in the budget deficit. Net national savings fell from 
an average of 8.5 percent of net national product during the 
1970s to 4.7 percent during the 1980s, and to only 2.4 percent 
so far during the 1990s.\2\
---------------------------------------------------------------------------
    \2\ Economic Report of the President. U.S. Department of Commerce.
---------------------------------------------------------------------------
    The overall economy and individual Americans alike are 
being hurt by this drop-off in savings. At the national level, 
the savings crisis saps the fuel for long-term growth, because 
domestic savings is a vital source of capital for domestic 
investment. In today's economy, the fall in personal savings 
from 8 percent to 4 percent represents a loss of roughly $200 
billion of capital that could have been put to work in the U.S. 
economy. The cost of losing this capital is evident in the 
steady declines of U.S. domestic investment. While domestic 
investment averaged about 8 percent of NNP from the 1950s 
through the 1970s, it fell to 6.1 percent in the 1980s and has 
fallen further to just 3.1 percent so far in the 1990s. By 
limiting investment in the American economy, the saving crisis 
slows business growth and keeps living standards from rising.
    The impact of the savings crisis is personal, as well as 
national. As SIA member firms witness every day in our dealings 
with clients across the U.S., low savings has direct and 
serious implications for individual families. Simply stated, 
Americans are not saving enough for a secure retirement. A 
recent study of household finances found that half of all 
American households has less than $1,000 in net financial 
assets.\3\ Current trends indicate the likelihood that in the 
next century, many Americans will spend as much time in 
retirement as they did working. Moreover, the amount of 
retirement income considered adequate is increasing because of 
early retirements, longer life expectancies, and escalating 
health care costs. These concerns are even more pronounced when 
you consider that the first of the 76 million baby boomers will 
reach retirement age in just 15 years. Research shows that this 
generation is woefully unprepared for the future--on average, 
they are saving at about one-third the rate necessary to 
maintain a comfortable standard of living in retirement.\4\
---------------------------------------------------------------------------
    \3\ Anderson, Joseph M. The Wealth of American Families in 1991 and 
1993. Capital Research Associates, December 1994. The study also found 
that even older families, headed by individuals ages 45 to 54, had only 
$2,600 in median net financial assets.
    \4\ Bernheim, Douglas B. The Merrill Lynch Baby Boom Retirement 
Index. Merrill Lynch, 1994. Dr. Bernheim compared the rate the Baby 
Boomers are actually saving with what they should be saving in order to 
retire at age 65 with the same standard of living they enjoyed during 
their pre-retirement years. An Index of 100 percent would mean that 
Baby Boomers are saving at the rate needed to retire at a consistent 
standard of living. Dr. Bernheim's calculations place the Index at 35.9 
percent, a little more than one-third the minimum rate.
---------------------------------------------------------------------------
    At the same time, fewer Americans believe they can depend 
on the government or their employer as their primary source of 
retirement income. The Nasdaq Stock Market, in a recent 
investor survey, found that 41 percent of investors believe 
that most of the money for their retirement will come from 
personal savings and investment. In contrast, only 25 percent 
are relying on a retirement plan, and just 4 percent on Social 
Security to make up the bulk of their retirement income.\5\ 
This is a remarkable shift in attitude--when SIA testified on 
these issues in 1993, only 11 percent of Americans believed 
personal savings would be their prime source of retirement 
income.
---------------------------------------------------------------------------
    \5\ Peter D. Hart Research Associates, A National Survey Among 
Stock Investors: Conducted for The Nasdaq Stock Market. February 1997.
---------------------------------------------------------------------------
    For our part, SIA has taken the initiative to educate 
Americans about the importance of savings and investment. We 
developed two publications to help people make sense of 
available investment options. The first--Investor Topics--is a 
pamphlet that answers the basic questions people have when they 
start investing. The second--Your Guide to Understanding 
Investment--is a comprehensive and accessible guide that walks 
the reader through the risks and rewards of investing. We have 
also worked with the Securities and Exchange Commission in 
their well-received series of investor town meetings across the 
country.

                       Solving the Savings Crisis

    Mr. Chairman, SIA believes America's economic future hinges 
in large part on solving the savings crisis. Increased savings 
is vital both to prepare the overall economy for strong growth 
into the next century and to provide American households with 
greater financial security today and into retirement. Expanding 
IRAs would be a giant step toward reviving America's savings 
habit. Congress started down this road last year, with passage 
of the ``spousal IRA,'' which increases the amount a non-
working spouse can contribute to an IRA to $2,000. SIA commends 
you for making this enhancement to the law. Already, it is 
making an impact--the industry is seeing a significant upswing 
in IRA applications since the law was signed last October.\6\ 
This shows that Americans do respond to improvements in IRAs. 
SIA urges you to build on what you started and further expand 
and simplify IRAs for all Americans.
---------------------------------------------------------------------------
    \6\ SIA is currently surveying its membership to determine the full 
effect of the spousal IRA provisions on the market. Results of this 
survey will be available later this year.
---------------------------------------------------------------------------

                               IRAs Work

    The restriction of IRAs played an important role in the 
decline of U.S. savings. Indeed, the drop in annual IRA savings 
is equal to about 40 percent of the decline in annual personal 
savings since 1986. Annual IRA contributions peaked in 1985, at 
just over $38 billion. They have fallen every year since, 
reaching a level of just $8 billion in 1993.\7\ If the IRA had 
not been curtailed by the Tax Reform Act of 1986, we 
conservatively estimate that the total pool of IRA assets would 
be $400 billion larger than it is today. SIA believes that a 
revitalized IRA will be popular with the American people, will 
lift the personal and national savings rates, and will provide 
an important middle class tax cut.
---------------------------------------------------------------------------
    \7\ Hubbard, R. Glenn and Jonathan Skinner. The Effectiveness of 
Savings Incentives: A Review of the Evidence, Paper sponsored by the 
Faculty Research Fund of the Graduate School of Business of Columbia 
University and the Securities Industry Association. January 1995.
---------------------------------------------------------------------------
    Popular Support. IRAs enjoy exceptional public support. In 
fact, a survey conducted shortly after the 1994 Congressional 
election found that IRAs were the single most popular tax 
proposal included in the Republican Contract With America that 
year.\8\ Despite the strong support for IRAs in Congress and by 
the Administration, Americans do not believe Washington is 
helping them save for retirement. Fully 70 percent of baby 
boomers disagree with the statement, ``The government 
encourages me to save.'' \9\ Market research conducted by 
Opinion Research on behalf of Dean Witter supports this point. 
We found that nearly two-thirds of our clients said they would 
put money into an IRA if their contributions were tax 
deductible.
---------------------------------------------------------------------------
    \8\ The Luntz Research Companies. February Omnibus Survey II: 
Budget, Superfund, Medicare; Defense. February 22-23, 1995.
    \9\ Engin, Eric M., William G. Gale, and John Karl Scholz. Do 
Savings Incentives Work? Brookings Papers on Economic Activity. 1:1994.
---------------------------------------------------------------------------
    New Savings. Furthermore, IRAs represent new savings, and 
are not simply assets shifted from one account to another. 
Professors Glenn Hubbard of Columbia University and Jonathan 
Skinner of the University of Virginia performed an extensive 
analysis of the research on IRAs and savings patterns. They 
concluded that a ``conservative estimate of the effect of IRAs 
on personal saving would be about 26 cents per dollar of IRA 
contribution.''\10\
---------------------------------------------------------------------------
    \10\  Hubbard and Skinner. Op. cit.
---------------------------------------------------------------------------
    Cornell University economist Richard Thaler contends it 
doesn't matter if money is shifted into an IRA from other 
savings because the withdrawal penalties make it much more 
likely that savings in an IRA will accumulate over time. 
``Money in a savings account can be splurged on a new car, but 
money in an IRA is likely to stay put,'' Dr. Thaler 
observed.\11\ IRAs will increase long-term savings because they 
get money into an account where funds cannot be quickly spent, 
even if the funds would have been saved anyway in another type 
of savings account.
---------------------------------------------------------------------------
    \11\ Thaler, Richard H. Psychology and Savings Policies. AEA Papers 
and Proceedings. May 1994. Page 186.
---------------------------------------------------------------------------
    Benefit the Middle Class. Improved IRAs will benefit the 
middle class. From 1982-1986, IRAs were overwhelmingly used by 
middle-income Americans. At the peak of the IRA's popularity in 
1985 and 1986, 75 percent of IRA contributions were made by 
Americans with incomes under $50,000. The IRA income limits 
established in 1986 were not indexed for inflation, which is 
why IRA eligibility continues to decline sharply. Among workers 
whose spouses also work, 53 percent were eligible for a full 
IRA deduction in 1987. This fell to 45 percent in 1991 and only 
38 percent in 1995.\12\
---------------------------------------------------------------------------
    \12\ Employee Benefit Research Institute. Individual Saving for 
Retirement. EBRI Fact Sheet. September 1995.
---------------------------------------------------------------------------
    The Tax Reform Act of 1986 transformed IRAs from a simple 
investment option into a more complex product with many 
eligibility requirements which limits its attractiveness. When 
the eligibility requirements were tightened and the accounts 
became more complex, financial institutions curtailed their 
advertising. This is an important point, because advertising 
contributed significantly to the widespread popularity of IRAs 
during the early 1980s. A simple, universally available IRA 
would undoubtedly encourage financial institutions to run 
advertisements encouraging savings. This, in turn, will succeed 
in getting many clients who used to contribute to IRAs back in 
to the ``saving habit,'' as well as lead many new savers to 
open IRA accounts. Indeed, Deputy Treasury Secretary Lawrence 
Summers said such an increase in advertising ``could encourage 
families to focus their energies on developing a savings plan, 
even if they do not open IRAs.'' \13\
---------------------------------------------------------------------------
    \13\ Testimony of Lawrence H. Summers, Deputy Secretary of the 
Treasury, before the Senate Committee on Finance. March 6, 1997.
---------------------------------------------------------------------------
    You only need to look as far as Canada to see how 
significant a change in the advertising message can be. Walk 
down a city street, and you will see financial institutions 
advertising the opportunity to save in a Canadian tax-preferred 
account. Contrast that message of savings with the U.S., 
however, where our financial services firms most often promote 
more and better ways to borrow. The difference is striking, and 
borne out in the fact that the household saving rate in Canada 
is more than twice that of the United States. By restoring the 
fully deductible IRA, Congress can literally change the 
advertising message reaching the passer-by on countless streets 
across America. The promotional efforts surrounding an improved 
IRA would reemphasize the importance of savings to U.S. 
consumers.

                       SIA Supports the Super IRA

    SIA believes IRAs must be universally available, simple to 
understand, must not penalize individuals who participate in 
other retirement plans, and must not tie non-wage-earning 
spouses' eligibility to whether their spouse has a pension 
plan. The Administration's proposal is a good start toward 
improving IRAs, but falls short of the mark on each of these 
principles. The Administration doubles the current income caps 
for deductible contributions to $50,000 for individuals and 
$80,000 for couples. Although this is an improvement over 
current limits, it is still not high enough to capture many 
middle income families with two wage-earners.
    The biggest problem with the Administration's IRA, however, 
is its five-year sunset. Americans need a permanent solution to 
the savings crisis--five years is not long enough to accumulate 
sufficient savings for a comfortable retirement. In fact, 
taxpayers who open a back-end IRAs under the President's 
proposal would never get to take advantage of it's key 
feature--tax deductible withdrawals after retirement--unless 
they were at least 55 when they opened the account.
    SIA believes Representatives Thomas' and Neal's ``Super 
IRA'' proposal contained in H.R. 446 achieves our goals. Unlike 
the President's plan, anyone--regardless of income or pension 
plan or marital status--may make an annual $2,000 tax-
deductible contribution to an IRA. This contribution limit is 
indexed to inflation.
    The Thomas-Neal Super IRA proposal also creates a new kind 
of IRA with a ``back end'' tax incentive. This feature would 
allow savers to make deposits to the account from after-tax 
dollars, while qualified withdrawals would be tax free. 
Although ``back-end'' savings incentives and traditional 
``front-end'' savings incentives are economically equivalent, 
we believe the back-end account can offer important new 
flexibility to Americans. We are pleased H.R. 446 gives 
Americans the option to choose the type of account that best 
suits their needs.
    Furthermore, the expanded withdrawal features of the Super 
IRA may attract savers who might not otherwise contribute to an 
IRA. In particular, these features will appeal to younger 
savers who--in addition to retirement--need a vehicle to save 
for major expenses, such as a down payment on a first home or 
college tuition.
    Mr. Chairman, a revitalized IRA would create a vast pool of 
new savings in the American economy. We believe that 
contributions to a new and popular IRA program could accumulate 
to more than $1 trillion in the first 10 years of the program. 
These funds would represent not only $1 trillion in capital for 
new investment by U.S. business, but also a $1 trillion nest 
egg for American families. The federal budget would be a huge 
beneficiary of increased savings, as the accumulation of 
savings could lead to lower interest rates in the long run. 
According to the Congressional Budget Office, every 50-basis-
point drop in interest rates would save the government more 
than $25 billion annually in lower interest payments on 
outstanding government debt alone.

            Reducing the Tax Code's Bias Against Investment

    The present tax system contributes to the savings crisis. 
With few exceptions, taxes are imposed twice--first when salary 
and wage income are earned, and again, when interest and 
dividends on the investment financed by savings are received. 
Corporate profits are taxed first at the corporate level, and 
again after they are distributed to shareholders as dividends. 
Capital gains are also singled out for harsh treatment--all 
taxpayers except those in the highest tax brackets pay the same 
rate for capital gains as ordinary income; inflationary gains 
are subject to taxation; and though taxpayers must pay taxes on 
all gains, they are allowed to deduct only $3,000 in capital 
losses annually. The individual or company that saves and 
invests pays more taxes over time than if all money were spent 
on consumption and no saving took place.
    In addition, the U.S. taxes capital gains more harshly than 
almost any other industrialized nation. An OECD survey of 12 
industrialized countries found that the U.S.'s capital gains 
tax rate on long-term gains on securities is higher than all 
countries except Australia and the U.K. Those countries, 
however, index the cost basis of the asset. The countries 
surveyed also treat corporate capital gains more favorably than 
the U.S. Not surprisingly, most of these countries have higher 
national and personal savings and investment rates than the 
U.S.\14\
---------------------------------------------------------------------------
    \14\ Organization for Economic Cooperation and Development. OECD 
Economic Outlook 57, June 1995, Annex Table 26, page A-29. Countries in 
the OECD survey included the U.S., Japan, Australia, Belgium, Canada, 
France, Germany, Hong Kong, Italy, the Netherlands, Sweden, and the 
United Kingdom.
---------------------------------------------------------------------------
    Lower Cost of Capital. Taxes on income from investment 
raise the cost of capital of new, productive investment for 
both individuals and corporations. Studies show that the user 
cost of capital for most types of productive equipment would be 
15 percent lower if the Tax Reform Act of 1986 had not been 
enacted. Moreover, a capital gains tax rate in the range of 15 
to 20 percent would reduce the cost of capital by 4 to 8 
percent. Lowering the cost of capital will encourage businesses 
to make the kinds of investment in plant and equipment, 
research and development, and new technologies that increase 
productivity and create new jobs.
    Encourage Small Business and Entrepreneurs. A lower cost of 
capital is especially important for small businesses. According 
to the U.S. Small Business Administration, small businesses 
employ 53 percent of the private work force in the U.S., 
contribute 47 percent of all sales in the country, and are 
responsible for 50 percent of the gross domestic product. Of 
the 3.3 million new jobs created in 1994, an estimated 62 
percent were produced by small businesses. Clearly, this is a 
growing sector of the economy--indeed, the number of small 
businesses has increased by almost 50 percent since 1982, with 
800,000 new businesses incorporated in 1995 alone.
    Many small businesses are newer, riskier enterprises that 
do not have the same financing options or flexibility as 
Fortune 500 companies. Much of the start-up money comes from 
investors, venture capital pools, family members, and 
acquaintances. Because these investors' return is in 
appreciated stock, lower capital gains taxes will make people 
more willing to risk their savings on new ventures. High 
capital gains taxes, on the other hand, frustrate would-be 
entrepreneurs and reduce the rate of return for investors.
    Benefit All Investors. Capital gains tax cuts would benefit 
all investors. Individuals are investing in the capital markets 
as never before. More than one-third of all adult Americans 
owns stock either directly or indirectly though a mutual fund, 
corporate savings program, or a defined retirement contribution 
plan. Investors now have more of their liquid financial assets 
in capital market investments than in bank accounts. This cuts 
across all income levels--IRS statistics show that more than 
half of all returns reporting capital gains are from households 
with incomes below $50,000. These statistics are not surprising 
when you consider that 60 percent of households in this income 
range own mutual funds.
    Increased Revenue. Not only will lower capital gains taxes 
encourage savings, investment, and entrepreneurship, they will 
also bring in more revenue for the government in the long run. 
There is an abundance of anecdotal evidence of investors who 
hold on to assets that they would otherwise sell simply to 
avoid paying capital gains taxes. Lower rates would ``unlock'' 
this capital by giving investors incentive to sell these 
assets.
    Beyond the anecdotes, however, every time Congress lowered 
capital gains tax rates in the past, the Treasury saw an 
increase in revenues. For example, from the years 1978 to 1985, 
the marginal federal tax rate on capital gains was cut from 
almost 50 percent to 20 percent. At the same time, total 
individual capital gains tax receipts increased from $9.1 
billion to $26.5 billion. Revenue estimates do not fully 
consider the unlocking effect or other positive macroeconomic 
effects (i.e., lower cost of capital, greater productivity, 
increased jobs, stronger economy) when predicting that lower 
capital gains taxes will be a money loser for the Treasury.

            SIA Supports Broad-Based Capital Gains Tax Cuts

    SIA supports a broad-based capital gains tax cut that 
treats all investors and assets equally. The President's 
proposal, however, only allows individuals to exclude up to 
$250,000 profit from the sale of their home from capital gains 
taxes. The amount of the exclusion rises to $500,000 for 
couples. We believe this provision is far too narrow to produce 
the considerable economic benefits that will result from a 
broad-based cut. In addition, the President's budget includes 
two proposals that will raise the effective tax rates on 
securities transactions. SIA is opposed to the average cost 
basis and short against the box proposals, and believes they 
should be deleted from the budget at the outset.\15\
---------------------------------------------------------------------------
    \15\ SIA appeared before the Ways and Means Committee on March 12, 
1997, to discuss its views on the revenue raising provisions in the 
President's budget. SIA's testimony for that hearing sets out in detail 
its opposition to 14 tax proposals in the budget, including average 
cost basis and short against the box.
---------------------------------------------------------------------------
    Other proposals have been introduced in Congress to target 
certain investments for favorable capital gains treatment or to 
compute the rate on a sliding scale based on how long the 
investor has held the asset. While both of these types of 
proposals have some merit, SIA believes they do not go far 
enough. The sliding scale approach would counteract some of the 
effects of inflation and reward long-term investors. These 
benefits, however, will be far outweighed by the complexity and 
administrative burdens of different rates. In addition, tying 
the tax rate to the length of time an asset is held draws 
arbitrary lines that will distort investment decisions as much 
as the current high rate.
    Targeted tax cuts also draw arbitrary lines. Though we 
understand the policy behind encouraging investments in small 
business, venture capital, real estate, enterprise zones, and 
farms, targeted cuts will not produce the same impact on the 
economy as a broad-based cut. They are also unfair to holders 
of ineligible assets. In recent testimony before the Senate 
Finance Committee, former Federal Reserve Board Chairman Paul 
Volcker said, ``The trouble is targeted reductions require 
rather arbitrary distinctions, add greatly to administrative 
complexity, and generate essentially unproductive efforts to 
artificially meet the favored tax criteria.'' \16\
---------------------------------------------------------------------------
    \16\ Statement of Paul A. Volcker before the Senate Committee on 
Finance. March 13, 1997.
---------------------------------------------------------------------------
    Legislation has been introduced in Congress, however, that 
meets our objectives for a capital gains tax cut. H.R. 14, 
introduced by Representative Dreier, together with Mr. English, 
Mr. Moran, Mrs. McCarthy, and Mr. Hall, provides for an across 
the board 50-percent exclusion for capital gains on assets held 
longer than a year. Under their proposal, the top individual 
capital gains rate would be reduced to 14 percent, while the 
rate would fall to 7.5 percent for taxpayers in the lowest tax 
bracket.
    The broad-based cuts in H.R. 14 make good economic sense--
they will lower the cost of capital and help reduce the tax 
code's bias against savings and investment. Broad-based cuts 
are also fair to all income groups and all sectors of the 
economy. And finally, SIA believes H.R. 14 will be at least 
revenue neutral. As investors ``unlock'' existing capital 
gains, they will make the types of investment that expand 
businesses, create jobs, and spur economic growth.

                               Conclusion

    In conclusion, Mr. Chairman, SIA commends you once again 
for your emphasis on savings and investment in the context of a 
balanced budget. Thank you for allowing me to share the 
securities industry's views on these vitally important 
subjects. Expanded IRAs and broad-based tax capital gains tax 
cuts will go a long way toward increasing the savings rate in 
the U.S., encouraging Americans to save for their retirements, 
and expanding the economy. SIA looks forward to working with 
you as you consider the role savings and investment incentives 
will play in the debate.
      

                                

    Chairman Archer. Thank you, Mr. Higgins.
    Our next witness is Dr. Paul Yakoboski. Did I get that 
pronunciation pretty close?
    Mr. Yakoboski. Yes, you did.
    Chairman Archer. We are happy to have you before the 
Committee, and if you will identify yourself for the record, we 
will be pleased to receive your testimony.

    STATEMENT OF PAUL J. YAKOBOSKI, PH.D., SENIOR RESEARCH 
         ASSOCIATE, EMPLOYEE BENEFIT RESEARCH INSTITUTE

    Mr. Yakoboski. Thank you, Mr. Chairman.
    My name is Paul Yakoboski. I am a senior research associate 
at the Employee Benefit Research Institute, a nonprofit, 
nonpartisan, public policy research organization based in 
Washington, DC.
    EBRI has been committed since its founding in 1978 to the 
accurate statistical analysis of economic security issues. 
Through our research, we strive to contribute to the 
formulation of effective and responsible health and retirement 
policies. Consistent with our mission, we do not lobby or 
advocate specific policy solutions.
    I am pleased to appear before you this afternoon to discuss 
issues of individual retirement accounts and alternative tax-
qualified retirement savings plans.
    The original objective in establishing IRAs was to provide 
a tax-deferred retirement savings vehicle for those workers who 
did not have an employment-based retirement plan. However, the 
fact is that the vast majority of workers eligible for a tax-
deductible IRA contribution do not contribute.
    According to our tabulations of 1993 current population 
survey data, the latest data available, 89 percent of single 
workers are eligible for a deductible IRA contribution, but 
only 5 percent of these contribute. Fifty-six percent of dual-
income couples are eligible for a deductible IRA contribution, 
but only 10 percent of these contribute. Seventy-two percent of 
single-income couples are eligible for a deductible IRA 
contribution, but only 9 percent of these contribute. 
Participation rates are higher for those with greater incomes, 
but still, the highest participation rate is 27 percent among 
single workers with annual incomes of $50,000 or more.
    Alternatives to IRAs exist that allow workers to save money 
for retirement on the same tax-deferred basis enjoyed by fully 
deductible IRA contributions. Such plans include the Federal 
thrift savings plan, private sector 401(k) plans, SIMPLE plans 
for small employers, public sector 457 plans, and 403(b) plans 
for certain charitable organizations, public school and 
university systems. These plans, referred to here as salary 
reduction plans, are the employment-based, tax-qualified plans 
offered at an employer's discretion and, therefore, are not 
available to all workers.
    Differences between IRAs and salary reduction plans include 
the amount that can be contributed on a tax-deductible basis, 
which is typically much higher through a salary reduction plan 
than with an IRA. Salary reduction contributions may, however, 
be limited by nondiscrimination standards, while IRAs are not 
subject to such standards.
    Some salary reduction plans allow loans to participants, 
while IRAs are prohibited from offering loan features. IRA 
money can be withdrawn at any time for any purpose, but it is 
typically subject to a 10-percent penalty tax, in addition to 
income taxation if withdrawn before age 59\1/2\.
    Penalty-free IRA withdrawals can now be made to pay medical 
expenses that exceed 7.5 percent of a taxpayer's adjusted gross 
income. If a salary reduction plan does not allow loans or 
withdrawals, a worker cannot access funds in his account until 
he leaves that employer.
    Salary reduction plans continue to grow as an important 
element of the employment-based retirement income system. 
According to our tabulations of the 1993 CPS, 65 percent of 
workers with an employer who sponsors such a plan choose to 
contribute, and this figure is up from 55 percent 5 years 
earlier.
    Why are participation rates among eligibles so much higher 
for employment-based salary reduction plans than with IRAs? A 
likely reason is that participation in a salary reduction plan 
is generally more convenient. Since it is offered through the 
workplace, it involves automatic contribution deductions from a 
worker's paycheck.
    Also, plan sponsors typically market the plan to their 
employees and educate them as to the importance of saving for 
their retirement income security through the plans. Employer-
matching contributions are also available in many salary 
reduction arrangements.
    Finally, it is possible that some workers who are eligible 
for a tax-deductible IRA contribution may not be aware of their 
eligibility or they may not appreciate the inherent tax 
advantages offered by an IRA.
    Thank you.
    [The prepared statement and attachments follow:]

Statement of Paul J. Yakoboski, Ph.D., Senior Research Associate, 
Employee Benefit Research Institute

    I am pleased to appear before you this morning to discuss 
issues of individual retirement accounts (IRAs) and alternative 
tax-qualified retirement saving plans. My name is Paul 
Yakoboski. I am a senior research associate at the Employee 
Benefit Research Institute (EBRI), a nonprofit, nonpartisan, 
public policy research organization based in Washington, DC.
    EBRI has been committed, since its founding in 1978, to the 
accurate statistical analysis of economic security issues. 
Through our research we strive to contribute to the formulation 
of effective and responsible health and retirement policies. 
Consistent with our mission, we do not lobby or advocate 
specific policy solutions.

                               IRA Usage

    Through enactment of the Employee Retirement Income 
Security Act of 1974 (ERISA), Congress established IRAs to 
provide workers who did not participate in employment-based 
retirement plans an opportunity to save for retirement on a 
tax-deferred basis. U.S. tax law has substantially changed the 
eligibility and deduction rules for IRAs since then. The 
Economic Recovery Tax Act of 1981 (ERTA) extended the 
availability of IRAs to all workers, including those with 
pension coverage. The Tax Reform Act of 1986 (TRA '86) retained 
tax-deductible IRAs for those who did not participate in an 
employment-based retirement plan (and if married, whose spouse 
did not participate in such a plan), but restricted the tax 
deduction among those with a retirement plan to individuals 
with incomes below specified levels. In addition, TRA '86 added 
two new categories of IRA contributions: nondeductible 
contributions, which accumulate tax free until distributed, and 
partially deductible contributions, which are deductible up to 
a maximum amount less than the $2,000 maximum otherwise 
allowable. The Small Business Job Protection Act of 1996 
increased the amount that may be contributed on a deductible 
basis on behalf of a nonworking spouse (if the working spouse 
is eligible for a deductible contribution) from $250 to 
$2,000.\1\
---------------------------------------------------------------------------
    \1\ Under current law, individuals who are not active participants 
(and, if married, whose spouse is not an active participant) in a 
qualified employment-based retirement plan can make fully tax-
deductible contributions up to a $2,000 maximum per year to an 
individual retirement account (IRA). Individuals who are active 
participants or whose spouse is an active participant in a qualified 
employment-based plan and whose adjusted gross income (AGI) does not 
exceed $25,000 (single taxpayers) or $40,000 (married taxpayers filing 
jointly) may make a fully deductible IRA contribution. Individuals who 
are active participants or whose spouse is an active participant in a 
qualified employment-based plan and whose AGI falls between $25,000 and 
$35,000 (single taxpayers) and between $40,000 and $50,000 (married 
taxpayers filing jointly) may make a fully deductible IRA contribution 
of less than $2,000 and a nondeductible IRA contribution for the 
balance, as follows. The $2,000 maximum deductible contribution is 
reduced by $1 for each $5 of income between the AGI limits. Individuals 
who are active participants or whose spouse is an active participant in 
a qualified employment-based plan and whose AGI is at least $35,000 
(single taxpayers) or at least $50,000 (married taxpayers filing 
jointly) may only make nondeductible IRA contributions of up to $2,000; 
earnings on the nondeductible contribution are tax deferred until 
distributed to the IRA holder. The Small Business Job Protection Act of 
1996 increased the amount that may be contributed on a deductible basis 
on behalf of a nonworking spouse (if the working spouse is eligible for 
a deductible contribution) from $250 to $2,000. Thus a single earner 
couple, if eligible for a fully deductible IRA contribution, may 
contribute $4,000. IRAs can also be established as rollover vehicles 
for lump-sum distributions from employment-based retirement plans or 
other IRAs.
---------------------------------------------------------------------------
    The overwhelming majority of those workers eligible to make 
a tax-deductible contribution to an IRA currently choose not to 
do so. This is true among single workers and among married 
couples (both one earner and two earner couples). And it is 
true across income groups, although those with higher incomes 
are more likely to contribute when eligible (table 1).
    According to EBRI tabulations of the April 1993 Current 
Population Survey employee benefits supplement (CPS-ebs), in 
1992, 89 percent of all single workers were eligible to make an 
IRA contribution that was at least partially tax deductible. 
All such workers earning less than $35,000 (86 percent of 
single workers) were eligible. In addition, 22 percent of 
single workers earning between $35,000 and $49,999 and 20 
percent of those earning $50,000 or more were eligible for a 
deductible IRA contribution.
    Among single workers, only 5 percent of those eligible for 
a deductible IRA contribution actually contributed to an IRA in 
1992. The likelihood of making a contribution increased with 
worker earnings. Only 1 percent of those eligibles making less 
than $10,000 contributed, compared with 27 percent of those 
making $50,000 or more.
    Fifty-six percent of married couples with both spouses 
working were eligible to make an IRA contribution that was at 
least partially tax deductible. All such couples with combined 
incomes of less than $50,000 were eligible, and 10 percent of 
those with combined incomes greater than $50,000 were eligible. 
Among eligible two earner couples, 10 percent made an IRA 
contribution in 1992. Among eligible two earner couples, the 
likelihood of making a contribution increased with the couples' 
income. Among couples with a combined income of less than 
$10,000, essentially none contributed, while 23 percent of 
couples making $50,000 or more made an IRA contribution.
    Married couples with one earner are more likely than those 
with two earners to be eligible for a deductible IRA 
contribution. Seventy-two percent of single earner couples were 
eligible to make an IRA contribution that was at least 
partially tax deductible. This included 100 percent of those 
earning less than $35,000, 22 percent of those earning $35,000 
to $49,999 and 16 percent of those earning $50,000 or more. 
Among eligible single earner couples, 9 percent made an IRA 
contribution in 1992. Six percent of those making less than 
$10,000 made a contribution, compared with 22 percent of those 
making $50,000 or more.
    While IRAs were created to allow individuals without an 
employment-based retirement plan to save for retirement on a 
tax-deferred basis, the fact is that the vast majority of those 
eligible to make tax-deductible contributions to an IRA choose 
not to do so. It is often speculated that this is due to a lack 
of money, but even among higher earning workers, those who are 
eligible for a deductible IRA still do not, in general, 
participate. It is also often speculated that individuals are 
reluctant to tie up their savings in a vehicle where it is 
beyond their reach, without significant tax penalties, should 
they need the money before retirement.\2\
---------------------------------------------------------------------------
    \2\ Distributions from IRAs are taxed as ordinary income in the 
year received, except for the portion of the total IRA distribution 
that is attributable to nondeductible contributions, which are 
excludable from gross income. Taxable distributions prior to age 59\1/
2\ are subject to a 10 percent penalty tax, unless they are taken as 
part of a series of equal payments made for the life (or life 
expectancy) of the IRA owner and his or her beneficiary, or the IRA 
owner dies or becomes disabled.
---------------------------------------------------------------------------

                         Salary Reduction Plans

    Alternatives to IRAs exist that allow workers to save money 
for retirement on the same tax-deferred basis enjoyed by fully 
deductible IRA contributions. These plans, referred to here as 
salary reduction plans, are offered through work at an 
employer's discretion, and therefore are not available to all 
workers. However, when they are available to workers, they do 
have some advantages relative to IRAs as a retirement wealth 
accumulation tool. These are discussed shortly.
    Salary reduction plans include 401(k) plans, 457 plans, 
403(b) plans, and the federal Thrift Savings Plan (TSP). The 
Revenue Act of 1978 permitted employers to establish 401(k) 
arrangements, named after the Internal Revenue Code (IRC) 
section authorizing them. In 1981, the Internal Revenue Service 
(IRS) issued the first set of proposed regulations covering 
such plans. These proposed regulations provided some 
interpretive guidelines for sec. 401(k) and specifically 
sanctioned ``salary reduction'' plans. Through 401(k) 
arrangements, participants may contribute a portion of 
compensation (otherwise payable in cash) to a tax-qualified 
employment-based plan. Typically, the contribution is made as a 
pretax reduction in (or deferral of) salary that is paid into 
the plan by the employer on behalf of the employee.\3\ In many 
cases, an employer provides a matching contribution that is 
some portion of the amount contributed by the employee, 
generally up to a specified maximum. The employee pays no 
federal income tax on the contributions or on the investment 
earnings that accumulate until withdrawal. Some plans also 
permit employee after-tax contributions; the earnings on these 
contributions are also not taxed until withdrawal.
---------------------------------------------------------------------------
    \3\ The Tax Reform Act of 1986 placed a $7,000 limit on pretax 
employee contributions to private-sector 401(k) plans. This limit was 
indexed to the consumer price index beginning in 1988. The 1997 limit 
is $9,500.
---------------------------------------------------------------------------
    Public-sector employers can establish deferred compensation 
plans under IRC sec. 457; charitable organizations qualified 
under IRC sec. 501(c)(3) (for example, a tax-exempt hospital, 
church, school, or other such organization or foundation) and 
public school systems and public colleges and universities can 
establish tax-deferred annuity plans under IRC sec. 403(b). The 
1983 Social Security Amendments required that a new civil 
service retirement system be established to cover federal 
employees hired after December 31, 1983. The Federal Employees 
Retirement System (FERS), which Congress adopted in 1986 and 
which went into effect in January 1987, combines Social 
Security, a defined benefit pension plan, and an optional tax-
deferred thrift plan similar to a private-sector 401(k) 
arrangement. Employees hired before the end of 1983 were given 
the option of joining the new system or remaining in the old 
Civil Service Retirement System (CSRS) during a six-month 
period ending in December 1987.\4\
---------------------------------------------------------------------------
    \4\ The thrift plan is available to workers covered by either FERS 
or CSRS, but different rules apply to the two groups. FERS employees 
are automatically covered under the thrift plan, and the government 
contributes the equivalent of 1 percent of pay for each employee 
whether or not the individual contributes. Employees may make further 
contributions of up to 10 percent of base salary (up to the same dollar 
maximum as 401(k) plans). The government will then match, dollar for 
dollar, the first 3 percent of employee contributions and 50 percent of 
the next 2 percent, with no match beyond 5 percent. CSRS participants 
may contribute up to 5 percent of their salaries to the thrift plan but 
are not entitled to government contributions.
---------------------------------------------------------------------------

                          Comparison with IRAs

    Salary reduction plans offer an advantage over IRAs in that 
the amount that can be contributed on a tax-deductible basis is 
much higher. The maximum deductible IRA contribution is $2,000 
annually, compared with $9,500 for 401(k), 403(b) plans, and 
the federal TSP, and $7,500 for 457 plans. Furthermore, the 
limits on the salary reduction plans are indexed for inflation, 
while the IRA maximum is not. However, nondiscrimination 
standards for salary reduction plans in the private sector may 
limit the amount that highly compensated employees \5\ can 
contribute. In some instances such highly compensated employees 
may not be allowed to contribute the dollar amount cited above, 
and in extreme cases they may not be allowed to contribute 
anything to the plan as a result. Since IRAs are not 
employment-based, they are not subject to such 
nondiscrimination standards.
---------------------------------------------------------------------------
    \5\ 5. See IRC sec. 414(q) for definition of highly compensated 
employee.
---------------------------------------------------------------------------
    Employers will often provide matching contributions on a 
certain percentage of the earnings that a worker chooses to 
contribute (e.g., an employer may match 50 percent of the first 
6 percent of pay that participants in the plan choose to 
contribute). Such matching contributions are optional on the 
part of the employer, and thus do not constitute an inherent 
advantage for these plans over IRAs. They may, however, serve 
as a strong incentive to participate, as will be discussed 
later.
    A second advantage of salary reduction plans over IRAs is 
that the plan sponsor serves as a fiduciary filter for the 
thousands of investment options available today. Salary 
reduction plans offer participants a limited menu of investment 
options from which to choose. The plan sponsor has a fiduciary 
duty to choose the options offered in a prudent manner. In 
essence, the sponsor has already done the first round of 
screening for the participant.
    Sec. 401(k) and 403(b) plans can allow loans to 
participants. Whether a plan has a loan feature is at the 
discretion of the plan sponsor. The federal TSP does have a 
loan feature. Sec. 457 plans are not allowed to offer loans. 
IRAs do not have loan features. However, IRA money can be 
withdrawn at any time for any purpose (it is generally subject 
to a 10 percent penalty tax if withdrawn before age 59, in 
addition to income taxation). Salary reduction plans may allow 
withdrawals in instances of ``hardship,'' but they are not 
required to do so. If a plan does not allow loans or hardship 
withdrawals, a worker would not be able to access the funds in 
his or her account under any circumstances until the time he or 
she leaves that employer.

                             Participation

    Salary reduction plans continue to grow as an important 
element of the employment-based retirement income system. 
According to EBRI tabulations of the April 1993 CPS-ebs, the 
percentage of civilian nonagricultural wage and salary workers 
with an employer who sponsors a salary reduction plan (the 
sponsorship rate) increased from 27 percent (27 million 
workers) in 1988 to 37 percent (39 million workers) in 1993 
(table 2). Over the same time period, the fraction of all 
workers participating in such plans (the participation rate) 
rose from 15 percent (16 million workers) to 24 percent (25 
million workers). The fraction of participating workers among 
those where a salary reduction plan was sponsored (the 
sponsored participation rate) also increased, rising from 57 
percent to 65 percent. The growth in salary reduction plan 
sponsorship and participation has occurred across almost all 
worker and job-related characteristics, including firm size.
    The likelihood of salary reduction plan sponsorship and 
participation increased with firm size (table 2). In 1993, 5 
percent of those employed by a firm with fewer than 10 
employees reported that their employer sponsored a salary 
reduction plan, as compared with 54 percent of those employed 
by firms with 1,000 or more employees. When a plan was 
sponsored, the participation rate did not vary systematically 
with firm size. In all but the smallest employer category, the 
participation rate among workers where a plan was sponsored was 
about two-thirds. In the smallest firms (fewer than 10 
employees), almost three-quarters of workers where a plan was 
sponsored chose to participate. Therefore, the positive 
relationship between firm size and overall participation rates 
was solely a function of the positive relationship between firm 
size and sponsorship rates.
    The higher a worker's earnings, the more likely he or she 
was to have a plan available at work. Two-thirds of workers 
earning $50,000 or more had an employer that sponsored a salary 
reduction plan, compared with only 8 percent of workers earning 
less than $5,000 (table 2). Furthermore, when a plan was 
available, higher earning workers were more likely to 
participate than lower earners. Twenty percent of workers 
earning less than $5,000 contributed to a plan when one was 
offered, compared with 83 percent of workers earning $50,000 or 
more.

                               Discussion

    As seen above, participation rates among eligibles are much 
higher for employment-based salary reduction plans than for 
IRAs. Why?
    Participation in a salary reduction plan is generally more 
convenient since it is offered through the workplace and 
involves automatic contributions from a worker's paycheck 
before he or she even sees the money. Plan sponsors will also 
market the plan to their employees and typically educate them 
as to the importance for their retirement income security of 
participating in the plan. With IRAs, on the other hand, an 
individual must make a conscious decision to seek out such 
information on his or her own (unless it is offered through 
work). Moreover, it has been speculated that some workers who 
are eligible for a tax-deducible IRA contribution may not be 
aware of their eligibility.
    Another important reason is the availability of employer 
matching contributions with salary reduction plans. Among 
workers whose employer sponsored a salary reduction plan in 
1993, 51.3 percent reported that their employer provided 
matching contributions to the plan. The actual percentage was 
likely higher because 30.2 percent did not know if their 
employer matched contributions. Among those responding that 
their employer did provide a matching contribution, the average 
reported match rate was 65 percent (i.e., for every $1 the 
employee contributed, the employer contributed 65 cents). Such 
employer matching contributions are not available with IRAs.
    Studies have found evidence that the availability of an 
employer match does have an effect on participation. For 
example, a 1995 Hewitt Associates' study of 401(k) plans found 
an average participation rate of 76 percent in plans with an 
employer match as opposed to an average of 59 percent in plans 
with no employer match.\6\ Similarly, a 1996 Buck Consultants 
study of 401(k) plans found an average participation rate of 67 
percent in plans with no employer match, compared with 
participation rates near 80 percent in plans with some form of 
employer matching contribution.\7\
---------------------------------------------------------------------------
    \6\ See Hewitt Associates, Trends; Experience in 401(k) Plans, 1995 
(Lincolnshire, IL: Hewitt Associates, 1995).
    \7\ See Buck Consultants, 401(k) Plans: Employer Practices; 
Policies, September 1996 (New York, NY: Buck Consultants, Inc., 1996).
---------------------------------------------------------------------------
    Finally, the other notable point from the data presented 
above is that, despite the rapid growth over recent years in 
the number of salary reduction arrangements in small firms, it 
is at the small plan level that a noticeable gap in plan 
sponsorship remains. The question naturally arises as to what, 
if anything, can be done to fill this void? SIMPLE IRAs and 
SIMPLE 401(k)s were created by the Small Business Job 
Protection Act of 1996 for this very reason. Time will tell how 
successful they will be.

                   Table 1. Individual Retirement Account (IRA) Participation and Eligibility
----------------------------------------------------------------------------------------------------------------
                                                                    Percentage        Number
                                                                   Eligible for    Eligible for    Percentage of
                                                      Number      Deductible IRA  Deductible IRA     Eligible
                                                    (thousands)    Contribution    Contribution    Contributing
                                                                      in 1993       (thousands)       in 1992
----------------------------------------------------------------------------------------------------------------
Single Workers
  Total.........................................          40,151            88.9          35,684             4.7
Annual Earnings (1993)
  Less than $10,000.............................          10,655           100.0          10,655             1.4
  $10,000-$24,999...............................          17,974           100.0          17,974             4.7
  $25,000-$34,999...............................           5,879           100.0           5,879             8.4
  $35,000-$49,999...............................           3,547            21.6             766            12.1
  $50,000 or more...............................           2,097            19.6             411            27.2
Married Couples, Two Earners
  Total Households..............................          19,389            56.4          10,934            10.0
Annual Earnings (1993)
  Less than $10,000.............................              61           100.0              61             0.0
  10,000-$24,999................................           1,584           100.0           1,584             5.7
  $25-$49,999...................................           8,398           100.0           8,398             9.5
  $50,000 or more...............................           9,345             9.5             890            23.1
Married Couples, One Earner
  Total Households..............................          14,212            72.4          10,288             8.5
Annual Earnings (1993)..........................
  Less than $10,000.............................           1,653          100.00           1,653             5.5
  $10,000-$24,999...............................           5,331           100.0           5,331             6.3
  $25,000-$34,999...............................           2,383           100.0           2,383            11.5
  $35,000-$49,999...............................           2,443            22.2             542            17.3
  $50,000 or more...............................           2,402            15.8             380            21.9
----------------------------------------------------------------------------------------------------------------
Source: EBRI tabulations of the April 1993 Current Population Survey employee benefit supplement.


   Table 2. Civilian Nonagricultural Wage and Salary Workers, Ages 16 and Over, by Salary Reduction Plan Sponsorship and Participation, 1988 and 1993
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               Total Workers        Sponsorship Rate a     Participation Rate b          Sponsored
                                                                (thousands)      ------------------------------------------------  Participation Rate c
                                                         ------------------------                                                -----------------------
                                                             1988        1993        1988        1993        1988        1993        1988        1993
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total...................................................     101,745     105,815       26.9%       36.8%       15.3%       23.8%       57.0%       64.6%
Firm Size
  Less than 10..........................................      13,561      14,032         3.0         5.1         2.2         3.8        74.3        74.3
  10-24.................................................       8,164       8,466         8.0        12.1         5.7         8.4        70.9        69.5
  25-49.................................................       6,781       6,716        14.2        20.1         7.8        12.7        55.2        62.9
  50-99.................................................       5,563       6,185        18.0        29.9        11.0        20.9        61.2        69.8
  100-249...............................................       7,497       7,775        22.8        39.0        13.3        25.0        58.4        64.2
  250 or more...........................................      51,274      54,709        41.5        53.2        23.4        34.5        56.2        64.9
  250-499...............................................         (d)       5,471         (d)        49.9         (d)        32.5         (d)        65.2
  500-999...............................................         (d)       5,485         (d)        47.8         (d)        30.5         (d)        63.7
  1,000 or more.........................................         (d)      43,753         (d)        54.3         (d)        35.3         (d)        65.0
Annual Earnings, 1993 ($)
  Less than $5,000......................................       7,595       7,275         3.8         8.1         1.1         1.6        28.0        19.9
  $5,000-$9,999.........................................      10,119      10,419         8.8        13.1         2.6         4.4        29.7        33.6
  $10,000-$14,999.......................................      12,463      15,015        15.3        22.7         5.6        10.0        36.6        43.9
  $15,000-$19,999.......................................      13,658      14,238        22.2        35.7        10.3        19.5        46.2        54.6
  $20,000-$24,999.......................................      10,956      12,408        30.2        43.9        15.5        26.7        51.2        60.8
  $25,000-$29,999.......................................       9,841       9,737        35.4        46.5        20.0        31.1        56.7        66.8
  $30,000-$49,999.......................................      20,993      19,858        43.9        57.1        27.8        41.3        63.2        72.4
  $50,000 or more.......................................       7,876       8,566        55.4        67.6        40.9        56.3        73.7        83.2
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: EBRI tabulations of the May 1988 and April 1993 Current Population Survey employee benefit supplements.
a The fraction of workers whose employer sponsors a salary reduction plan for any of the employees at the worker's place of employment.
b The fraction of all workers participating in a salary reduction plan.
c The fraction of workers participating in a salary reduction plan among those whose employer sponsors a plan for any of the employees at the worker's
  place of employment.
d Data not available.

      

                                

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    Chairman Archer. Thank you, Dr. Yakoboski.
    Our last witness is Dr. William Gale, who is also no 
stranger to the Committee. We are happy to have you back before 
the Committee. If you will identify yourself for the record, we 
would be glad to receive your testimony.

    STATEMENT OF WILLIAM G. GALE, JOSEPH A. PECHMAN FELLOW, 
         ECONOMIC STUDIES PROGRAM, BROOKINGS INSTITUTE

    Mr. Gale. Thank you very much, Mr. Chairman, for inviting 
me to testify. It is a pleasure to be here today to talk about 
IRAs.
    My testimony is based in part on the research I have 
conducted over many years on the effect of IRAs on saving, and 
let me start by saying that I think the low level of private 
and national saving is one of the most important economic 
problems we face in the United States today, but in terms of 
thinking about IRAs, we need to think about IRAs in the larger 
context of tax policy toward saving.
    It has been noted many times in the hearings so far, that 
certain forms of income are taxed at very high, even punitive 
rates. What should also be noted is that a very large 
proportion of capital income or saving is taxed at either zero 
or negative rates. Currently, people can invest in IRAs, 
defined benefit plans, defined contribution plans, 401(k)s, 
Keoughs, 403(b) plans, 457 plans, Federal Government thrift 
plans, SIMPLE plan, SEP plans, fixed and variable annuities, 
and life insurance saving. There is no shortage, in short, of 
opportunities for tax-deferred saving.
    In fact, there is so much tax-deferred saving right now 
that tax-deferred saving accounts for roughly 100 percent of 
net personal saving in the last decade.
    Over the last two decades, tax-deferred saving has gone up 
rather dramatically, at the same time that the personal saving 
rate has come down. If the contributions to tax-preferred 
saving rates were, indeed, net additions to private saving, we 
would expect that private saving would have gone up with this 
surge in tax-preferred saving, but in fact, we see the 
opposite. Private saving has either held constant or fallen.
    One reason for that can be given by thinking about how 
people make contributions to IRAs. There are basically two ways 
to contribute to an IRA, a painless way and a painful way. The 
painless way is pretty obvious. You take money from one 
account, a taxable account, and move it into an IRA. You take 
money you would have saved anyway, put it in an IRA, or you 
borrow money and you put it in the IRA. Those are all painless 
because they don't force you to reduce your current 
consumption, but they do allow you to take advantage of the tax 
benefit of having an IRA.
    The painful way to contribute to an IRA is to raise your 
saving; that is, to reduce your consumption and reduce your 
current standard of living.
    There has been a lot of research on this topic. I have been 
part of that research, and my summary of the research is that 
there are a number of statistical problems in this literature, 
but studies that correct for the problems give the intuitive 
and I think the correct result, which is that people so far 
have contributed to IRAs in mainly the painless way; that is, 
they have found ways to get a hold of the tax break without 
reducing their living standards. I don't blame people for doing 
this. It is exactly what I do when I contribute to an IRA or a 
tax-deferred account, but as a matter of policy, it indicates 
that the programs have not been as effective as they could be.
    How big of an effect on saving might we expect if we 
expanded IRAs? Well, in the ``golden years,'' before 1986, IRAs 
were about 1 percent of GDP, but the expansion is only partial. 
So let us suppose that contributions rise by about one-half of 
1 percent of GDP. If half of those contributions are new 
saving, which is an average from the literature, and then you 
deduct out government saving, you get the national saving rate 
going up by one-eighth of 1 percentage point of GDP. So the IRA 
expansion would raise saving from 5 to about 5.12 percent.
    That is only the effect of expanding the income limits. The 
other part of these proposals would allow penalty-free 
withdrawals for other purposes; for example, first-time home 
purchase, unemployment, medical expenses, education expenses. 
If this provision were to be enacted, I would caution that it 
should not apply to preexisting balances. There are $1.2 
trillion in preexisting IRA and Keough balances. If people 
start taking that money out for other purposes, that will 
reduce the saving rate, not raise it.
    The problem here is the obvious one. You cannot encourage 
consumption and saving at the same time. So, if withdrawals are 
allowed for preexisting assets, the saving rate could very well 
fall if we expand IRAs, as proposed by the administration.
    As a matter of tax policy, expanding IRAs would definitely 
make the system more complicated. I know, Mr. Chairman, that 
you would like to get the IRS out of people's lives. I ask you 
to envision what kind of IRS rules and procedures would be 
required to verify that a certain IRA withdrawal was actually 
made for a certain purpose, like unemployment or health or 
education. That would, if anything, make the IRA more intrusive 
or increase the level of evasion in the existing tax system.
    So let me close by thinking about the bigger picture. There 
is a case, a mixed case, to be made for removing taxes on all 
capital income and moving more toward a consumption tax. That 
raises a whole host of new issues, but I think there is a 
legitimate case to be made, and there are legitimate issues to 
be talked about.
    The point I would like to leave you with is that moving 
part way there, that is, increasing the crazy quilt of tax 
policy toward savings, increasing the number of loopholes, can 
actually be a step backward. Moving partway there can actually 
be worse in terms of tax complexity, tax efficiency, tax 
equity, than moving all the way there. Even if we think we 
should move all the way there, it is not clear that moving 
partway there is a good idea.
    So what I would like to see the Congress do, returning the 
focus on raising the national saving rate, is to focus on 
financial education, to focus on pension reform, and to look 
quite seriously at Social Security reform.
    Modifying IRAs, even if it works, is not going to have a 
large effect, and my suspicion is that is not going to work on 
the basis of the evidence I mentioned earlier.
    Thank you very much.
    [The prepared statement and attachments follow:]

Statement of William G. Gale, Joseph A. Pechman Fellow, Economic 
Studies Program, Brookings Institute

    Mr. Chairman and Members of the Committee:
    The views expressed here are my own and should not be 
ascribed to the officers, trustees, or staff of the Brookings 
Institute.

                               Discussion

    Thank you for inviting me to testify today on the issue of 
expanding Individual Retirement Accounts. The low level of 
private and national saving is one of the most important 
economic problems facing our country today and in the future. 
American saving rates have been very low in recent years, 
compared to other countries and by historical standards. On a 
national level, more saving could finance increased investment. 
This in turn can make workers more productive, and raise their 
wages and standards of living. At the household level, 
increased saving helps people prepare for retirement, provides 
a cushion for financial downturns, and assists in meeting other 
financial goals.
    Many potential factors have been offered to explain the 
saving decline. These include: increased intergenerational 
transfers to the elderly; expansions of government programs 
that reduce the need to save (including Social Security, 
Medicare, Medicaid, unemployment insurance, workers' 
compensation, housing guarantees, and student loans); 
liberalization of debt markets; demographic changes; and the 
slowdown in income growth since the mid-1970s. Tax 
considerations are notably absent from this list; indeed, the 
general tax and inflation environment facing savers may be at 
least as favorable today as it has been in the past. The 
highest marginal tax rates are relatively low by historical 
standards and inflation, which raises the effective tax rate on 
financial assets, is quite low. Despite these considerations, 
tax policy is sometimes claimed to be an effective way to raise 
the saving rate substantially.
    Tax policy toward saving is inconsistent. Some assets are 
taxed at high effective rates, while a large number are taxed 
at rates that are very low and can even be negative. There is 
no shortage of tax-preferred methods of saving. Current options 
include IRAs, defined benefit pensions, defined contribution 
pensions, 401(k) plans, Keoghs, 403(b) plans, 457 plans, 
federal government thrift saving plans, SIMPLE plans, SEP 
plans, fixed and variable annuities, and life insurance saving. 
Moreover, housing and municipal bonds are also tax-favored, as 
are the capital gains that accrue to unincorporated businesses. 
Over the last several decades, as the personal saving rate has 
fallen, tax-favored saving (via pensions, 401(k)s, IRAs, 
Keoghs, and life insurance) has become an ever more important 
component of total personal saving. Between 1986 and 1993, 
saving in tax-preferred accounts constituted about 100 percent 
of net personal saving (Table 1). This does not mean there was 
no other saving activity, it just means that any gross saving 
in other accounts was fully offset by withdrawals from those 
accounts or by increases in borrowing.
    Wide variations in effective tax rates on saving creates 
opportunities for investors to shift funds into the most tax-
preferred accounts. The variation in rates, coupled with the 
tax-deductibility of interest payments, creates opportunities 
to game the system further by borrowing, deducting the interest 
payments, and investing in a tax-preferred asset.
    IRAs are just one more patch in the crazy quilt of saving 
policy. Contributions of up to $2,000 per year are tax-
deductible for households with income up to prescribed limits. 
Deductibility is then phased out as income rises further. 
Balances accrue tax-free. Ordinary income taxes are due on any 
withdrawals, and a 10 percent penalty is also assessed on 
withdrawals that are not related to death or disability, but 
occur before the account holder is 59.5 years old.
    Several current proposals would amend IRAs in a number of 
ways, including:
     Raising the income limits on deductible IRA 
contributions; indexing the income and contribution 
limits.Creating back-loaded IRAs: In a back-loaded IRA, the 
contribution is not deductible, but earnings and withdrawals 
are free of taxes and penalties, provided the funds were held 
in the account for a specified period, usually 5 years.
     Allowing penalty-free (and income-tax-free) 
withdrawals for specified purposes such as education, medical 
expenses, first-time home purchases, long-term unemployment, or 
business start-up expenses.
    These proposals involve issues of tax policy, budget 
policy, retirement income security, and saving policy.

                       Tax Policy Considerations

    Expanding IRAs would be counterproductive tax policy. The 
IRA proposals would make the tax system more complex and 
intrusive. Serious consideration of how the IRS would verify 
that a particular withdrawal was made for a particular purpose 
suggests compliance and enforcement difficulties. Enforcing the 
combined limits on IRAs and elective deferral plans would cause 
further compliance headaches. Tax debates in 1996 correctly 
emphasized the importance of broadening the base, removing 
loopholes, and reducing rates in a revenue-neutral manner. As 
we move into 1997, proposals that expand IRAs move in exactly 
the opposite direction.
    While IRAs are often described as tax-deferred saving, the 
effective tax rate on IRAs is typically zero or negative. The 
effective rate is zero if the tax rate that applies to the 
deductible contribution is equal to the rate that applies to 
the withdrawal. However, since marginal tax rates have fallen 
since 1986, and since people typically face lower marginal tax 
rates in retirement than during working years, the effective 
tax rate for many IRA holders is likely to be negative. For 
example, a household that deducts a $2,000 IRA contribution at 
a 28 percent tax rate, holds the asset for 20 years at a 10 
percent annual return, and withdraws the funds at a 15 percent 
tax rate pays an effective tax rate of negative 9 percent on 
the IRA. Punching a hole in the tax code to generate more 
assets with negative effective tax rates is inefficient and 
inequitable. Good tax policy would even out the taxation of all 
forms of saving, and possibly reduce the overall level of 
taxation on saving.

                      Budget Policy Considerations

    Expanding IRAs would also be counterproductive budget 
policy. First, it would create a new entitlement for anyone 
with enough funds to place money in a designated account. The 
fact that IRAs are tax rules rather than spending programs 
should not blind us to the essential equivalence of an 
entitlement set in the tax code and one set on the spending 
side. Tax entitlements are just as costly (and often more 
difficult to discern) than spending entitlements. The IRA 
entitlement would accrue largely to households in the top part 
of the income distribution, and would provide larger 
entitlement payments (i.e., tax cuts) to wealthier households 
who contributed more or faced higher tax rates. The key to long 
run budget control is to eliminate or reduce entitlement 
obligations rather than increase them.
    Second, current budget procedures understate the cost of 
back-loaded IRAs. The requirement of a 5-year holding period 
before penalty-free withdrawals are allowed effectively places 
most of the costs beyond the five-year budget window. Budget 
policy should move toward more complete accounting of the costs 
of government programs.
    Third, for any given amount of contributions, allowing both 
traditional front-loaded IRAs and back-loaded IRAs will prove 
more expensive in revenue terms than having either one. Other 
things equal, people who believe their tax rate will be lower 
when they withdraw the funds than it is now will tend to choose 
front-loaded IRAs, so they can take the deduction at the 
relatively higher current tax rate. Likewise, people who 
believe that their tax rate upon withdrawal will be lower than 
their current rate will tend to choose back-loaded IRAs to 
obtain the biggest tax cut.

                    Retirement Income Considerations

    Expanding the conditions for penalty-free IRA withdrawals 
would undermine the retirement income goals of IRAs, and could 
reduce both saving and tax revenue. One can imagine the list of 
favored uses of IRA funds expanding indefinitely. One can also 
imagine the list of favored accounts expanding as well: if IRA 
funds can be tapped, why not Keoghs, SIMPLE plans, SEPs, 
401(k)s, pensions, or fixed and variable annuities? Moreover, 
there would be difficult administrative problems associated 
with minimizing abuse of these provisions. These problems will 
make the tax code more complex, and will require the IRS to 
gather more information, which could be quite intrusive, or 
risk not enforcing the provisions.
    If withdrawals are allowed for new, favored uses of funds, 
two considerations are paramount. First, the withdrawals should 
be allowed only for funds contributed after legislation is 
enacted. As of the end of 1995, IRA and Keogh balances totalled 
$1.2 trillion. These funds were placed in the accounts with the 
understanding that they were to be held until retirement or 
would face a penalty. If these funds become eligible for 
penalty-free withdrawal, the saving rate could actually drop. 
For example, suppose that in one year, 5 percent of these funds 
were removed for other purposes. That would represent about a 
withdrawals of about $60 billion, or about 20 percent of 
personal saving. Second, funds withdrawn from deductible IRAs 
should face income taxes, even if the penalty is waived. 
Otherwise, the entire withdrawal will never have been taxed, 
which would create obvious inequities and inefficiencies.

                      Saving Policy Considerations

    All of these problems in tax policy, budget policy, and 
retirement income policy might be worth the cost if IRA 
expansions were certain to raise private and national saving 
substantially. The effect of IRAs on saving is the subject of 
considerable controversy, however, so it is useful to start 
with some basics.
    The single most important factor is that IRAs do not 
provide incentives to save. Instead, IRAs provide incentives to 
place funds in a designated account. The distinction is 
crucial.
    There are many ways to finance IRA contributions. One way, 
of course, is to raise saving. This involves consuming less, or 
to put it bluntly, reducing one's current standard of living. 
This is the painful way of taking advantage of the tax breaks 
afforded by IRAs. There are, however, relatively painless ways 
to capture the tax break as well. For example, the contribution 
may be financed by transferring existing taxable assets into 
IRAs, by reallocating into an IRA current or future saving that 
would have been done outside the IRA, or by increasing 
household debt. These painless methods of contributing to an 
IRA do not raise overall private saving. Thus, IRAs and other 
so-called saving incentives do not require that contributors 
save, or save more than they would have otherwise.
    How are people likely to react to IRAs? Common sense 
suggests that people will try to capture the tax breaks in the 
least painful way possible. A reasonable conjecture is that one 
reason IRAs are so popular with taxpayers is precisely because 
taxpayers do not need to reduce their standard of living (raise 
their saving) to claim the tax break.
    Research findings back up this claim at the most general 
level. Economists Joel Slemrod of the University of Michigan, 
and Alan Auerbach of the University of California, surveying a 
broad range of studies of the effects of the tax reform act of 
1986, have concluded that similar phenomena arise in a host of 
tax-related activities. They find that decisions concerning the 
timing of economic transactions are the most clearly responsive 
to tax considerations. The next tier of responses involves 
financial and accounting choices, such as allocating a given 
amount of saving to tax-preferred saving versus other saving. 
The least responsive category of behavior applies to agents' 
real decisions, such as changes in the level of saving. This 
hierarchy of responses, applied to IRAs, suggests that most IRA 
contributions are not new saving.

(A) What proportion of IRA contributions is new saving?

    In recent years, a number of studies have examined the 
effects of IRAs on saving and reached a variety of 
conclusions.\1\ The crucial issue in this literature is 
determining what households who had IRAs would have saved in 
the absence of these incentives.
---------------------------------------------------------------------------
    \1\ This section is based on Engen, Gale and Scholz (1966a,1996b), 
which provides details and additional evidence for the points made 
here.
---------------------------------------------------------------------------
    Several factors, however, make this a difficult problem and 
one subject to a series of biases that overstate the impact of 
IRAs on saving. Analyses that ignore these issues overstate the 
impact of IRAs on saving. No study that corrects for these 
biases finds that IRAs raise saving. Rather, Engen, Gale and 
Scholz (1996a, b) show that accounting for these factors 
largely or completely eliminates the estimated positive impact 
of IRAs on saving found in some studies.
    First, saving behavior varies significantly across 
households. Households that hold IRAs have systematically 
stronger tastes for saving than other households. Thus, a 
simple comparison of the saving behavior of households with and 
without IRAs will be biased in favor of ``showing'' that IRAs 
raise saving. To oversimplify somewhat, suppose there exist two 
groups: ``large'' savers and ``small'' savers. We would expect 
to see that IRA holders (where ``large'' savers are 
overrepresented) would save more than non-IRA holders (where 
small savers were overrepresented). But this would provide no 
information about the effects of IRAs per se, unless there is a 
way to control for the observable and unobservable differences 
between large and small savers.
    Even researchers that claim that IRAs raise saving 
recognize that the heterogeneity of saving behavior is a 
crucial factor in this literature. What is often overlooked, 
however, is that the implication of heterogeneity is that 
findings such as ``households with IRAs saved more than 
households without IRAs,'' do not imply anything about whether 
IRA contributions represent new saving, since those households 
would have been expected to save more to begin with.
    Due to heterogeneity in saving, studies that compare IRA 
contributors with noncontributors tend to ``find'' that IRAs 
raise saving (Hubbard 1984, Feenberg and Skinner 1989, Venti 
and Wise, 1987, 1988, 1990, 1991). However, statistical tests 
reject the validity of such comparisons (Gale and Scholz 1994.) 
In contrast, studies that compare one group of contributors to 
another tend to find much smaller or negligible effects of 
IRAs, or expansions of IRAs, on saving (Gale and Scholz 1994, 
Attanasio and De Liere 1994, Joines and Manegold 1995). By 
comparing two groups of contributors, these studies more 
effectively isolate groups with similar propensities to save 
and hence provide a more valid comparison.
    A second problem is that saving and wealth are net concepts 
and are broad concepts. If a household borrows $1000 and puts 
the money in a saving incentive account, net private saving is 
zero. The data indicate that households with saving incentives 
have taken on more debt than other households. Hence, studies 
should focus on how saving incentives affect wealth (assets 
minus debt), not just assets. Because financial assets are 
small relative to total assets, studies that focus only on the 
effects of saving incentives on financial assets may have 
particularly limited significance.
    Since the expansion of IRAs in the early 1980s, financial 
markets, pensions, and Social Security have undergone major 
changes. Pension coverage (other than 401(k)s) fell over the 
1980s, and social security wealth was reduced in the 1983 
reforms. Both of these factors would have caused people to have 
accumulated more assets in the late 1980s or early 1990s than 
in the early 1980s. Moreover, the reduction in inflation and 
tax rates that occurred over the 1980s made financial assets 
relatively more attractive than tangible assets (such as 
housing). This led to strong increases in the stock market and 
to shifts of wealth from nonfinancial to financial forms. For 
all of these reasons, it is important to study the impact of 
IRAs on broad wealth measures and to control for other events 
that occurred during the 1980s.
    Studies that examine only financial assets often find a 
large impact of IRAs on saving (Venti and Wise 1992, 1996). But 
extensions of those studies indicate that the effects disappear 
when the analysis examines the impact on broader measures of 
wealth that include debt or nonfinancial assets and include the 
impact of events that occurred during the 1980s (Engen, Gale 
and Scholz 1996a, b).
    Third, IRA balances represent pre-tax balances; one cannot 
consume the entire amount because taxes and perhaps penalties 
are due upon withdrawal. In contrast, contributions to other 
accounts are generally not deductible and one may generally 
consume the entire balance in a taxable account. Therefore, a 
given balance in a saving incentive account represents less 
saving (defined either as reduced previous consumption or 
increased future consumption) than an equivalent amount in a 
conventional account.
    Analyses that correct for these biases indicate that little 
if any of the overall contributions to IRAs have raised private 
or national saving. This conclusion arises consistently from 
evidence and estimates from a wide range of methodologies, 
including time-series data, cross-sections, panel data, cohort 
analysis, simulation models, and analysis of evidence from 
Canada (Engen, Gale, and Scholz 1996a, b).

(B) Who Contributed to IRAs and Why it Matters

    Supporting evidence for this view comes from data on who 
contributed to IRAs. Table 2 shows that households with IRAs in 
1986 were very different from households that do not have IRAs. 
In particular, compared to households without IRAs, the typical 
IRA holder had seven times the non-IRA financial assets, four 
times the overall net worth, and eight times the saving. 
Although some of these differences are due to observable 
characteristics, there is widespread agreement that households 
with IRAs tend to have stronger unobservable tastes for saving 
than do observationally equivalent households without IRAs.
    Two types of households will be most able and hence most 
likely to make painless contributions, that is, contributions 
that do not raise private saving. The first is households that 
have large amount of other assets. These households have more 
existing assets to shift, typically have more current saving to 
shift, and have less of a need to maintain all of their assets 
as precautions against emergencies. The second is older 
households, who are less likely to face a binding early 
withdrawal penalty. In the extreme, people older than 59.5 
years face no early withdrawal penalties. For each group, IRAs 
are good substitutes for the saving those households would do 
anyway, so the IRA contribution will be unlikely to represent 
new saving.
    Data from the 1980s show that households with non-IRA 
financial assets \2\ over $20,000 in 1986 (about $28,600 in 
1996 dollars) or who were 59 or older made more than two-thirds 
of all IRA contributions in the 1983-6 period. Households who 
had non-IRA financial assets in excess of $40,000 (about 
$57,200 in 1996 dollars) or where the head was 59 or older made 
half of all IRA contributions during this period. Thus, while 
some people have argued that many of the accounts were held by 
middle class households, the data show that most contributions 
were made by households that would consider IRAs and other 
saving good substitutes. This suggests that the overall effects 
of IRAs on saving were likely to have been small at best.
---------------------------------------------------------------------------
    \2\ Financial assets as defined here do not include employer-
provided pensions 401(k) plans, or after-tax thrift plans.
---------------------------------------------------------------------------
    In contrast, contributions will represent a net addition to 
saving only when they are financed by reductions in 
consumption, which will occur only when IRAs and other saving 
are poor substitutes for one another. This is more likely to 
occur for households that have lower asset holdings, and are 
younger. Thus, if IRAs are to be expanded, the expansion should 
be targeted to lower-income groups. Higher income groups will 
typically have higher assets and will find it easier to 
substitute other assets into IRAs.

(C) Aggregate Effects of Expanded IRAs on Saving

    How much would expanding IRAs raise national and private 
saving? One can get some perspective on this issue by noting 
that net national saving has fallen from 8 percent of net 
national product in the 1950s, 1960s, and 1970s, to 4.1 percent 
in the 1990s. Personal saving has fallen from 7 percent of 
personal disposable income between 1950 and 1980, to under 5 
percent in the 1990s.
    One way to gauge the effect of all tax policy on saving is 
to consider the effects of replacing the income tax with a 
consumption tax. Estimates by Engen and Gale (1996) suggest 
that a cold-turkey switch to a pure consumption tax--with no 
personal exemptions or transition relief--would raise the 
saving rate by about 1.5 percentage points in the short run and 
by about 0.5 percentage points in the long run. Output per 
capita would rise by about 1.5 percentage points over the first 
10 years. These effects are positive, but are modest compared 
to the decline in saving noted above.
    The results also provide a useful perspective on what 
targeted tax policy changes can achieve. If a complete overhaul 
of the income tax system raises the saving rate by at most 1.5 
percentage points, only a much smaller impact can be expected 
of policies that tinker around the edges of the system.
    The aggregate impact of expanding IRAs would be tiny. From 
1982 to 1986, IRA contributions constituted about 1 percent of 
GDP. Since then, however, tax rates have fallen and other 
saving incentives have proliferated. Moreover, expanding income 
limits for deductible IRAs would only affect a small portion of 
the population. If contributions rose by 0.5 percentage points 
of GDP and--splitting the difference among the studies--about 
half of those contributions were new saving, private saving 
would rise by 0.25 percentage points. But, assuming an 
effective federal and state tax rate of about 25 percent, 
government saving would fall by about one fourth of the 
contributions, so the net increase in national saving would be 
about 0.12 percentage points over the next few years.
    Note that this estimate does not include the impact of 
allowing penalty-free (and income-tax-free) withdrawals for 
specified purposes. If these withdrawals are allowed from pre-
existing balances, or if the withdrawals are made free of 
income tax, the impact on private and national saving of 
expanding IRAs could well be negative.

(D) Short-run versus Long-run Effects of IRAs on Saving

    Some commentators (including Engen and Gale 1993) have made 
the point that the short-term effects of IRAs are likely to be 
less favorable than the long-term effects. The idea is that 
when IRAs are introduced, people will shift funds from taxable 
sources into IRAs so the contributions at first will not be new 
saving. After awhile, the people who contribute to IRAs may run 
out of funds to shift so that IRA contributions may eventually 
become new saving. For example, in a simulation model in Engen, 
Gale, and Scholz (1994), IRAs reduce short-term saving, but 
raise the long-term saving rate by 0.2-0.3 percentage points.
    The crucial issue then becomes how long does it take until 
the saving rate rises? In Engen, Gale, and Scholz (1994) it 
takes 49 years for the wealth to income ratio to exceed its 
original (pre-IRA value). Some IRA proponents have reasoned 
that since the typical household has very little in pre-
existing financial assets, the transition period will be very 
short: a year or less.
    The logic of a short transition period is misleading for 
two reasons. The first is simply that the typical household in 
1986 did not have an IRA, so the typical household is 
irrelevant to the debate about how long the transition will 
last. The relevant households are those that contributed to 
IRAs and in particular those that continued to contribute to 
IRAs: Did these households have many pre-existing assets that 
they could shift into IRAs? The answer here is a resounding 
``yes.'' Table 2 shows that pre-existing asset balances are 
high among household with IRAs. The typical IRA household in 
1986 had over $20,000 in non-IRA financial assets. Among 
households that contributed to the limit for three years in a 
row, typical financial asset balances were $40,000. It is clear 
that for these households, IRAs could be financed from pre-
existing asset balances for several years without raising 
saving.
    The second problem with the proponents' logic is even more 
important: it ignores IRA contributions that are financed by 
current or future saving that would have been done even in the 
absence of IRAs. These contributions do not represent new 
saving. The table shows that typical IRA households and 3-year 
limit contributors have extremely high levels of other saving 
relative to their IRA contributions and so could easily finance 
contributions out of saving that would have been done anyway. 
The median 3-year saving level for 3-year limit contributors in 
the SCF was $60,000. Surely, it would not be difficult for many 
of them simply to shift $12,000 of that into an IRA. The median 
3-year saving level for the typical IRA contributor was 
$23,000. This is certainly large enough to fund all or most of 
a typical three years worth of contributions. These figures 
suggest that among households that did contribute to IRAs, 
there was a large on-going source of funds from which IRA 
contributions could be financed without raising saving. There 
is every reason to think the transition period could take a 
very long time.
    A second reason IRAs may raise long-term saving is that 
workers who leave jobs often roll their pension balances over 
into an IRA. Thus, the IRA provides a convenient way to keep 
the money ``tied up'' rather than encouraging people to spend 
the funds prematurely. Over long periods of time, the 
cumulative effect of having fewer people cash out their pension 
could raise the saving rate. Two caveats, however, should be 
noted. First, any such effect does not seem to have occurred 
yet. Second, this factor is already fully operable under the 
existing IRA system. No expansion of IRAs is needed.

(E) Did Advertising Make IRA Contributions New Saving?

    Some commentators have asserted that the heavy advertising 
of IRAs means that IRA contributions were new saving. However, 
while it seems likely that IRAs were advertised heavily by the 
financial industry in the 1982-6 period, that fact provides no 
information as to whether the source of IRA contributions was 
new saving (reduction in living standards) or shifted assets, 
redirected saving, or increases in debt. There is certainly no 
evidence to support the notion that advertising for IRAs 
affected the level of saving.
    Looking at the ads themselves, however, suggests that 
advertising may actually encourage asset shifting, rather than 
new saving. Some ads explicitly advocated financing IRAs with 
debt as an ``easy'' way to obtain the tax break (see Feenberg 
and Skinner 1989). Aaron and Galper (1984, p. 5) report the 
following ad from the New York Times in 1984:
    Were you to shift $2,000 from your right pants pocket into 
your left pants ``pocket,'' you wouldn't make a nickel on the 
transaction. However, if those different pockets were accounts 
at The Bowery, you'd profit by hundreds of dollars .... Setting 
up an Individual Retirement Account is a means of giving money 
to yourself. The magic of an IRA is that your contributions are 
tax-deductible.''
    For obvious reasons, advertising seems more likely to 
emphasize the possibility of painless contributions, which 
don't raise saving, rather than painful contributions that do 
raise saving.
    A second perspective on advertising is provided by the 
recent avalanche of ads for mutual funds and the accompanying 
massive inflows into those funds. Figure 1 shows that as mutual 
funds have increased dramatically in recent years, personal 
saving has not. Figure 2 shows that the increase in mutual fund 
saving has been matched by a decline in individual holdings of 
equities and bonds. That is, to a large extent households 
appear to have shifted their assets from one form to another. 
This is in no way a criticism of the mutual fund industry, 
which is supplying a product that the pubic demands. The point 
is just that the presence of massive advertising does not imply 
that the subsequent contributions are new saving.
    A similarly unproven assertion is that IRAs created a 
``culture of saving,'' or would have if they had not been 
curtailed in 1986. To some extent, this notion is based on 
evidence about the persistence of IRA contributions over time. 
Households that contributed in one year had a very high 
probability of contributing in the next year as well. This led 
to speculation that IRAs helped people create good saving 
habits over time (Skinner 1992, Thaler 1994). The problem with 
this conclusion is that the data on persistence are perfectly 
consistent with standard models (Engen and Gale 1993). There is 
nothing surprising about the persistence of contributions over 
time. A purely rational model with no ``habit formation'' 
generates the same persistence as the data.
    Moreover, other evidence makes it hard to believe that IRAs 
created a culture of saving. The early 1980s featured lower 
inflation, lower tax rates, high real interest rates, cuts in 
social security as well as expanded IRAs, yet the saving rate 
fell rather than rose during the ``golden years of IRAs.''

                              Conclusions

    Expanding targeted tax-based saving incentives is unlikely 
to raise the saving rate by very much if at all, but could have 
real costs in terms of tax, budget and retirement income 
policy. Excessive focus on tinkering with tax-based saving 
incentives obscures other possibilities for raising private and 
national saving. The surest way to raise national saving is to 
reduce the budget deficit in ways that do not reduce private 
saving.
    Raising private saving may prove more difficult, but 
several options are worth exploring. The most obvious candidate 
is improved financial education of workers. There is serious 
concern that a substantial fraction of the population will not 
be adequately prepared for retirement. At the same time, 
however, a large proportion of households do not use the saving 
incentives that are already available to them. Everyone, for 
example, can contribute to an IRA or a fixed or variable 
annuity if they so choose and receive a tax-preference relative 
to other saving. Only about two-thirds of workers eligible for 
401(k) plans actually participate. Improved education would 
also be worthwhile to provide needed assistance to American 
households as the pension system moves away from defined 
benefit plans and toward defined contribution plans, which 
place more responsibility on workers, and as social security 
reform is considered.
    Another fruitful area of reform in my view is pension 
legislation. An improved pension system would feature enhanced 
pension coverage, simplified nondiscrimination rules with a 
higher minimum contribution, higher maximum contribution 
limits, and removal of taxes on excess payouts and excess 
accumulations.

                               References

    Aaron, Henry J. and Harvey Galper. 1985. Assessing Tax Reform, 
Washington, DC: The Brookings Institution.
    Attanasio, Orazio, and Thomas De Leire. 1994. ``IRAs and Household 
Saving Revisited: Some New Evidence.'' Working Paper No. 4900. 
Cambridge, Mass.: National Bureau of Economic Research (October).
    Auerbach, Alan J., and Joel Slemrod. 1996. ``The Economic Effects 
of the Tax Reform Act of 1986.'' Forthcoming, Journal of Economic 
Literature.
    Board of Governors of the Federal Reserve System. 1996. Flow of 
Funds Accounts of the United States: Document Z.1. Economic Report of 
the President. 1997. U.S. Government Printing Office, Washington 
(February).
    Engen, Eric M., and William G. Gale. 1993. ``IRAs and Saving in a 
Stochastic Life-Cycle Model.'' Mimeo. UCLA and the Brookings 
Institution (April).
    Engen, Eric M., and William G. Gale. 1996. The Effects of 
Fundamental Tax Reform on Saving. In Henry J. Aaron and William G. 
Gale, eds., Economic Effects of Fundamental Tax Reform, The Brookings 
Institution, 1996.
    Engen, Eric M., William G. Gale, and John Karl Scholz. 1994. ``Do 
Saving Incentives Work?.'' Brookings Papers on Economic Activity 1: 85-
180.
    Engen, Eric M., William G. Gale, and John Karl Scholz. 1996a. The 
Illusory Effect of Saving Incentives on Saving. Journal of Economic 
Perspectives 10(4): 113-38.
    Engen, Eric M., William G. Gale, and John Karl Scholz. 1996b. The 
Effects of Tax-Based Saving Incentives on Saving and Wealth. NBER 
working paper No. 5759 (September).
    Feenberg, Daniel, and Jonathan Skinner. 1989. ``Sources of IRA 
Saving.'' In Lawrence H. Summers, ed., Tax Policy and the Economy, vol. 
3. Cambridge, Mass.: MIT Press.
    Gale, William G., and John Karl Scholz. 1994. ``IRAs and Household 
Saving.'' American Economic Review 84(5): 1233-60 (December).
    Hubbard, R. Glenn. 1984. ``Do IRAs and Keoghs Increase Saving?'' 
National Tax Journal 37: 43-54.
    Joines, Douglas H., and James G. Manegold. 1995. ``IRAs and Saving: 
Evidence from a Panel of Taxpayers.'' Mimeo. USC.
    Sabelhaus, John. 1996. ``Public Policy and Saving Behavior in the 
U.S. and Canada.'' Mimeo. (February).
    Skinner, Jonathan. 1992. ``Do IRAs Promote Saving? A Review of the 
Evidence.'' Tax Notes (January 13).
    Thaler, Richard. 1994. ``Mental Accounts and Household Saving.'' 
American Economic Review (May).
    Venti, Steven F., and David A. Wise. 1986. ``Tax-Deferred Accounts, 
Constrained Choice, and Estimation of Individual Saving.'' Review of 
Economic Studies 53: 579-601.
    Venti, Steven F., and David A. Wise. 1987. ``IRAs and Saving.'' In 
Martin Feldstein, ed., The Effects of Taxation on Capital Accumulation. 
Chicago: University of Chicago Press.
    Venti, Steven F., and David A. Wise. 1990. ``Have IRAs Increased 
U.S. Saving?: Evidence from Consumer Expenditure Surveys.'' Quarterly 
Journal of Economics 105: 661-698 (August).
    Venti, Steven F., and David A. Wise. 1991. ``The Saving Effect of 
Tax-Deferred Retirement Accounts: Evidence from SIPP.'' In B. Douglas 
Bernheim and John B. Shoven, eds., National Saving and Economic 
Performance. University of Chicago Press and NBER.
    Venti, Steven F., and David A. Wise. 1992. ``Government Policy and 
Personal Retirement Saving.'' In James M. Poterba, ed., Tax Policy and 
the Economy, vol. 6. Cambridge, Mass.: MIT Press.
    Venti, Steven F., and David A. Wise. 1996. ``The Wealth of Cohorts: 
Retirement Saving and the Changing Assets of Older Americans.'' NBER 
working paper No. 5609.
      

                                
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    Chairman Archer. Thank you, Dr. Gale.
    I can see that my colleague, Mr. Neal, is just ready to 
jump in and have a debate with you on this, but unfortunately, 
unless he wants to stay and Chair the Committee while I go 
vote, we are going to have to recess while both of us can go 
vote.
    Mr. Neal. Would you offer that to me on a permanent basis, 
Mr. Chairman?
    Chairman Archer. I don't think that would play too well.
    Mr. Neal. Well, then we had better go vote.
    Chairman Archer. Yes.
    We will recess temporarily to go vote, and if you don't 
mind, we will be back in about 5 or--well, maybe 8 or 9 
minutes.
    [Recess.]
    Chairman Archer. Could I ask you to take your seats again 
at the witness table.
    Dr. Gale, I was hoping I could conclude my questioning 
before Mr. Neal got back, but I see that I didn't succeed in 
doing that. So I guess you still will be engaged by him in a 
colloquy.
    I would like to inquire particularly about what I think I 
heard Dr. Yakoboski say, which is that today, 89 percent of the 
single employed people are eligible for IRAs. Did I understand 
you correctly to say that?
    Mr. Yakoboski. That is correct. Of that 89 percent, not all 
are eligible for the full $2,000 deduction. Some are only 
eligible for a partial deduction, but 89 percent are eligible 
for at least a partial deduction.
    Chairman Archer. I would like to engage Mr. Higgins, then, 
because you have suggested that we need a broader application 
of IRAs in order to increase national savings, but if 89 
percent of the people are already eligible, then will we only 
increase it for 11 percent of the working single people if we 
accept your suggestion for changes in the IRAs?
    Mr. Higgins. Mr. Chairman, I think that is a good question. 
I believe most Americans do not know whether they are, in fact, 
entitled to a full or partial IRA. There is, I would say, a 
lack of education. There clearly is a lack of advertising in 
the post-1986 period on IRAs and the benefits to consumers from 
IRAs, and that is why we feel quite strongly that we need a 
simple IRA that every American can understand. We need as an 
incentive, a tax-deductible contribution, that every American 
can understand, and it has been my experience in the pre-1986 
period that a large percentage of Americans would respond 
positively to that and would move from consumption to savings 
if they understood the proposition clearly.
    Chairman Archer. Thank you.
    My colleague, Congressman Bill Thomas from California, 
because of other commitments, is unable to be here for the 
hearing today, and he has asked that I submit to you, Mr. 
Higgins, five questions in writing which may already have been 
delivered to you, but for the record, I am submitting those to 
you and we would appreciate your responses in writing.
    Mr. Higgins. We will respond promptly, Mr. Chairman.
    Chairman Archer. All right. Thank you very much.
    [The followup answers were subsequently submitted by Mr. 
Higgins to Congressman Thomas:]
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[GRAPHIC] [TIFF OMITTED] T8616.041

      

                                

    Let me ask all of you, have you had an opportunity to look 
at the entire Clinton budget proposal relative to taxation? 
Have all four of you had a chance to do that? Have you only 
looked at the IRA provisions?
    Mr. Gale. The whole thing.
    Mr. Higgins. The whole thing.
    Mr. Yakoboski. I have just looked at the IRA provisions.
    Chairman Archer. Only at the IRA provisions.
    I wanted to get your input as to what you thought overall 
of the Clinton tax proposals, relative to savings and 
investment.
    Mr. Thayer. Mr. Chairman, we have looked at it, and in 
general, I think we would support greater tax relief than what 
is there right now.
    Our members, in general, in most of the surveys we have had 
of them, have obviously gone right to that--wanting more tax 
relief. We think the budget as it stands right now does not go 
forward enough, and that would be the one thing we would submit 
here today.
    Chairman Archer. Well, what can you isolate in the Clinton 
proposals that does impact favorably on savings and investment?
    Mr. Thayer. Excuse me for consulting with my tax consultant 
there. The issue is really----
    Chairman Archer. As long as we have this code, you have to 
do that.
    Mr. Thayer. You have got to do that sometimes. That is 
right.
    This goes directly to those issues that you are very 
familiar with and we have talked about before. Of course, that 
is the self-employed deduction of the health insurance and 
other tax issues that we have lobbied long and hard for, as you 
very well know.
    We also sent a letter over to the White House asking that 
there be some tax relief for the self-employed and that the 
home office deduction be included in the budget package itself.
    Obviously, we didn't get that, but that would make life a 
lot easier for us.
    Chairman Archer. What did you get in the Clinton budget 
package?
    Mr. Thayer. I am still looking. We really are still 
looking. We didn't get that much, and that is what we are 
saying. The self-employed community really would have liked to 
have seen some specific relief like the self-employed health 
insurance deduction, the home office deduction, obviously 
pension relief. We could have used more there. We didn't see 
that. So that is why we have come at it from a different route, 
as you very well know, Chairman Archer, thanks to many of the 
things you have joined us on.
    Chairman Archer. Thank you.
    Mr. Higgins, Have you had a chance to evaluate the savings 
and investment provisions in the President's budget, and if so, 
What is in there that you particularly like? Obviously, it 
doesn't go far enough from your testimony, but what is in there 
that you think is positive?
    Mr. Higgins. Mr. Chairman, the two components that we like 
most are IRA provisions and capital gains relief, and in the 
case of IRAs, we think the President's proposal is a step in 
the right direction, but we think, quite frankly, it falls 
woefully short of the mark in terms of what will change 
behavior across the length and breadth of this country as it 
relates to savings and investment.
    Chairman Archer. I don't want to put words in your mouth, 
but what I understand you to have just said is that the 
President's proposal on IRAs really, in your opinion, will not 
do anything to significantly improve the savings rate in this 
country.
    Mr. Higgins. Mr. Chairman, I would say that the impact will 
be modest.
    Chairman Archer. On capital gains, of course, the only 
thing I can see in this proposal is something on principal 
residences, and I would assume that that really does not strike 
at the real need for investment capital to create jobs in this 
country.
    Mr. Higgins. That is correct, Mr. Chairman.
    Chairman Archer. All right. Thank you very much.
    Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman.
    Mr. Higgins, do you believe that carefully designed IRAs 
will create new savings?
    Mr. Higgins. Yes, I do.
    Mr. Neal. Would you elaborate on that?
    Mr. Higgins. Congressman, I believe the IRA account, as we 
knew it prior to 1986, was a proposition that most, if not all, 
Americans understood, and the features of the immediate tax 
deductibility, coupled with tax-deferred gains, is a 
proposition that was effective pre-1986 and will be, if 
enacted, extremely effective going forward and should have a 
meaningful effect on increasing savings rates in this country.
    Mr. Neal. How do you respond to the suggestion in some 
quarters that the IRA will only benefit the wealthy classes as 
opposed to the middle class?
    Mr. Higgins. Congressman Neal, I can only relate to some 
surveys, some data that I have seen over the years that 
indicate the primary beneficiaries are what I would call 
middle-class Americans, not the wealthy, and I would say from 
my own experience, our accounts at Dean Witter and Co. who have 
IRA accounts have balances that average about $20,000 and 
incomes that are less than $100,000.
    Mr. Neal. Mr. Thayer, do you believe that IRAs will create 
new savings?
    Mr. Thayer. Do I believe--I am sorry?
    Mr. Neal. Do you believe that IRAs will create new savings 
if carefully designed?
    Mr. Thayer. I certainly do if they are more universal. Let 
me talk about what you just alluded to, Congressman, when you 
talked about them being just for the rich.
    As you and I know, frankly, $2,000 isn't too much for a 
rich person, but even if it was, the benefits of making IRAs 
universal far outweigh, as far as I am concerned, the 
disadvantages.
    Let us take the self-employed people. We often experience 
large income fluctuations from year to year, and it isn't fair 
and it isn't good economic policy to say to us that in the good 
years, you can save money in an IRA, but in the bad years, you 
can't. So we certainly believe that expanding it universally 
would increase those people saving in America.
    Mr. Neal. OK, thank you.
    Now, Mr. Gale, Do you think we can ever have meaningful 
entitlement reform without offering some incentives to citizens 
as it relates to the national savings rate?
    Mr. Gale. I think entitlement reform is a good idea. I 
think raising the saving rate is a good idea.
    I would submit to you that establishing a new IRA is 
establishing a new entitlement. It is establishing the 
entitlement on the tax side rather than on the spending side, 
but it is an entitlement, nonetheless, and the entitlement 
would go to anyone that had enough money to put funds in the 
account.
    If IRAs required you to actually save, then they could be 
more accurately called the saving incentive, but as long as you 
don't have to save, you don't have to reduce your consumption 
to get the tax break associated with an IRA, then IRAs 
essentially are an entitlement, and creating new entitlements 
makes the entitlement problem worse.
    Mr. Neal. Do you think a carefully designed IRA might 
overcome some of the objections that you have raised?
    Mr. Gale. It depends on what you mean by that. If you mean 
an IRA that you cannot finance by borrowing money and putting 
the money in the IRA, that you cannot finance by shifting 
already-existing assets or current saving into an IRA, then the 
answer is yes, but then, the question is how do you design an 
IRA like that. I know of no one who has been able to come up 
with such an animal.
    Mr. Neal. So you are concerned about what might become kind 
of a Christmas club effect?
    Mr. Gale. Pardon me?
    Mr. Neal. Put it in, take it out, put it in, take it out, 
is that something that troubles you?
    Mr. Gale. What troubles me most is the ability to put it 
in, put the money in without sacrificing consumption.
    Mr. Neal. Mr. Chairman, I know that the caution light is 
on. The only thing I would suggest is that the term that has 
been so popular around here now for the last 3 or 4 years has 
been the term ``personal responsibility,'' and it seems to me 
this is an opportunity for us to speak to that issue of 
personal responsibility, and if we are to proceed down the road 
to some sort of meaningful discussion about entitlement reform 
and the national savings rate, that these are the kinds of 
vehicles that we are going to have to put before the entire 
membership of the House and hope that good sense will prevail 
and that we might restore some of these incentives for 
addressing what Alan Greenspan has suggested time and again. It 
is the number one economic problem that faces the Nation, and 
that is our low national savings rate.
    Chairman Archer. Thank you, Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Rangel, do you care to inquire?
    Mr. Rangel. No. I just want to thank the witnesses, Mr. 
Chairman, for their comments on a policy option that is very, 
very popular here, and of course, is quite controversial as to 
whether it increases savings.
    One thing that this Committee has to consider is, How much 
does any policy cost, no matter how good any program is, or how 
much revenue does it bring in.
    So having the expert testimony of these witnesses and being 
able to read it will be of great help to me and the rest of the 
Committee. Thank you for your time and effort.
    Chairman Archer. My compliments to all four of you. I think 
it has been an exceedingly interesting exchange of two 
different viewpoints, and that is what we need to hear before 
the Committee as we make our decisions. We appreciate your 
testimony, and you are excused.
    The Committee will stand in recess while we vote, and I am 
told that there will be another, maybe, 15 minutes after this 
vote before we can reconvene for our last panel, but we will be 
back as soon as we can get away from the House.
    Thank you very much, gentlemen.
    Mr. Gale. Thank you, Mr. Chairman.
    [Recess.]
    Chairman Archer. The Committee will come to order, and our 
next panel of witnesses are invited to take seats behind the 
witness table.
    Our first witness is Martin Regalia--or Dr. Martin Regalia. 
My apologies.
    Welcome to the Committee. If you will identify yourself for 
the record, we will be pleased to receive your testimony.

STATEMENT OF MARTIN A. REGALIA, PH.D., VICE PRESIDENT AND CHIEF 
              ECONOMIST, U.S. CHAMBER OF COMMERCE

    Mr. Regalia. I will do so. My name is Martin Regalia, and I 
am vice president for economic policy at the U.S. Chamber of 
Commerce.
    We appreciate the opportunity today to come and voice our 
opinion and give you our views on the savings and investment 
provisions contained in President Clinton's fiscal year 1998 
budget proposal.
    The Chamber believes that public policy should not only 
improve our current economic environment, but also ensure our 
economic prosperity in the future, and the key to this future 
economic prosperity really is productivity growth.
    Virtually, all economists agree that increases in 
productivity growth will require savings and investment in 
capital, both human capital and physical capital, and we 
further believe that government policies can play an important 
role in this capital formation.
    To boost productivity, the Federal Government must end its 
misdirection of resources and curb its appetite for borrowing. 
In addition to balancing the budget, other policy prescriptions 
include overhauling our regulatory and tort systems, enhancing 
education, job training programs, and most importantly, 
reducing the tax burden while reforming the Tax Code.
    Measured against this criteria, we find the President's 
fiscal year 1998 budget proposals to be a major disappointment. 
Fundamental problems are left unaddressed, real spending cuts 
are delayed, so-called tax cuts are offset by other tax 
increases and tax triggers, and budgetary legerdemain is still 
required for the budget to even come close to balancing. Long-
term economic growth appears to be a lower priority than 
continuing business as usual in the Federal Government.
    Focusing primarily on the tax aspects, the U.S. Chamber 
believes that to increase national savings and investment, 
substantive policy reforms must be made to the estate and gift 
tax, to individual retirement accounts, to the capital gains 
tax, and to the alternative minimum tax.
    The Federal estate and gift tax system, or the death tax as 
many refer to it, is a major source of our Tax Code's bias 
against savings and investment. The estate tax penalizes those 
who have saved and invested for their entire lives, and the 
confiscatory nature of this tax clearly discourages 
entrepreneurship, job creation, capital formation, and can in 
extreme cases contribute to the demise of family businesses.
    Ongoing businesses have no choice but to expend large 
amounts of their financial and human resources on complicated 
estate tax planning and tax compliance services. This is why we 
believe the best approach to relieve small businesses from the 
burdensome and ineffective estate tax would be to repeal it 
outright. Short of that, we believe there are several ways in 
which the estate tax can be reformed in order to make it less 
harmful to small businessowners and their workers. These 
include: Increasing the unified credit, reducing tax rates, and 
exempting family owned businesses.
    By virtually any measure, savings in the United States has 
declined in recent decades. The ominous shortfall over such a 
long period of time imperils our economic future because saving 
funds the investment needed for future growth.
    We believe one way to encourage higher personal savings 
would be through the expansion of individual retirement 
accounts. The Chamber believes that IRAs should be expanded as 
broadly as possible in order to give individuals additional 
incentives to save, and we believe that increasing the 
deductible contribution amount, repealing the active 
participant rule between spouses, permitting penalty-free 
withdrawals for qualified purposes, and creating new backloaded 
IRAs would all help in this regard.
    A vibrant healthy economy also requires that resources be 
allocated to their most efficient and productive uses, but high 
tax rates on capital gains impose a barrier to the efficient 
flow of capital.
    Capital gains tax reform would spur investment activity, 
create jobs, and expand the economy, which would benefit 
individuals of all income levels.
    We believe that reducing capital gains rates on individuals 
and corporations, indexing the basis of capital assets for 
inflation, providing capital loss treatment for sales of 
principal residences, and expanding the preferential capital 
gains treatment for small business stock would all work toward 
increasing the amount of investment and savings in this 
country.
    Originally envisioned as a method to ensure that all 
taxpayers pay a minimum amount of tax, the AMT has become 
unfair and penalizes businesses that heavily invest in plant, 
machinery, equipment, and other assets. The AMT significantly 
increases the cost of capital and discourages investment in 
productivity-enhancing assets by negating many of the capital 
formation incentives provided under the regular tax system, 
most notably accelerated depreciation. In fact, the AMT cost 
recovery system is the worst among industrialized nations and 
places our businesses at a competitive disadvantage 
internationally.
    As with the Federal estate and gift tax, the best way to 
provide individuals and corporations with relief from AMT would 
be to repeal it altogether. Short of that, however, the AMT 
should be substantially reformed in order to reduce the harmful 
effects it imposes on businesses. Such reforms include 
conforming the AMT depreciation rules with the regular tax 
depreciation rules, allowing taxpayers to offset their current 
year AMT liabilities with their accumulated minimum tax 
credits, and making the AMT system less complicated and easier 
to comply with.
    Our long-term economic health depends upon sound economic 
and tax policies. Today, we are critically shortchanging 
ourselves and, more importantly, our children as we commit too 
many of our scarce resources to current consumption and away 
from prudent investment. Our tax system encourages waste, 
retards savings, and punishes capital formation, all to the 
detriment of long-term economic growth. As we prepare for the 
economic challenges of the next century, we must orient our 
current fiscal policies in a way that encourage more savings, 
more investment, more productivity growth, and ultimately, more 
economic growth.
    Thank you.
    [The prepared statement follows:]

Statement of Martin A. Regalia, Ph.D. Vice President and Chief 
Economist, U.S. Chamber of Commerce

    The U.S. Chamber of Commerce appreciates this opportunity 
to express our views on the savings and investment provisions 
contained in President Clinton's Fiscal Year 1998 budget 
proposal. The U.S. Chamber is the world's largest business 
federation, representing an underlying membership of more than 
three million businesses and organizations of every size, 
sector and region. This breath of membership places the Chamber 
in a unique position to speak for the business community.

                              Introduction

    The Chamber believes that public policies should not only 
improve our current economic environment but also ensure our 
future prosperity. The key to a stronger economic future is 
simple to define but difficult to achieve: a high rate of 
economic growth. It's strong economic growth that will allow us 
to maintain our position of world leadership, increase our 
domestic standard of living, and meet the daunting demographic 
challenges that will begin to present themselves early in the 
next century.
    But economic growth does not occur by accident. Just as our 
farmers do not rely on good luck for bountiful harvests, 
neither can we rely on chance or the momentum of the past to 
propel us in the future. The seeds of tomorrow's economic 
success must be planted today, and so, when evaluating economic 
policies, we must ask how they would cultivate long-term 
economic growth.
    By definition, economic growth is simply the product of 
growth in the labor force (i.e., the number of hours worked) 
and growth in productivity (i.e., output per hour). With growth 
in hours worked largely determined by demographics, sensible 
economic policy must emphasize strong productivity growth.
    This is a crucial issue because productivity growth has 
been languishing for the past quarter-century or so. After 
expanding at a healthy 2.7 percent rate during the 1960's, for 
example, productivity growth has slowed to an anemic 1 percent 
rate so far in the 1990's. With growth in hours worked hovering 
a little below 1.5 percent, long-term economic growth is thus 
limited to 2.5 percent--well below the average of the post-
World War II era.
    While measurement problems related to productivity have 
expanded with the growing share of the economy devoted to 
service-producers rather than goods-producers, the decline in 
economic growth over the same period confirms that we are 
suffering a decline in the underlying growth rate in 
productivity. The question then becomes: What can we do to 
raise productivity growth?
    Like the farmer who sows the seed corn and cultivates the 
soil, households and businesses must also prepare for the 
future. Virtually all economists agree that this is done by 
saving and investing in capital--both human capital (education) 
and physical capital (plant and equipment). Thus the issue of 
long-term productivity growth and, in turn, economic growth 
becomes one of fostering additions to, and improvements in, 
capital. Consequently, the U.S. Chamber believes that today's 
economic policies must be targeted toward improving economic 
growth by fostering saving, investment, and capital formation. 
Only through such pro-growth policies can we lay the foundation 
of prosperity and security for our children into and beyond the 
21st century.
    To boost productivity, the federal government must end its 
misdirection of resources and curb its appetite for borrowing 
so that national savings and investment can be increased. This 
will yield stronger productivity growth, which in turn will 
propel the economy on a higher growth track. Besides balancing 
the budget, other policy elements that would aid long-term 
economic growth include overhauling our regulatory and tort 
systems, enhancing education and job training programs, 
reducing the tax burden, and reforming the tax code.

                         The President's Budget

    Measured against this criteria, we find that the 
president's FY1998 budget proposal is a major disappointment. 
Unfortunately, fundamental problems are left unaddressed, 
economic assumptions are too optimistic, and budgetary 
legerdemain is still required for the budget to even come close 
to balancing. Long-term economic growth appears to be a lower 
priority than continuing business as usual in the federal 
government.
    We believe that the chief weaknesses of the president's 
budget are:
    Failure to use CBO economic assumptions--After agreeing to 
use the Congressional Budget Office economic assumptions two 
years ago as a common starting point, the Administration has 
again reversed course and used its own Office of Management and 
Budget numbers. CBO calculates that the Administration will 
fall $69 billion short of eliminating the deficit in 2002.
    Failure to address entitlement spending--The dramatic 
growth in Social Security spending is not addressed, and the 
Administration's Medicare Asolution merely shifts health care 
costs instead of providing the market incentives that would 
lower them. The viability of the Medicare Part A trust fund is 
extended a few more years only by increasing payment 
responsibility from the trust fund to the general taxpayer.
    Establishment of new entitlements--The president has 
proposed new, embryonic education entitlements that, like 
earlier entitlements, can be expected to mushroom in cost, 
expanding the federal government's presence.
    Deferral of deficit reduction to the later years--The 
president's budget treads water for the next four years, saving 
most of the deficit reduction for the final two years of the 
plan--after the president is out of office.
    Not a path to continued balance in 2003 and beyond--The 
president's proposal does not establish the groundwork for 
maintaining a balanced budget in 2003 and beyond. The proposal 
relies on one-time budgetary maneuvers that will make balancing 
the budget even more difficult in later years, further 
diminishing the chances of faster productivity growth.
    Tax increases--Despite the Administration's talk about tax 
cuts, tax increases are also an integral part of the budget. 
The advertised $98 billion in tax cuts is a gross, not net, 
figure. Over five years, the Clinton plan would provide at most 
$22 billion in tax relief.
    The tax trigger--The Administration relies on a a trigger 
mechanism in the out years that would repeal many of the 
proposed tax cuts and impose an across-the-board spending cut 
against most programs to achieve balance by 2002. However, the 
trigger may be pulled even if the budget were on target to 
reach balance. According to statutory language provided by the 
Treasury Department to the Joint Committee on Taxation after 
the budget proposal was released, four of the president's tax-
cut provisions (education tax incentives, the child tax credit, 
expanded IRAs, and brownfield provisions) would expire after 
2000 regardless of how close the budget was to its target path 
to balance by 2002.

                          Specific Tax Issues

    In order to increase national savings and investment, 
substantive policy reforms must be made to the estate and gift 
tax, individual retirement accounts (IRAs), the capital gains 
tax, and the alternative minimum tax (AMT). Each of these is 
discussed below.

Estate And Gift Tax Reform

    The federal estate and gift tax system--or the Death Tax, 
as many refer to it--is a major source of our tax code's bias 
against savings and investment. The estate tax confiscates 
between 37 percent and 55 percent of a family's after-tax 
savings, thereby penalizing those who have saved and invested 
their entire lives. The confiscatory nature of this tax clearly 
discourages entrepreneurship, job creation and capital 
formation.
    A growing economy depends on the ability of small 
businesses to succeed. The heavy estate tax burden, coupled 
with the limited amount of liquid assets available to business 
owners, causes many small businesses to curtail operations, 
sell income-producing assets, or, in extreme cases, liquidate. 
In fact, the estate tax can be blamed for being a major 
contributing factor to the demise of family businesses, which 
are often not passed down from one generation to the next.
    Furthermore, businesses often have no choice but to expend 
large amounts of their financial and human resources on 
complicated estate planning and tax compliance services--all 
for a tax which generates a mere one percent of total federal 
revenue. In addition, the estate tax is extremely costly for 
the government to administer.
    That is why we believe strongly that the best approach to 
relieve small businesses from the burdensome and inefficient 
estate tax would be to repeal it outright. Short of that, 
however, there are several ways in which the estate tax can be 
reformed in order to make it less harmful to small business 
owners and their workers.
    First, the unified credit--which currently provides a 
credit of up to $192,800 against the estate tax--should be 
increased. This credit effectively exempts up to $600,000 of a 
decedent's lifetime transfers from the estate tax. At a 
minimum, this credit should be indexed for inflation. If the 
unified credit had been indexed since 1987 when its current 
amount was phased-in, it would now effectively exempt up to 
approximately $830,000 in lifetime transfers. Second, overall 
estate tax rates--which effectively begin at 37 percent and 
rise to a crushing 55 percent--should be significantly reduced. 
Third, in order to promote prosperity for our nation's family 
businesses, such businesses should be exempted from the estate 
tax.
    The president's budget, unfortunately, would provide 
individuals or small businesses with little, or no, estate tax 
relief. His proposal would merely lower the interest rate on 
the deferred estate tax liabilities of certain closely held 
businesses. It would not reduce the underlying estate tax 
liabilities of these or any other types of businesses.
    However, many proposals have been introduced in the 105th 
Congress which would provide taxpayers with significant estate 
tax relief. For example, The Family Heritage Preservation Act 
(S. 75 and H.R. 902)--introduced by Senator Kyl (R-AZ) and 
Representative Cox (R-CA), respectfully, would simply repeal 
the federal estate and gift tax altogether.
    The American Family Tax Relief Act (S. 2)--introduced by 
the Senate Republican leadership--would effectively increase 
the exemption amount from $600,000 to $1,000,000 over eight 
years, exclude the first $1.5 million in value of a qualified 
family-owned business interest and 50 percent of any excess 
value from tax, and extend the maximum period for which federal 
estate tax installments could be made from 14 to 24 years.
    Other relief bills have also been introduced, including 
those by Senators Lugar (R-IN), McCain (R-AZ) and Dorgan (D-ND) 
and Representatives Crane (R-IL), Livingston (R-LA), Solomon 
(R-NY) and Stump (R-AZ), which would either repeal the estate 
tax, increase the unified credit, reduce estate tax rates, or 
provide family-owned businesses with tax relief.

Expanded Individual Retirement Accounts

    By virtually any measure, savings in the United States has 
declined in recent decades. This ominous shortfall over such a 
long period of time imperils our economic future because 
savings funds the investment necessary to keep the economy 
vibrant. One way to encourage higher personal savings would be 
through the expansion of individual retirement accounts.
    The Chamber believes that IRAs should be expanded as 
broadly as possible in order to give individuals additional 
incentives to save. Ways in which IRAs should be expanded 
include removing the income limits on active participants in 
retirement plans, increasing the deductible contribution amount 
(at least for inflation), repealing the active participant rule 
between spouses, permitting penalty-free withdrawals for 
qualified purposes, and creating new backloaded IRAs.
    Furthermore, IRAs should not be made more restrictive or 
take away from other savings vehicles. For example, the IRA 
contribution limits should not be coordinated with those of 
salary reduction plans.
    There are several ways in which IRAs can be improved and 
expanded. First, the existing income limitations that apply to 
those who are active participants in employer-sponsored 
retirement plans should be completely removed. Individuals of 
all income levels should be encouraged to save for their 
futures.
    Second, the active participation rule between spouses 
should be repealed. Currently, one is treated as an active 
participant in an employer-provided plan (and therefore subject 
to the income limits for deductible IRAs) if his or her spouse 
is such an active participant. This rule should be repealed not 
only because it serves as a disincentive for couples to save 
more for retirement, but because it can cause a serious 
shortfall in savings for those who later divorce and are not 
participants in a retirement plan.
    Third, the deductible IRA contribution amount of $2,000 
should be increased to promote additional savings. At a 
minimum, the amount should be indexed for inflation. Fourth, 
penalty-free withdrawals should be permissible for qualified 
purposes, such as first-time home purchases, higher education, 
medical expenses, long-term unemployment and start-up business 
costs. Allowing for such withdrawals to be penalty-free would 
give individuals greater incentive to establish and put money 
into their IRAs.
    Finally, creating a new vehicle for savings, such as a 
backloaded IRA, would give individuals an additional option to 
increase personal savings. Under a backloaded IRA, 
contributions would not be deductible, but distributions 
(including earnings) would not be taxable if the account is 
open for a certain number of years and/or the proceeds are used 
for a qualified purpose.
    The president's proposed budget would gradually double the 
present-law income limits on deductible IRAs, index the $2,000 
contribution limit for inflation, allow penalty-free 
withdrawals for special purposes (i.e., first-time home 
purchases, higher education, qualified medical and long-term 
unemployment expenses), and create backloaded Special IRA 
accounts.
    Unfortunately, his proposal would maintain the active 
participant rule between spouses. Therefore, one would continue 
to be considered an active participant in a retirement plan if 
his or her spouse is an active participant. In addition, this 
proposal would coordinate the IRA contribution limits with 
those of salary reduction plans (i.e., 401(k) plans). The 
effect of this provision is that the maximum amount individuals 
could contribute to their salary reduction plans would be 
reduced by the amount of their IRA contribution.
    Several expanded IRA proposals have been introduced so far 
in the 105th Congress, including The Savings and Investment 
Incentive Act of 1997 (S. 197 and H.R. 446). Introduced by 
Senators Roth (R-DE) and Breaux (D-LA) and Representatives 
Thomas (R-CA) and Neal (D-MA) respectively, these bills would 
completely phase-out the income limits for deductible IRAs over 
five-years, index the $2,000 contribution limit for inflation 
in $500 increments, immediately repeal the active participant 
rule between spouses, allow penalty-free withdrawals for 
special purposes (i.e., first-time home purchases, higher 
education, qualified medical and long-term unemployment 
expenses), and create backloaded IRA PLUS accounts.
    Expanded IRA legislation was also included in S. 2, the 
Senate Republican leadership's The American Family Tax Relief 
Act. This bill would completely phase-out the income limits for 
deductible IRAs over five-years, immediately repeal the active 
participant rule between spouses, allow withdrawals free of 
income tax and penalties for special purposes (i.e., business 
start-up expenses, long-term unemployment, or higher 
education), and create backloaded IRA PLUS accounts. Their 
bill, however, would coordinate the IRA contribution limits 
with those of salary reduction plans and would not index the 
$2,000 contribution limit for inflation.

Capital Gains Tax Reform

    Vibrant, healthy economies require resources to be 
allocated to their most efficient, or productive, uses, but 
high tax rates on capital gains impose a barrier to the 
efficient flow of capital. Lower capital gains taxes would spur 
investment activity, create jobs and expand the economy, which 
would benefit individuals of all income levels.
    Many investors and businesses are unwilling or unable to 
sell their capital assets due to the high rate of tax that 
would be imposed on the gain of such assets--much of which can 
be due to inflation, rather that real appreciation. This 
creates a locking effect of capital assets which prevents 
investors and businesses from allocating their resources to 
more productive capital or business ventures. Scarce capital, 
therefore, remains tied up in suboptimal uses, to the detriment 
of economic growth.
    Bold capital gains reforms should be implemented to boost 
capital formation and mobility. These reforms include reducing 
capital gains rates on individuals and corporations, indexing 
the bases of capital assets for inflation, providing capital 
loss treatment for sales of principal residences and expanding 
the preferential capital gains treatment for small business 
stock.
    Under the president's budget proposal, a taxpayer would 
generally be able to exclude up to $250,000 ($500,000 if 
married filing a joint return) of capital gain realized on the 
sale or exchange of a principal residence every two years. No 
other capital gains provisions were included in his package. As 
a result, the president would not provide substantial capital 
gains tax relief to individuals, and none to businesses. 
Furthermore, only a small number of homeowners would benefit 
from the president's provision since most homeowners currently 
do not pay tax on their home sales due to the tax code's 
rollover provisions and $125,000 exclusion for those age 55 or 
older.
    Several bills, however, have been introduced in the 105th 
Congress which would provide broader capital gains relief. For 
example, S. 2, the Senate Republican leadership's tax bill, 
would permit individuals to exclude 50 percent of their net 
capital gains from tax, subject corporations to a maximum 
capital gains tax rate of 28 percent, permit certain taxpayers 
to index certain capital assets for inflation, allow taxpayers 
to treat losses on the sales of principal residences as 
deductible capital losses, rather than nondeductible personal 
losses, and modify rules relating to sales of certain small 
business stock.
    The Capital Formation Act of 1997 (S. 66)--introduced by 
Senators Hatch (R-UT) and Lieberman (D-CT)--would permit 
individuals to exclude 50 percent of their net capital gains 
from tax, subject corporations to a maximum capital gains rate 
of 25 percent and modify the rules relating to sales of certain 
small business stock.
    In addition, The Capital Gains Reform Act of 1997 (S. 72)--
introduced by Senator Kyl (R-AZ)--would provide individuals 
with a 70 percent capital gains exclusion and corporations with 
a maximum capital gains tax rate of 22 percent. Another bill, 
S. 306, introduced by Senator Ford (D-KY), would reduce the 
current 28 percent individual maximum capital gains tax rate 
for assets held more than two years on a sliding scale down to 
a 14 percent maximum rate for assets held more than eight 
years.
    The Chamber believes that substantive capital gains reform 
is needed in order to spur business investment and productivity 
growth. Short of repeal, capital gains rates should be reduced 
for both individuals and corporations, capital assets should be 
indexed for inflation, and losses on principal residences 
should be treated as deductible capital losses.

Alternative Minimum Tax Reform

    Originally envisioned as a method to ensure that all 
taxpayers pay a minimum amount of taxes, the AMT had become 
unfair and penalizes businesses that invest heavily in plant, 
machinery, equipment and other assets. The AMT significantly 
increases the cost of capital and discourages investment in 
productivity-enhancing assets by negating many of the capital 
formation incentives provided under the regular tax system, 
most notably accelerated depreciation. In fact, the AMT cost-
recovery system is the worst among industrialized nations, 
placing our businesses at a competitive disadvantage 
internationally.
    To make matters worse, many capital-intensive businesses 
are perpetually trapped in AMT as they are unable to utilize 
their suspended AMT credits. The AMT is essentially a 
prepayment of tax which is substantially unrecoverable for many 
taxpayers. Furthermore, the AMT is extremely complex, 
burdensome and expensive to comply with. Even businesses not 
subject to the AMT must go through the time and expense of AMT 
calculations.
    As with the federal estate and gift tax, the best way to 
provide individuals and corporations with relief from the AMT 
would be to repeal it altogether. Short of that, however, the 
AMT should be substantially reformed in order to reduce the 
harmful effects it imposes on businesses. Such reforms include 
conforming the AMT depreciation rules with the regular tax 
depreciation rules, allowing taxpayers to offset their current 
year AMT liabilities with their accumulated minimum tax 
credits, and making the AMT system less complicated and easier 
to comply with.
    Unfortunately, the president has not offered any AMT reform 
proposals in his budget plan. However, several reform bills 
have been introduced in the 105th Congress which would repeal 
or reform the AMT. For example, The Corporate Tax Equity Act 
(S. 73)--introduced by Senator Kyl (R-AZ)--would repeal the 
corporate AMT.
    In addition, Senators Nickles (R-OK) and Rockefeller (D-WV) 
will soon be introducing legislation which would repeal the 
depreciation adjustment for both individuals and corporations, 
and allow taxpayers with accumulated minimum tax credits at 
least five years old to use a portion of those credits to 
offset up to 50 percent of their current year AMT liability.
    The Chamber believes that the individual and corporate AMT 
should be repealed in order to spur capital investment in the 
business community and make our nation's businesses more 
competitive in the global marketplace. To the extent repeal is 
not feasible, significant reforms--such as eliminating the 
depreciation adjustment and allowing taxpayers to utilize 
accumulated minimum tax credits--should be implemented in order 
to make the tax less harmful.

                               Conclusion

    Our long-term economic health depends upon sound economic 
and tax policies. Today we are critically shortchanging 
ourselves and, more importantly, our children as we commit too 
many of our scarce resources into current consumption and away 
from prudent investment. Our tax system encourages waste, 
retards savings, and punishes capital formation--all to the 
detriment of long-term economic growth. As we prepare for the 
economic challenges of the next century, we must orient our 
current fiscal policies in a way that encourages more savings, 
more investment, more productivity growth, and, ultimately, 
more economic growth.
    The president's budget fails to address these issues, and 
consequently it perpetuates the present anti-growth policies 
that have limited productivity for the past 25 years. The U.S. 
Chamber urges Congress to pass legislation that balances the 
budget, repeals or at least reforms the estate and gift tax 
system, expands IRAs, reduces the tax on broad-based capital 
gains, andeliminates the alternative minimum tax.
      

                                

    Chairman Archer. Thank you, Dr. Regalia.
    Our next witness is Mark Kalish. Welcome to the Committee, 
and if you will identify yourself for the record, you may begin 
your testimony.

 STATEMENT OF C. KENT CONINE, OWNER, CONINE RESIDENTIAL GROUP, 
   DALLAS, TEXAS; ON BEHALF OF NATIONAL ASSOCIATION OF HOME 
     BUILDERS; AS PRESENTED BY MARK KALISH, EXECUTIVE VICE 
    PRESIDENT, MICHAEL T. ROSE ASSOCIATES, LAUREL, MARYLAND

    Mr. Kalish. Yes, Mr. Chairman. Mr. Chairman, Members of the 
Committee, my name is Mark Kalish. I am executive vice 
president of Michael T. Rose Associates. I was also a delegate 
to the 1994 White House Conference on Small Business. Our 
company is a builder developer located in Laurel, Maryland. 
Although Kent Conine from Dallas, Texas, was originally 
scheduled to testify this morning, he had an unexpected 
emergency yesterday afternoon and asked me to take his place. 
So, on behalf of the 190,000 member firms, which employ 
approximately 7 million people of the National Association of 
Home Builders, I want to thank you for the opportunity to 
testify before the Ways and Means Committee today.
    At the outset, let me state that NAHB has been a long-time 
supporter of tax cuts the Committee is discussing today. Even 
though we support balancing the budget, we hope, Mr. Chairman, 
that you will continue your commitment to enact tax cut 
legislation this year. We are particularly appreciative, Mr. 
Chairman, of your longstanding support of the broad-based 
capital gains relief, and we thank you for your continued 
efforts over the years.
    As you know, the home building industry is comprised mostly 
of small business men and women. Over 50 percent of the 
national members build less than 10 houses per year. 
Approximately 15 percent build more than 25 houses per year, 
and less than 2 percent build over 500 houses per year.
    Further, about 80 percent of our members are family owned 
businesses. Unlike many other industries, homebuilders are 
affected by all three provisions that you have been addressing 
today in these hearings. The exclusion of capital gains on the 
sale of primary residence, the expansion of individual 
retirement accounts, and the death tax relief, all directly 
impact the ability of builders to provide affordable housing.
    Mr. Chairman, the home building industry plays an 
instrumental role in our Nation's economy. Housing construction 
contributes jobs, taxes, and economic activity to the economy. 
Each year, nearly 3 million jobs are created in the 
construction of new homes. For every house that is built, 2.4 
jobs are created. These jobs create $98 billion in wages and 
$45 billion in Federal, State, and local taxes on those wages 
and business income.
    Even greater economic activity is created as the income is 
generated in the construction, manufacturing, and sales jobs 
that are spread throughout the rest of the local economy.
    NAHB estimates that housing, including new construction, 
remodeling, repairing, and maintenance, and the value provided 
by existing homes account for 13 percent of the U.S. economy. 
The ongoing benefit provides most American homeowners and 
renters with decent, safe, affordable housing.
    Affordable housing means more Americans can be homeowners, 
which is an important impact on our society. We should strive 
to do what is possible to provide the opportunity of home 
ownership for more young families, and that, Mr. Chairman, is 
the expansion of the individual retirement accounts, the IRAs, 
and the penalty-free withdrawal from the IRAs for first-time 
home purchases will do.
    NAHB supports the expansion of tax-deferred retirement 
savings and the use of IRA deposits for the downpayment on a 
first home.
    The proposal currently before the Committee would create a 
new IRA and allow penalty-free distribution of funds from that 
account and from existing IRAs for first-time home purchases. 
NAHB supports this proposal and suggests modifications to 
better accomplish its intended purposes.
    Specifically, NAHB believes that any legislation should 
also allow the tax-free withdrawal of funds in addition to 
penalty-free withdrawals and provide affiliated individuals, 
such as parents and grandparents, the access to the retirement 
savings to help a first-time buyer.
    Accumulating the downpayment for the purpose of a first-
time home is a primary barrier to home ownership for many young 
households. IRAs could be a useful resource to assist in a 
first-time home purchase downpayment.
    In designating a successful proposal for using retirement 
funds for downpayment, NAHB believes there are three important 
components. One, the use must be considered as an alternative 
investment, rather than a withdrawal. Eligibility must be open 
to the parents and grandparents of first-time buyers, as well 
as the buyers. Eligible plans must include IRAs, Keoughs, 
401(k)s, other salary reduction plans, and the Federal 
Government retirement system.
    In the alternative, an attractive and economic proposal 
would allow downpayments for first-time home buyers to be 
treated as an investment for tax-deferred accounts rather than 
as penalty-free withdrawals. Withdrawing the funds also 
subjects the taxpayer to implicit penalties and that the 
accountholder's investments in tax-deferred assets are reduced.
    From the point of withdrawal on, interest of dividends on 
withdrawing funds will be taxed at current marginal tax rates, 
again, often higher than those anticipated during retirement.
    Treating the downpayment as an alternative investment would 
avoid both explicit and implicit penalties.
    Mr. Chairman, NAHB encourages you to make rules for the IRA 
use as flexible as possible. For example, if legislation 
requires that the funds be maintained on deposit at least for 5 
years prior to withdrawal, many young people would not be able 
to take advantage of this legislation. First-time home buyers 
are typically in their early thirties and currently have small 
account balances in tax-deferred retirement accounts.
    The long waiting period, coupled with the first-time 
purchasers, are funds deferred and diminish the stimulative 
impact of the proposal.
    Mr. Chairman, now turning to the issue of capital gains 
relief, NAHB remains committed to a broad-based tax cut in 
capital gains rate. However, we realize that the purpose of 
today's hearing is to discuss the targeted cuts contained in 
President Clinton's fiscal year 1998 budget. Increasing the 
capital gains exemption for home ownership would increase the 
incentive to own and to own a larger house. Allowing repeated 
use of the exemption after each sale would enhance housing as 
an asset by removing barriers to trading before and after the 
age of 55, which is the current law.
    Allowing a repeal, repeated exemption will also remove 
significant reporting burdens now required of homeowners. Under 
current law, a typically elderly homeowner who has moved to a 
retirement community must calculate capital gains liability by 
going back to records of the first home purchase and following 
each successive sale and purchase. The recordkeeping and effort 
necessary to calculate tax liability is daunting for anybody 
and all the worst for the individuals who have already paid a 
lifetime of taxes.
    Raising the amount of home appreciation exempt from taxes 
is also necessary now in order to anticipate future home 
appreciation that will dilute the value of current one-time 
exemption levels of $125,000.
    At the current levels of house price appreciation, a 
typical home buyer in 1997 will see $265,000 of appreciation in 
their home-owning lifetime. Increasing the limit now will 
assure those young households that they will enjoy the same tax 
advantages of owning as their parents and grandparents.
    Finally, Mr. Chairman, I turn my remarks to the issue of 
death tax relief. Although the President's budget contains some 
estate tax relief for closely held businesses, it is minimal 
and needs to be significantly expanded. The President's 
proposal does very little to eliminate the estate tax burden on 
small business and is merely a loan program. Although complete 
repeal makes the most economic sense, NAHB understands the 
revenue constraints associated with the appeal. Thus, NAHB 
believes the best solution would be to raise the exemption 
level from $600,000 and reduce the overall estate tax rate.
    NAHB looks forward with working with the Ways and Means 
Committee, as well as the administration, to craft a workable 
proposal that is passable. Home building is dominated by small 
firms which very often are family owned and operated. The 
current estate and tax laws operate to destroy family owned 
businesses. Although a credit is allowed against estate and 
gift tax sufficient to allow a taxpayer upon death to transfer 
up to $600,000 without paying taxes, this exemption amount has 
not been raised.
    The forced sale of family business is disruptive to the 
home-building industry and increases the cost of producing 
housing. Further, building homes and developing subdivisions is 
a long-term process which many times is interrupted and frozen 
as part of builder's estate. Creation of affordable housing 
should not be stalled or curtailed as a result of complicated 
estate issues or the eventual sale of the business.
    For these reasons, NAHB supports estate tax relief. 
Although complete repeal of the estate tax makes the most 
economic sense, NAHB also supports a reduction in the current 
estate tax rate and increasing the current estate tax 
exemption.
    Additionally, NAHB supports legislation to preserve family 
owned businesses by either repealing the estate tax in general 
or eliminating it from small family owned businesses. We also 
understand that Senate Majority Leader Lott, with a group of 
bipartisan Senators, will be introducing an estate tax bill 
that takes a step in this direction.
    In conclusion, for the reasons stated above, the National 
Association of Home Builders believes that the tax cut proposal 
currently being considered by Congress and the administration 
are important to our Nation's economy and the creation of 
affordable housing.
    Home building creates jobs, both directly and indirectly, 
as well as fuel our economy.
    Again, Mr. Chairman, NAHB thanks you for this opportunity 
to present our recommendations, and we look forward to working 
with you, your staff in the coming months as the budget process 
and tax cut proposals move forward.
    I also have a copy of our 1997 legislative tax reform 
policy which I would like to give to you that has all of our 
legislative issues, and we have them available for all the 
Members of the Committee.
    [The statement and attachment follow. The entire book, 
``Building the American Dream,'' is being retained in the 
Committee files.]

Statement of C. Kent Conine, Owner, Conine Residential Group, Dallas, 
Texas; On Behalf of National Association of Home Builders; as Presented 
by Mark Kalish, Executive Vice President, Michael T. Rose Associates, 
Laurel, Maryland

    Mr. Chairman, members of the committee, my name is Kent 
Conine and I am a home builder from Dallas, Texas. On behalf of 
the 190,000 members of the National Association of Home 
Builders (NAHB), I want to thank you for the opportunity to 
testify before the Ways and Means Committee today. At the 
outset, let me state that NAHB has been a long supporter of the 
tax cuts the Committee is discussing this morning. We are 
particularly appreciative, Mr. Chairman, of your long-standing 
support of broad based capital gains relief and we thank you 
for your continued efforts over the years.
    As you know, the home building industry is comprised mostly 
of small businessmen and women. Over 50 percent of NAHB members 
build less than 10 houses per year. Approximately 15 percent 
build more than 25 houses per year and less than two percent 
build over 500 houses per year. Further, about 80 percent of 
our members are family owned businesses. Unlike many other 
industries, home builders are affected by all three of the 
provisions that have been addressed by this morning's hearing. 
The exclusion of capital gains on the sale of a primary 
residence, an expansion of Individual Retirement Accounts and a 
modification to the estate tax all directly impact the ability 
of builders to provide affordable housing.

                      Housing--Its Economic Impact

    Housing construction contributes jobs, taxes, and economic 
activity to the U.S. economy. Each year, nearly 3 million jobs 
are created in the construction of new homes. These jobs create 
$98 billion in wages and $45 billion in federal, state and 
local taxes on that wage and business income. Even greater 
economic activity is created as the income generated in the 
construction, manufacturing, and sales jobs spread throughout 
the rest of the local economy.
    NAHB estimates that housing, including new construction, 
remodeling, repairing and maintenance, and the value provided 
by existing homes accounts for 13 percent of the U.S. economy. 
The on-going benefit provides most American homeowners and 
renters with decent, safe affordable housing.

          Table 1. Number of Workers Needed to Construct 1,000 Houses and Total Wages by Major Industry
----------------------------------------------------------------------------------------------------------------
                                                                        Single Family           Mulitfamily
                                                                   ---------------------------------------------
                          Industry Groups                             No. of                 No. of
                                                                    full-time     Wages    full-time     Wages
                                                                     jobs (1)  (millions)   jobs (1)  (millions)
----------------------------------------------------------------------------------------------------------------
All Industries....................................................      2,448       $75.5      1,030       $31.9
Construction......................................................      1,125        34.1        428        13.0
Onsite............................................................        957        29.0        376        11.4
Offsite...........................................................        168         5.1         52         1.6
Other industries..................................................      1,323        41.4        602        18.9
Manufacturing.....................................................        597        20.9        279         9.8
Trade, transportation, and services...............................        675        19.3        304         8.7
Mining and Other..................................................         51         1.2         19         0.5
----------------------------------------------------------------------------------------------------------------
(1)  Full-time, year round jobs.
 
Source: Number of workers: NAHB estimates from Bureau of Labor Statistics surveys of labor inputs in residential
  construction. Wages: NAHB estimes from Bureau of Economic Analysis data.


 Table 2. Tax Revenue Generated from Constructing 1,000 Homes: 1994 U.S.
                                Averages
------------------------------------------------------------------------
                                         Single Family     Multifamily
             Tax by Source             ---------------------------------
                                           (Millions)       (Millions)
------------------------------------------------------------------------
Total.................................            $37.0            $15.8
Federal Taxes.........................             26.9             11.3
  Personal Income Tax.................              6.9              2.9
  Corporate and Business Income Tax...              8.4              3.5
  Social Security Tax.................             11.6              4.9
  Employee share......................              5.8              2.4
  Employer share......................              5.8              2.4
State & Local Taxes and Fees..........             10.1              4.5
  State & Local General Sales Taxes...              3.3              1.4
  State & Local Personal Income Taxes.              1.7              0.7
  State Corporate and Business Income
   Taxes..............................              2.1              0.9
  Local Real Estate Taxes and Fees (1)              3.0              1.5
  Property transfer tax...............              0.5              0.2
  Building permits, approval and
   impact fees........................              2.5              1.3
------------------------------------------------------------------------
  (1) Excludes ongoing local property taxes of $1.7 million on 1,000
  single family homes and $0.9 million on 1,000 multifamily homes.
 
Sources: Table II-4, U.S. Department of the Treasury, Internal Revenue
  Service, Statistics of Income Bulletin, Summer 1994; and U.S.
  Department of Commerce; Bureau of Economic Analysis, Survey of Current
  Business, July 1994 and February 1995; U.S. Advisory Commission on
  Intergovernmental Relations, Significant Feautres of Fiscal
  Federalism; 1993, Volume I; National Apartment Association and NAHB
  estimates.

               Home Ownership--It's Impact on Our Society

    Homeownership truly is a fundamental part of the American 
Dream. Getting a good education, working hard, practicing 
thrift so that home ownership can become a reality, has been a 
motivating force for millions of Americans. NAHB's surveys show 
that 80 to 90 percent of all Americans want to become home 
owners. Recent studies by Fannie Mae have demonstrated the goal 
for home ownership is strong among all age and income groups. 
Homeownership not only allows families to establish roots in 
their communities, but it strengthens neighborhoods, expands 
participation in civic, religious, and community activities--it 
is what ties our neighborhoods together.
    Financial security is another benefit of homeownership. A 
home is the largest single asset of most Americans. For 
millions it represents a nest egg for retirement which has 
provided the elderly a strong supplement to social security. 
Many point to the low rate of per capital savings in the United 
States. However, if the equity in the homes of individuals were 
calculated, our per capita savings rates would be dramatically 
higher.
    The tax base for our public schools and community services 
results from homeownership. It provides a safe haven, a 
sanctuary, a secure place for families to live, grow and 
prosper. This environment is essential for the development and 
growth of our children. How can a child study properly, develop 
family values, excel and expand their goals and dreams without 
the proper environment Homes are what provide that secure, 
protected and nurturing environment for millions of Americans. 
We should strive to do what is possible to provide the 
opportunity of homeownership for more young families, and that 
Mr. Chairman is what expansion of Individual Retirement 
Accounts (IRAs) and the penalty free withdrawal from IRAs for 
first time home purchases will do.

              Expansion of Individual Retirement Accounts

    NAHB supports expansion of tax-deferred retirement savings 
and use of IRA deposits for down payment on a first home. The 
proposal currently before the committee would create a new IRA, 
and allow the penalty-free distribution of funds from that 
account and from existing IRAs for first-time home purchase. 
NAHB supports this proposal and suggests modifications to 
better accomplish its stated purposes. Specifically, NAHB 
believes that any legislation should also allow the tax free 
withdrawal of funds in addition to penalty free withdrawal sand 
and affiliated individuals (e.g. parents and grandparents) 
should be allowed acess to retirement savings for a first-time 
home buyer.
    Accumulating the down payment for the purchase of a first 
home is the primary barrier to home ownership for many young 
households. Even with lower down payment requirements under FHA 
and special affordable housing programs from Fannie Mae, 
Freddie Mac, and the Federal Home Loan Bank System, first-time 
homebuyers find it difficult to accumulate the cash necessary 
to make the leap into homeownership. The U.S. Census bureau and 
the Harvard Joint Center for Housing Studies have reported that 
down payment remains a serious barrier to home ownership for 
young renters.\1\ Approximately nine-out-ten young renters 
cannot afford to purchase even a modest home in their area.
---------------------------------------------------------------------------
    \1\ The State of the Nation's Housing 1993. Joint Center for 
Housing Studies of Harvard University and Who Can Afford to Buy in 
House in 1991. Current Housing Reports H121/93-3. Bureau of the Census.
---------------------------------------------------------------------------
    Increasing housing costs add to the housing affordability 
problem in this country. From World War II until 1980 home 
ownership rates in the U.S. increased. Since that time home 
ownership rates overall has declined. Particularly hard hit are 
those in the prime home buying age of 25-34. The home ownership 
rates of those in the age group 25-29 dropped from 43.1% to 
34.4% and those in the 30-34 age group dropped from 62.2% to 
53.1%. This trend is of significant concern.

                 Table 3. Homeownership Rates (Percent)
------------------------------------------------------------------------
        Age Group           75      80      85      90      94      95
------------------------------------------------------------------------
<25.....................    20.4    21.3    17.0    15.7    14.9    15.9
25-29...................    43.1    43.3    37.4    35.2    34.1    34.4
30-34...................    62.2    61.1    53.8    51.8    50.6    53.1
35-39...................    69.0    70.9    65.3    63.0    61.2    62.1
40-44...................    73.9    74.2    71.2    69.9    68.2    68.6
45-54...................    77.0    77.6    75.4    74.9    74.9    74.8
55-64...................    77.0    79.2    79.2    79.3    79.3    79.5
65-74...................    71.8    75.2    77.8    79.3    80.4    80.9
75+.....................    67.3    67.8    69.2    72.3    73.5    74.6
All.....................    64.7    65.6    63.9    63.9    64.0    64.7
------------------------------------------------------------------------

    There are many factors that contribute to the housing 
affordability problem we are facing in this country. Certainly 
a factor has been increasing housing costs. Higher mortgage 
interest rates and general economic inflation have also been 
factors. The National Association of Home Builders believes 
that government over-regulation is a significant contributor to 
increased land development and housing costs. The Kemp 
Commission on Removing Barriers to Affordable Housing 
identified numerous government regulations that add to the 
problem. We strongly urge Congress to make an aggressive review 
of these regulations and eliminate or change those that are 
unnecessary, costly and counter productive.
    NAHB urges Congress to pass legislation expanding IRAs to 
create an incentive which will promote savings and encourage 
homeownership. Mr. Chairman, this proposal will make it 
possible for thousands of young working families to obtain the 
American Dream of home ownership. In turn, the construction of 
their homes will create jobs and the expansion of our economy. 
Equally important the expansion of homeownership contributes to 
the social/political stability of our society.

IRA Savings for a Downpayment

    IRAs could be a useful resource to assist in first-time 
home purchase. IRAs already have substantial deposits. Total 
assets held in IRAs and Keogh plans (retirement plans for the 
self-employed) reached $773 billion at the end of 1992. Another 
$230 billion is invested in salary reduction plans (401(k), 457 
and 403(b) tax deferred employer and employee contribution 
retirement plans) and $304 billion is invested in the federal 
government retirement plan for civil servants.\2\ Collectively, 
these retirement plans could provide up to 1.3 trillion 
dollars.
---------------------------------------------------------------------------
    \2\ Employee Benefit Research Institute, EBRI Notes, November 1993 
and Issue Brief, December 1993.
---------------------------------------------------------------------------
    A number of proposals have been made to increase the 
potential use of retirement accounts for first time home 
purchase down payments. Proposals for use of existing front-end 
accounts typically propose penalty-free withdrawals of funds 
from the IRA for specified purposes. However, the tax that was 
deferred when the deposit was originally made must be paid at 
the time of withdrawal. Accordingly, withdrawal would be 
relatively expensive, especially if the funds were deposited at 
a time when the taxpayer's marginal tax rate was lower.
    To this end, the Savings and Investment Incentive Act of 
1997, S. 197, introduced by Senators William Roth (R-DE) and 
John Breaux (D-LA) in the Senate and the House companion bill 
sponsored by Representative Bill Thomas (R-CA), restores the 
IRA deduction and adjusts the $2,000 deductible amount for 
inflation. It would also create nondeductible tax-free IRAs 
called IRA Plus accounts. Under the provisions of S. 197, 
distributions may be made free of penalty if used for first-
time home purchase by the individual, their spouse, child, 
grandchild or ancestor. NAHB urges the Committee to consider 
these bills as it begins drafting legislation on expanded IRAs.
    Mr. Chairman, NAHB encourages you to make the rules for IRA 
use as flexible as possible. For example, if the legislation 
requires that the funds be maintained on deposit at least 5 
years prior to withdrawal, the impact on home ownership would 
be minimal. First time home buyers are typically in their early 
30s and currently have small account balances in tax-deferred 
retirement accounts. The long waiting period coupled with the 
first-time purchaser's paucity of funds defer and diminish the 
stimulative impact of the proposal. Although with such a rule 
there would still be an increase in the incentive to save, 
resulting in greater participation, the likelihood of 
generating substantial savings is small.
    NAHB also suggests that the current proposal be modified to 
allow home purchase withdrawals to be made from parents' and 
grandparents' accounts. This modification is important because 
those very individuals this proposal is targeted to assist, 
young working families who are recently out of college trying 
to pay off students loans, or finance a car, have precious 
little left over for a retirement account.
    In designing a successful proposal for using retirement 
funds for down payments, there are three important components: 
1) The use must be considered an alternative investment rather 
than a withdrawal; 2) Eligibility must be open to parents and 
grandparents of first time home buyers as well as the buyer; 
and 3) Eligible plans must include IRAs, Keoghs, 401(k) and 
other salary reduction plans, and the federal government 
retirement system. In the alternative, an attractive and 
economical proposal would allow down payments for first home 
purchase to be treated as an investment for tax deferred 
accounts rather than as a penalty-free withdrawal. Withdrawing 
the funds also subjects the taxpayer to implicit penalties in 
that the account holder's investments in tax deferred assets 
are reduced. From the point of withdrawal on, interest on 
withdrawn funds would be taxed at current marginal tax rates, 
again often higher than those anticipated during retirement. 
Treating the down payment as an alternative investment would 
avoid both explicit and implicit penalties.
    The ability to use tax deferred retirement accounts for a 
down payment must be open to parents and grandparents because 
few young people have sufficient retirement savings to be 
useful. Table 1 shows participation rates by age of employee in 
employer pension plans. Table 2 shows account balances by age 
for salary reductions plans, chiefly 401(k) plans. Employees 
between 25 and 30 years old have the lowest participation rate 
in retirement plans and an average account balance of $5,185. A 
10 percent down payment and associated closing costs on a 
median priced existing home sold would require cash in the 
amount of $13,000.\3\
---------------------------------------------------------------------------
    \3\ The median existing home sales price for the first half of 1993 
was $106,000 and closing costs for an FHA loan are about 2.5 percent of 
the mortgage amount. Hence, cash required is $10,600 for the 10 percent 
down payment and $2,456 for closing costs on a 90 percent mortgage plus 
the 3-percent upfront insurance premium.
---------------------------------------------------------------------------
    On the other hand, the parent of a potential first time 
home buyer is at least 45 years old, with an average IRA 
balance of approximately $16,380. Grandparent IRAs are most 
likely to have sufficient balances to provide down payment 
support in that workers between 60 and 64 years old have 
average IRA balances of $25,011.
    Under current law, IRAs are primarily alternative forms of 
retirement savings when the savers' employer does not offer a 
retirement account, the saver is not self-employed, or the 
saver's income is under $40,000. About 20 percent of all 
workers have IRAs compared to 53 percent who participate in 
some employer pension plan. In order to have any sufficient 
impact, the first-time home purchase provision should also 
apply to other retirement accounts.
    Expanding the eligible investments of a tax deferred 
retirement account to include qualified first time home 
purchase will have very little impact on federal tax receipts 
in the near term. The transfer of funds across investment 
opportunities is already a frequent occurrence and has no 
federal tax implications. The ability to use retirement funds 
for first time home buyer assistance may increase the 
desirability of saving in this form, both for potential first 
time home buyers as well as their parents and grandparents. Any 
increase in tax deferred in tax deferred savings because of the 
expanded options would decrease federal tax revenues over a 
longer period of time as deposits increased.
    Therefore, NAHB recommends that such use (by either the 
buyer, parents or grandparents of the buyer) be deemed an 
eligible investment of the IRA. Roughly 15 percent of potential 
first-time home buyers have invested in IRAs and another 9 
percent have invested in 401(k) plans.\4\ NAHB estimates that 
allowing a first-time home buyer's purchase to be a qualified 
investment within the plan would create 20,000 jobs and 
generate 36,000 additional home purchases.
---------------------------------------------------------------------------
    \4\ ``Down Payment for Retirement Accounts,''Housing Economics, 
March 1991.
---------------------------------------------------------------------------

                             Capital Gains

    NAHB supports reinstatement of a capital gains rate 
differential for real estate and other assets and indexing 
their basis for inflation. More favorable capital gains 
treatment would not only encourage purchases of existing 
properties, but would also encourage investment in new 
construction. For example, taxation of capital gains at 50% of 
ordinary income rates would eventually reduce all rents by 5%. 
This represents a tax cut for the middle class and those 
struggling to become middle class. Yet another example of why a 
capital gains tax break is not for the wealthy.
    NAHB believes that taxation of assets held for one year or 
more at a lower rate than ordinary income encourages investment 
and savings. However, taxation of realized gains on long-held 
assets at ordinary income rates (i.e. on sale or transfer) 
reduces the economic incentives to invest in the most 
efficient, highest return opportunities. Removal of the 
retardant effect of current law taxation would allow taxpayers 
to place their capital in the most promising sectors of the 
economy. More efficient capital flows would create jobs and 
stimulate the economy. A capital gains tax cut would not 
benefit only higher income taxpayers. Encouraging investment 
through reduced taxes on the gains from that investment would 
create jobs and economic activity at all levels of income.
    With respect to real estate, a capital gains preference 
would increase investors and owners incentives to purchase, 
rehabilitate and operate rental housing. Part of the total 
return to investors who own rental housing is property 
appreciation. The greater the owner's after-tax income from the 
appreciation portion of their return, the less income required 
from rents to achieve the same earnings. Reducing capital gains 
tax rates will reduce residential rents. Since much of the 
appreciation in housing is due to price inflation, adjusting 
the gains for inflation will reduce rents even more.
    We must insist however, that any capital gains incentive 
include real estate. Just as real estate serves as the engine 
to lead the economic recovery, so it must be included in any 
capital gains reduction in order to maximize the dynamic 
economic impact of the proposal. Indeed, inclusion of real 
estate effectively rebuts any argument that a capital gains tax 
cut would favor only wealthy taxpayers. Mr. Chairman, I know 
this has been a long standing position of yours.

Depreciation Recapture

    There is a technical aspect of the capital gains issue 
relating to the taxation of business and investment real estate 
which could have strong negative economic impact on our 
industry. If, as was considered in 1996 budget talks, 
depreciation rules are altered so that only gain in excess of 
depreciable real estate's original costs would qualify for a 
new lower capital gains tax rate, three out of five (60 
percent) of investment and business real estate sales would 
effectively be excluded form a capital gains tax cut. Real 
estate, therefore, would be disadvantaged vis-a-vis other 
investments, such as stock, further slowing additional recovery 
in the nation's still fragile real estate markets.
    Depreciation deductions for real estate are intended to 
reflect the inevitable costs associated with the deterioration 
of a long-lived structure and its many components, such as the 
roof, heating, ventilation and air conditioning units, plumbing 
and electrical fixtures, etc. Sale of real estate for more than 
its adjusted basis is therefore likely the result of the 
combination of a number of factors--such as, inflation, 
appreciation in the value of the underlying land and market 
conditions.
    In 1964, Congress required that a portion of the 
accelerated depreciation on real property be recaptured as 
ordinary income. Subsequent amendments to the tax law have 
required that the entire amount of accelerated depreciation on 
real property be recaptured as ordinary income. However, any 
depreciation taken to the extent allowable under the straight-
line method is generally not recaptured as ordinary income, but 
rather creates capital gain.
    The theory behind depreciation recapture is that to the 
extent depreciation allowances reflect real economic 
depreciation, there is no ordinary-income tax benefit to 
recapture, only a capital gain. Also, to the extent that 
depreciation allowances exceed economic depreciation, there is 
an ordinary-income tax benefit which should be taxed at 
ordinary-income tax rates.
    Changing the current depreciation recapture law for 
improved real property in the manner that has been discussed by 
the Treasury department would not sufficiently unlock real 
estate assets and would seriously disadvantage improved real 
estate to other investments. To be meaningful, a capital gains 
tax cut must maintain the current depreciation recapture rules.

Capital Gains Tax on Home Sales
Roll-over and One-Time Exemption Provisions

    While NAHB remains committed to a broad base cut in the 
capital gains tax rate, we realize the purpose of this 
morning's hearing is to discuss the targeted capital gains cut 
contained in President Clinton's FY1998 budget.
    Owning your own home provides a personal satisfaction such 
as the ability to control your living environment and the 
feeling of being an integral part of your community. Owning 
also brings financial gains through appreciation, and tax 
preferences. One of the tax preferences accorded owning is the 
ability to postpone and partially or entirely exclude taxation 
on the appreciation.
    The roll-over provisions provide some relief to home owners 
who wish to trade homes but otherwise may incur a tax 
liability. The roll-over provisions effectively extend the tax 
treatment currently accorded tax-deferred retirement accounts 
to housing. If a taxpayer moves deposits in a retirement 
account from one asset to another, the activity is not taxed. 
Since home equity is the single largest asset for most 
families, equivalent treatment would seem appropriate. 
Financial and real investments not sheltered in retirement 
accounts do not enjoy these tax benefits and capital gains tax 
is normally due when realized. The long-run impact of the 
proposal enhances housing relative to other investments. To a 
home owner deciding whether to invest in housing, greater 
relief from tax on gains in an owned home versus some other 
asset will tilt the tax decision towards housing.

Magnitudes

    There are roughly 65 million home owners currently and most 
would be likely to incur a tax if they were to sell and buy a 
less expensive home or decide to rent. After the typical length 
of stay in one home (15 years), a typical home seller today 
will have $60,000 in taxable gain if they do not qualify for 
the rollover or exemption. However, few do pay capital gains 
tax for one reason or another. According to 1993 IRS 
statistics, 150,000 tax payers claimed a taxable gain in the 
sale of a residence in 1992. About 30,000 had no tax liability, 
and the remaining 110,000 taxpayers claimed an average of 
$17,200 in gain. The federal government collected an estimated 
$300 million on these gains.
    Estimates have been made regarding the number of home 
sellers who used the roll-over and the one-time exemption to 
avoid tax in a particular year. The results have been that only 
half of all home sellers even file the proper form. Presumably, 
those that did not file were eligible for deferral and didn't 
realize they still must file (or they lied to avoid paying 
tax). Additionally, it is estimated that 62 percent of the 
gains that are reported are not taxed because the home owner 
bought or is planning to buy a more expensive home and 33 
percent of the gain was subject to the one-time exclusion, 
leaving 5 percent of the gain taxed. Since these ratios omit 
the sales not reported, the portion of all gains that is 
actually taxed is even smaller.

Effect of Change

    Increasing the current capital gains exemption for home 
ownership would increase the incentive to own and to own more 
house. Allowing repeated use of the exemption after each sale 
would enhance housing as an asset by removing barriers to 
trading before and after a certain age (55 under current law). 
Allowing a repeated exemption will also remove significant 
reporting burdens now required of home owners. Under current 
law, a typical elderly home owner who moves to a retirement 
community must calculate capital gains liability by going back 
to records of the first home purchased and follow each 
successive sale and purchase. The record keeping and effort 
necessary to calculate tax liability is daunting for anyone, 
and all the worse for an individual who has already paid a 
lifetime of taxes.
    Increasing the amount of capital gains that is exempt from 
tax will increase home ownership by removing the capital gains 
reporting burden and by making the financial investment in home 
owning more attractive than the financial investment in other 
assets. Raising the amount of home appreciation exempt from tax 
is also necessary now in order to anticipate future home 
appreciation that will dilute the value of the current one-time 
exemption level of $125,000. At current levels of house price 
appreciation, typical home buyers in 1997 will see $265,000 of 
appreciation in their homeowning lifetime. Increasing the limit 
now will assure those young households that they will enjoy the 
same tax advantages of home owning as their parents and 
grandparents.

                          ``Death Tax'' Relief

    Home building is dominated by small firms which very often 
are family owned and operated. The current estate and gift tax 
laws operate to destroy family-owned businesses by imposing a 
tax upon the inter-generational transfer of the business. 
Moreover, the economic impact of the tax increases from year to 
year because of inflation. Under present law, estate and gift 
taxes of up to 55% are imposed on the value of transfers. 
Although a credit is allowed against estate and gift taxes 
sufficient to allow a taxpayer upon death to transfer up to 
$600,000 without paying tax, this exemption amount has not been 
increased since 1987.

Impact on Housing

    Eighty percent of home building firms in our country are 
small family-owned businesses. The current tax treatment that 
we live under limits the ability for current owners to pass 
these companies onto their family members. Family businesses 
should be passed to heirs without tax. Death taxes force family 
owners to liquidate, sell off at a fraction of market value, or 
pay dearly in estate planning costs instead of growing their 
business. Additionally, these taxes make parents reluctant to 
help their children establish themselves in independent 
business. This forced sale of the family business is disruptive 
the home building industry and increases the cost of producing 
housing. Further, building homes and developing subdivisions is 
a long term process which many times is interrupted and frozen 
as an estates of a builder. Creation of affordable housing 
should not be stalled or curtailed as a result of a complicated 
estate issue or the eventual sale of the business.
    For these reasons, NAHB supports estate tax relief. 
Although complete repeal of the estate tax makes the most 
economic sense, NAHB also supports a reduction in the current 
estate tax rate and increasing the current estate tax 
exemption. Additionally, NAHB supports legislation to preserve 
family-owned business by either repealing the estate tax in 
general or eliminating it for small family-owned businesses.
    Although the President's budget contains some estate tax 
relief for closely held businesses, it is minimal and needs to 
be significantly expanded. His budget proposes to ease the 
burden of estate taxes on farms and other small businesses, 
allowing their owners to defer taxes on $2.5 million of value, 
up from $1 million under current law. The deferred taxes could 
be paid over 14 years at a favorable interest rate. The 
proposal expands the type of businesses eligible for such 
treatment by making the form of business organization 
irrelevant.
    The President's proposal does very little to eliminate the 
estate tax burden on small business and is merely a loan 
program. Many other proposals on estate tax relief have also 
been introduced on the Hill--ranging from complete repeal to an 
approach similar to the President's. The best solution would be 
to raise the exemption level from $600,000 to $1 million and 
reduce the overall estate tax rate. NAHB looks forward to 
working with the Ways and Means Committee as well as the 
Administration to craft a workable, passable proposal.

                               Conclusion

    For the reasons stated above, the National Association of 
Home Builders believes that the tax cut proposals currently 
being considered by the Congress and the Administration are 
important to our nation's economy and the creation of 
affordable housing. Home building creates jobs both directly 
and indirectly, as well as fuel our economy.
    Once again Mr. Chairman, NAHB thanks you for this 
opportunity to present our recommendations. We look forward to 
working more closely with you and your staff in the coming 
months as the budget process and tax cut proposal move forward.
      

                                

National Association of Home Builders

             A. Contributions-In-Aid of Construction (CIAC)

Policy

    Contributions-in-aid of construction (CIAC) must not be 
taxable to utilities in the year of receipt.

Background

    The 1986 Tax Reform Act (TRA) changed the tax treatment of 
contributions-in-aid of construction and required utilities to 
include in their gross taxable income the contributions in the 
year of the receipt. The Small Business Job Protection Act of 
1996 contained a provision which repealed part of the changes 
made in 1986 with regard to CIAC. Specifically, the newly 
enacted law restores the tax-free treatment only to CIACs made 
to public utilities that provide water and sewage services. 
Therefore, any payments made to a water or sewage utility after 
June 12, 1996 will not be treated as gross income and thus will 
not be taxable.
    These grossed up CIAC (taxes paid by utilities) are passed 
on to the ultimate home purchaser by the builder. Prior to 
1986, Internal Revenue Code Section 118(a) allowed utilities to 
exclude contributions received in-aid of construction to be 
excluded from taxable income. Because of the changes in the TRA 
of 1986, the buyer pays not only for the capital improvements 
provided to the utility company, but also the resultant tax. In 
areas affected, the price of housing has risen as much as 
$1,000 to $2,000 per unit.

Solutions

     Seek and support an amendment to the Tax Reform 
Act of 1986 to reinstate Internal Revenue Code Section 118 (a) 
for electric and gas utilities.

                          B. Business Taxation

Policy

    Federal income tax liability for businesses should be determined by 
allowing firms to deduct expenses, reserves and depreciation in the 
year incurred, and by including income received in that year only. 
Further, businesses that are organized as limited liability companies 
(LLC's) or limited partnerships should not be subject to the self-
employment tax.

Background

    Some rules of the Internal Revenue Service and some tax laws do not 
permit businesses to deduct business costs in the year in which they 
occur. Under these circumstances, tax liabilities are determined by 
amounts that may be larger than the actual resources available to the 
firm. For instance, under current law a firm cannot deduct the cost of 
removing an environmental hazard, but rather must capitalize the 
expense over the life of the project. Requiring cost amortization 
discourages acquisition, development and subsequent clean-up of 
environmentally impaired real estate and discourages holding property 
for sufficient time to plan and develop the property to its full 
potential. Requiring amortized costs encourages land owners to sell 
quickly in order to record the cost against income which further delays 
careful planning and orderly development.
    The current method for depreciating capital assets calculates 
annual depreciation based on the original value of the asset without 
regard to replacement cost. However, most capital goods, e.g. 
equipment, buildings and machines, cost more to replace than their 
original cost because general price inflation pushes up the cost of all 
goods over time. Environmental restrictions and technological advances 
make certain components of a building such as heating, ventilation and 
air conditioning systems (HVAC) obsolete or unusable prior to the 
applicable recovery period for residential and commercial real estate. 
Major repairs or replacements of these components often have adverse 
tax consequences by creating an asset with a recovery period far in 
excess of its real useful life. Consequently, investors in capital 
equipment and other long-lasting goods are discouraged from investing. 
A neutral cost recovery system in the tax code would increase 
investment in rental housing by making the tax consequences of 
investing reflect the real world impacts of inflation, the economically 
useful life of major components, and other factors. Under current rules 
home building firms that set aside reserves against possible future 
warranty claims cannot deduct the reserves from income even though the 
funds are inaccessible until the warranty has expired. On the income 
side prior to 1986, a taxpayer that sold property on the installment 
basis was taxed as payments were received. Treating the income 
otherwise requires a tax on the entire gain in the year of sale when 
only a small portion of total sale proceeds may have been received in 
the year of sale, resulting in a taxpayer being unable to pay the taxes 
due. The 1986 Tax Reform Act prohibited the use of the installment 
method for dealer sales of developed lots. As a result, landowners are 
less likely to sell to builders on an installment basis and seek higher 
prices to compensate for the extra tax burden. Under this change, 
developers and home builders also are discouraged from building common 
infrastructure before the homes are completed. Higher land costs and 
fewer willing land owner partners in new home building increases the 
cost of new homes and creates affordability problems for potential home 
buyers.
    Under current law, limited partners currently are exempt from self-
employment tax under Section 1042 of the Internal Revenue Code. The IRS 
has issued proposed regulations that would subject certain limited 
partners and LLC members to self-employment tax. The Taxpayer Relief 
Act imposed a moratorium on the issuance of final regulations until 
July 1, 998 and the conference report to the new law indicates that the 
self-employment tax treatment of limited partners and LLC members 
should be determined by legislation.

Solutions

    1. Seek and support legislation to allow an inflation-adjusted 
depreciation allowance.
    2. Seek and support legislation to allow environmental cleanup 
costs to be deductible by the owner in the year in which they are 
incurred.
    3. Obtain clear ruling from the Treasury Department to allow a 
current year deduction of the costs for clean up of property that is 
already contaminated when purchased.
    4. Seek and support legislation to repeal the restrictive 
provisions of the 1986 Tax Reform Act which require reporting income 
from installment sales before it is received. H Seek and support 
legislation to amend the Internal Revenue Code to define the term 
``common infrastructure'' to include public use facilities.
    5. Seek and support legislation to allow builders to deduct 
reserves established for future warranty losses.
    6. Seek and support legislation to preserve the current treatment 
of limited partners and LLC members under the self-employment tax.

                   C. Differential Capital Gains Tax

Policy

    A capital gains tax rate differential should be reinstated 
for real estate.

Background

    The Taxpayer Relief Act of 1997 reinstated a preferential 
capital gains rate of 20 percent for capital assets held for 
eighteen months. Under the new law, however, any gain 
attributable to depreciation is recaptured and taxed at a 25 
percent rate. Gain attributable to real estate investments 
should be treated the same as gain attributable to the sale of 
stocks or bonds.

Solution

    1. Seek and support legislation re-establishing a lower 
capital gains rate for gain attributed to recaptured 
depreciation.
    2. Support legislation to increase the amount of capital 
gains on a primary residence that is exempt from tax and to 
remove the one-time restriction on use of the exemption.

                    D. Estate and Gift Tax Treatment

Policy

    Family businesses should be passed to heirs without tax.

Background

    The recently enacted ``Taxpayer Relief Act of 1997'' 
increases the estate tax exemption from the current level of 
$600,000 to $1 million by the year 2006. Additionally, the new 
law allows an additional $300,000 exemption for qualified 
family-owned businesses and farms. The phase-in of these 
increases in the exemption, however, is too long and should be 
immediate. Further, the exemption should be indexed for 
inflation. Currently, the value of your estate over the 
exemption amount can be taxed at rates as high as 55 percent. 
Therefore, the overall rate of taxation should also be reduced.

Solutions

    1. Seek and support legislation to phase-in more quickly 
the increase in the estate tax exemption.
    2. Seek and support legislation to reduce the overall 
estate tax rate.

                 E. First-Time Home Buyer Down Payments

Policy

    First-time home buyers should be able to use tax-deferred 
retirement savings accounts to accumulate a down payment.

Background

    Current law discourages the use of tax-deferred retirement 
funds for use in purchasing a home. Distributions from tax-
deferred retirement accounts made before age 59 are subject to 
an additional 10-percent tax. Borrowing from an IRA or use of 
funds in an Individual Retirement Account (IRA) as security for 
a loan is treated as a distribution. Allowing an eligible 
first-time home buyer or an or affiliated individual (e.g., 
parent) to treat a down payment on a home as alternative 
investment would increase first-time home buyers' access to 
down payment funds and increase home ownership opportunities 
for young families. Alternative forms of tax encouragement for 
savings exempt the interest earnings and withdrawals from 
taxation but do not exempt the deposit from taxation. Sometimes 
referred to as ``back-end'' or the ``American Dream Savings 
Accounts,'' this form of savings encouragement also increases 
potential first-time home buyers' ability to save for a down 
payment. A ``back end'' savings account reduces federal tax 
revenue in the early years of the program less than the current 
``front-end''method of favoring retirement savings.

Solutions

    1. Allow retirement plans of first-time home buyers and 
their family members to make equity investments in principal 
residences for the first-time home buyer.
    2. Seek and support legislation to increase the current 
limit on deductible IRA contributions.
    3. Restore the deductibility of IRA contributions for all 
taxpayers.
    4. Seek and support legislation to establish a ``back-end'' 
tax-favored savings account that would allow for tax-and 
penalty-free withdrawals for a first home purchase.

Related Issue

    Section VI. Issue--Down Payments

                        F. Home Owner Deductions

Policy

    The home mortgage interest and property tax deductions must be 
maintained without restriction or limitation.

Background

    Deductions for mortgage interest and property tax expenses 
encourage home ownership and stimulate home building which creates jobs 
both directly and indirectly, fuels our economy and benefits growth at 
all government levels with increased taxes and revenues. Further 
restriction would decrease home ownership, depress housing values, and 
reduce home construction.

Solution

    Insist that Congress maintain full deductibility of home mortgage 
interest and property taxes.

                        G. Home Office Deduction

Policy

    Home office expenses should be fully deductible.
Background

    Until 1993, home office expenses were fully deductible. The 
Supreme Court's decision in Commissioner of Internal Revenue 
Service v. Soliman substantially narrowed the availability of 
the home office deduction. The ruling unfairly restricts small 
businesses, especially those in the construction industry.
    Disallowing the home office deduction either forces a 
builder to rent or buy space away from home for the same 
purpose or use the home as an office, but lose the legitimate 
expense as a deduction. Either choice increases the cost of 
doing business without improving the delivery of new homes to 
buyers. The effect adds cost to new homes and reduces 
affordability.

Solution

    Seek and support legislation that allows the full deduction 
of home office expenses.

                       H. Independent Contractor

Policy

    Home building contractors should qualify as independent 
contractors for tax purposes.

Background

    The promise and vibrancy of the American economy generally 
and the home building industry in particular lies in its make 
up of millions of independent business persons. As a matter of 
sound public policy, independent contractor businesses should 
be fostered, and they should not be discriminated against by 
Internal Revenue Code regulations. The 1996 Small Business Job 
Protection Act improved the independent contractor safe harbor 
relief in two respects--by injecting some clarity into the 
distinction between an independent contractor and an employee, 
and by putting constraints on the IRS's practice of over 
aggressive auditing of small business owners using independent 
contractors. These provisions take effect on September 1, 1997 
but do not go far enough in clarifying independent contractor 
distinctions in the home building industry.

Solution

    1. Seek and support legislation to protect independent 
contractor status and facilitate qualification as such.

Related Issue

    Section VII., Issue--B. Health Care

                       I. Lobbying Tax Deduction

Policy

    Lobbying expenses should be an allowable business expense 
deduction.

Background

    The tax code prohibits the business expense deduction for 
any amounts paid in an attempt to influence federal or state 
(but not local) legislation through communication with members 
or employees of legislative bodies or other government 
officials who may participate in the formulation of 
legislation. The code also disallows a deduction for costs of 
contacting certain high-ranking federal executive branch 
officials in an attempt to influence their official actions or 
positions. Trade associations allow their members to learn 
about their industry and to participate in a complex democratic 
process through professional staff and volunteer members. This 
education and participation process provides a public good to 
the rest of the economy by focusing issues and concerns on the 
voters most affected. Taxing the dues that support this process 
retards the democratic process.

Solution

    1. Seek and support legislation which allows members of a 
trade association to deduct lobbying expenses.

                    J. Low-Income Housing Tax Credit

Policy

    The Low-Income Housing Tax Credit must be maintained to 
encourage investment in affordable housing.

Background

    The Low-Income Housing Tax Credit (LIHTC) and tax-exempt 
bond financing are the primary vehicles for financing the 
construction of low-income rental housing. Restrictions on 
these tax incentives unnecessarily raise the cost of rental 
units and subsequently reduce the number of rental units that 
could be provided to low-income families. The LIHTC provides a 
critical incentive for the production of affordable rental 
apartments, and more than 95 percent of affordable units 
produced for low-and moderate-income households involve the use 
of this program.
    Under the current law, states have an allocation of total 
credits which can be issued and When the LIHTC was created in 
1986 the annual amount of authority for the program was fixed 
at $1.25/capita. This annual authority amount has not been 
increased since 1986 and as a result the number of affordable 
units produced annually has decreased steadily from a high of 
124,500 units in 1989 to 75,000 units last year. The cost of 
producing affordable housing has increased, but the amount of 
authority has not.
    Further, under current law states are responsible for 
allocating tax credits to projects, but are restricted to two 
credit rates, 9 percent and 4 percent. Allowing states to 
divide their allocation of subsidy in different ways would 
provide greater local flexibility and provide greater 
incentives where they are needed without changing the overall 
federal cost.

Solutions

    1. Oppose any efforts to repeal the Low-Income Housing Tax 
Credit.
    2. Seek and support legislation to exempt low-income 
housing tax credits from the alternative minimum tax.
    3. Seek and support modification to existing law to allow 
states to determine the credit rate.
    4. Seek and support legislation to modify the occupancy and 
income targeting requirements to enhance the use of tax-exempt 
financing for low-moderate income rental projects.
    5. Seek and support legislation to increase the annual 
amount of authority for the LIHTC to reflect increases in 
housing production costs and permit the authorized amount to be 
adjusted annually for inflation.

Related Issues

    Section V., Issue--B. Government Support for Affordable 
Housing
    Section V., Issue--D. Housing Finance Agency Programs

                  K. Mortgage Revenue Bond Eligibility

Policy

    Certification of buyer's eligibility for the mortgage 
revenue bond program should be made at the time of mortgage 
application, not at the time of closing.

Background

    The proceeds of mortgage revenue bonds (MRBs) are used to 
finance the purchase, or qualifying rehabilitation or 
improvement, of single family, owner-occupied residences. 
Between the time of the original MRB application and closing 
(when income is certified under the federal rules), the buyer's 
family income may rise above the MRB income limit making the 
buyer ineligible for MRB financing. Certification of 
eligibility so late in the process unfairly harms builders who 
have paid costs and met their contractual obligations in good 
faith.

Solutions

    1. Urge Congress to preserve the Mortgage Revenue Bond 
program.
    2. Seek and support legislation to modify the current rules 
to provide for certification of buyers at time of mortgage 
application.

                     L. Passive Activity Loss Rules

Policy

    Private investment in rental projects should be encouraged 
through the repeal of the passive activity loss tax treatment.

Background

    The Tax Reform Act of 1986 discriminated against real 
estate activity by enacting limitations on the deduction of 
``passive'' activity losses (PAL). The impact of this rule 
decreased the effective return on all investments in rental 
housing--for new owners as well as existing owners. The result 
has been a decrease in the value of existing properties and a 
decline in investment in new rental housing. Ultimately, as the 
rental inventory adjusts to the new tax rules, rents will rise 
to equalize the after-tax returns on investments in rental 
housing with other investment opportunities. The 1993 Budget 
Act removed real estate professionals from the coverage of the 
PAL rules, but imposed restrictions that allow few owners to 
benefit from these changes.

Solutions

    1. Seek and support legislation to repeal the passive 
activity loss rules.
    2. Urge the Internal Revenue Service to permit grouping 
rental real estate activity with other builder-related real 
estate activities.

Like Kind Exchange of Property

Policy

    The current rules that allow the tax deferred exchange of 
like kind property should not be changed.

Background

    Under current law, section 1031 of the Internal Revenue 
Code (IRC) provides for the tax deferred exchange of like kind 
property. Under this section of the Code an individual may 
exchange like property and defer recognition of their taxable 
gain on the property until they accept cash or other payment 
for the property.
    The current definition of ``like kind'' allows for the 
exchange of developed property for undeveloped property. There 
have been legislative proposals to change the definition of 
``like kind'' to ``similar use'' which would severely curtail 
many beneficial real estate transactions and reinvestment in 
communities struggling to improve distressed properties. 
Further, changing the definition would cause taxpayer 
uncertainty and create complex new administrative burdens.

Solution

    Oppose any proposals to change or limit the definition of 
``like kind'' for the purposes of section 1031 exchange.

                           M. Rehabilitation

Policy

    A rehabilitation tax credit should be available for owner-
occupied historic homes.

Background

    Under current law, rehabilitation of historic commercial 
buildings used in a trade or business or rented are eligible 
for a rehabilitation tax credit. However, owner occupants are 
not eligible for the credit. Expanding the credit to owner-
occupied homes would create incentives to rehabilitate 
historically significant properties and revitalize older 
neighborhoods.

Solution

    Seek and support an amendment to the Internal Revenue Code 
to extend the historic rehabilitation tax credit to owner-
occupied residences.
      

                                

    Chairman Archer. Thank you, Mr. Kalish.
    Our last witness in this panel, I would like personally to 
have the honor to introduce, but I am going to yield to my 
colleague from New York, Mr. Rangel, for the introduction.
    Mr. Rangel. Bipartisanship at its height.
    Let me thank the entire panel for your patience. We have 
had more activity on the House floor today than we expected. I 
thank the Chair for giving me the honor of introducing an old 
friend, Morty Davis. Not only is he a self-made businessman and 
chairman of the board of D.H. Blair Investment Banking Corp., 
but he has also spent quite a bit of time trying to reenergize 
that engine that America depends on, and that is small 
business. There is hardly a capital gains tax relief program 
that somehow he has not managed to have his ideas incorporated 
in. This Committee is privileged to have you to share those 
views with us today.
    Thank you for being here, Morty.
    Chairman Archer. Mr. Davis, if you will identify yourself 
for the record, we would be pleased to receive your testimony.

STATEMENT OF J. MORTON DAVIS, CHAIRMAN OF THE BOARD, D.H. BLAIR 
          INVESTMENT BANKING CORP., NEW YORK, NEW YORK

    Mr. Davis. I thank you very much, Mr. Chairman. Thank you 
very much, Congressman Rangel. You are both sensational guys. I 
love you both, and I think you are doing fabulous jobs. You are 
both great statesmen.
    I am chairman of the board of D.H. Blair Investment Banking 
Corp. in New York. I am also, incidently, founder, funder, and 
largest stockholder of your new exciting weekly down here, The 
Hill. I hope you enjoy it.
    Mr. Chairman, Congressman Rangel, and Members of the 
Committee, I very much appreciate the opportunity to present 
testimony on the critical issue of how to promote savings and 
investment.
    Mr. Chairman, I am a great admirer of yours. Again, let me 
repeat that. I am a great admirer of yours and particularly 
your efforts to reform the present Tax Code which is biased in 
favor of consumption over savings and investment.
    I strongly support your campaign to remove tax barriers to 
the capital formation needed to fuel economic growth and job 
creation in our country.
    Congressman Rangel, I am also a great admirer of your 
efforts to ensure that economic growth and job creation, which 
we all want, include those persons who historically have not 
shared fully in the American dream.
    I am testifying today in support of legislation which I 
strongly believe would contribute greatly to meeting both your 
objectives, specifically targeted capital gains tax relief to 
new and small businesses. This legislation would build the pool 
of investment capital by deferring taxes on capital gains 
realized from direct investments in new and small businesses, 
so long as those gains are reinvested in similar small and new 
companies.
    These tax-deferred rollovers would work much like the tax 
treatment afforded to those who sell a home and purchase 
another within a specified period of time or to those who roll 
over their IRAs or 401(k) plans from one investment to another.
    Mr. Chairman, you rightly have called for reform of the Tax 
Code to promote investment and eliminate the prevailing bias 
toward consumption. The rollover proposal would do both. The 
rollover legislation would defer capital gains taxes on an 
entire class of investments, so as to encourage such productive 
investments, if, and only if, the initial investment and the 
gain thereon is promptly reinvested in another new or small 
business.
    By deferring the tax on capital gains from investments in 
new or small businesses, the market would be incentivized to 
allocate capital to where it would do the most good. On the 
other hand, if gains are not promptly reinvested in another new 
or small company or, instead, used for consumption, then that 
gain would immediately be taxed.
    Congressman Rangel, the rollover proposal would also help 
achieve your goals. The legislation would ensure that 
sufficient investment capital is directed to new and small 
businesses which have proven to be the most potent catalyst for 
economic development and job growth in distressed urban areas.
    Capital spending by small business produces jobs and lots 
of them. It accounts for almost all of the new jobs. It 
produces spending for capital equipment and lots of it, and far 
out of proportion to the dollars invested by large companies, 
and this is statistically demonstrated, capital spending by 
small companies produces the most new technologies and exciting 
discoveries to enhance the quality of our lives and those of 
our children and our children's children. I must just add, 
particularly in the new areas of biotech, where we are working 
on cures for cancer and heart disease and all the things that 
will enhance the quality of our lives, and particularly, in my 
case, I am working especially to halt the aging process and 
even reverse it so we can get even with our kids, be younger 
than them, but that is the kind of exciting things we are 
working on and that are so promising for the future.
    As an investor, I repeatedly have observed that instead of 
creating jobs with new capital, the Fortune 500 has been a net 
loser of jobs, but as soon as a new or small company receives a 
check, not in 1 year, not in 1 month, but the very next day, it 
is out hiring new workers, purchasing new capital equipment, 
and creating almost all of the new jobs and new products. This 
is true capitalism and true growth enhancement.
    Large companies have easy access to capital through banks, 
commercial paper, and various established private and public 
markets for their debt and equity securities.
    Entrepreneurs and small companies, on the other hand, have 
no place to go. They have to scramble around for capital and 
usually often unsuccessfully.
    The rollover proposal would help entrepreneurs and new and 
small businesses get the capital they need. I strongly believe 
that the small business capital gains rollover proposal is a 
critical component of any new capital gains tax relief 
legislation.
    H.R. 1033, introduced last week by Congresswoman Dunn and 
Congressmen Herger, Weller, Collins, Christensen, Ensign, and 
others, provides for such rollovers as part of a larger package 
of broad-based capital gains tax cuts. I believe that such a 
comprehensive approach is the most effective means to promote 
savings and investment.
    Yet, I also believe the small business capital gains 
rollover proposal has great merit as a freestanding bill, the 
approach taken by Senator Daschle and other Senate Democrats in 
S. 20.
    I also wish to note the important work Congressman Matsui 
had done in this area.
    Finally, I very much recognize that if we are to balance 
the budget, as we must, any tax proposal, no matter how worthy, 
must promote maximum growth on a cost-effective basis. On that 
count, the rollover is a winner.
    The Joint Tax Committee has estimated the rollover 
legislation introduced in the 104th Congress, which is very 
similar to H.R. 1033 and S. 20, which would cost a total of 
$100 million over 7 years.
    Mr. Chairman, I think you will agree that in the context of 
capital gains, that figure, $100 million over 7 years, 
approaches de minimis.
    Mr. Chairman and Congressman Rangel, I have prepared a more 
detailed statement, and Members of the Committee, I have 
prepared a more detailed statement which I ask for your 
permission to be included in the record. I would be happy to 
answer any questions you or the Committee may have, and I can't 
thank you enough for inviting me to have this opportunity to 
present this legislation as I see it.
    Thank you very much.
    [The prepared statement follows:]

Statement of J. Morton Davis, Chairman of the Board, D.H. Blair 
Investment Banking Corp., New York, New York

                                Summary

    Mr. Chairman, Congressman Rangel, and members of the 
Committee, I very much appreciate the opportunity to present 
testimony to the Committee on the pressing question of how we 
may most effectively promote the capital formation needed to 
fuel economic growth and job creation in our country. I thank 
the Committee for seeking to address this problem.
    The Congressional debate over capital gains taxes is no 
longer focused on the question of whether there should be a 
capital gains tax cut. Both the President and a great majority 
of members of Congress have called for some type of capital 
gains tax relief to be enacted. As a result, the question now 
before Congress is how to structure a capital gains tax cut so 
as to create the most new jobs, provide for the largest 
increase in capital spending, and generally best stimulate 
economic growth--while minimizing the loss of tax revenues to 
the federal treasury.
    I am testifying today in support of legislation which I 
strongly believe would best meet those criteria: targeted 
capital gains tax relief to small companies. Specifically, this 
legislation would build the pool of investment capital 
available to small businesses by deferring taxes on capital 
gains realized from direct investments in small companies so 
long as those gains are reinvested in similar companies. These 
tax-deferred roll overs would work much like the tax treatment 
afforded to those who sell a home and purchase another within 
two years, or those who roll over their IRAs or 401(k) plans 
from one investment to another.
    Mr. Chairman, you rightly have called for reform of the tax 
code to promote investment and eliminate the bias towards 
consumption. The ``roll over'' proposal would do both. Other 
witnesses today favor lowering capital gains rates overall, a 
goal I very much support. The ``roll over'' legislation would 
lower capital gains rates on an entire class of investments to 
the lowest rate of all--zero. By eliminating the tax on capital 
gains, the market would be allowed to allocate capital to where 
it would do the most good. On the other hand, if gains were not 
reinvested, but instead were used for consumption, that 
consumption would be taxed immediately.
    Congressman Rangel, the ``roll over'' proposal also would 
help achieve your goal of ensuring that the economic growth and 
job creation which we all want includes those persons who 
historically have not shared fully in the American Dream. 
``Roll over'' legislation now before Congress would ensure that 
sufficient investment capital is directed to small businesses, 
which have proven to be the most potent catalysts for economic 
development and job growth in distressed urban areas.
    Capital spending by small businesses produces jobs, and 
lots of them. As an investor, I repeatedly have observed that 
if an investment is made in a large company, that money often 
is parked in an account for an indefinite period before it is 
put to productive use. But when a small company receives a 
check, it goes out--not in a year, not in a month, but the very 
next day--and hires workers and purchases equipment. Yet larger 
companies have much easier access to capital--through banks, 
commercial paper, and established public markets for their debt 
and equity. The ``roll over'' proposal would provide small, 
entrepreneurial businesses with the capital they need.
    I strongly believe that the small business capital gains 
``roll over'' proposal is a critical component of any capital 
gains tax relief legislation. H.R. 1033, ``The Return Capital 
to the American People Act'' introduced by Congresswoman Dunn 
and Congressmen Herger, Weller, Collins, Christensen, Ensign, 
and others, provides for such ``roll overs'' as part of a 
larger package of broad-based capital gains tax cuts. I believe 
that such a comprehensive approach is the most effective means 
to promote savings and investment. Yet I also believe the small 
business capital gains ``roll over'' proposal has great merit 
as a freestanding bill, the approach taken by Senator Daschle 
and other Senate Democrats in S. 20, ``The Targeted Investment 
Incentive and Economic Growth Act of 1997.''
    Finally, I very much recognize that if we are to balance 
the budget, as we must, any tax proposal, no matter how worthy, 
must promote maximum growth on a cost-effective basis. On that 
count, the ``roll over'' is a winner. The Joint Committee on 
Taxation has estimated that H.R. 1785, roll over legislation 
introduced in the 104th Congress which is very similar to H.R. 
1033 and S. 20, would cost a total of $100 million over seven 
years. Mr. Chairman, I think you will agree that, in the 
context of capital gains, that figure--which does not give any 
effect to taxes paid by new businesses as they become 
profitable, or the taxes paid by the people employed by such 
businesses--approaches de minimis.
    In sum, I very much support prompt enactment of small 
business capital gains ``roll over'' legislation such as that 
included in H.R. 1033 or S. 20. The remainder of my testimony 
seeks to address policy considerations and technical issues 
relating to such legislation.

Small Business is Key to Job Creation, Economic Growth, and 
Technological Innovation

    In all probability we are not going to beat the newly 
industrialized countries of Asia and other regions in 
relatively mature industries, but we can surely improve our 
competitive position and leave them decades behind in what our 
pioneering and entrepreneurial spirit enables us to do best--
the development of new technologies and new products in such 
emerging fields as biotechnology, telecommunications, space and 
aerospace, superconductivity, laser technology, medical and 
pharmaceutical products, and all of the exciting yet undreamed 
of products of the 21st century and beyond.
    If we look historically at our economy, it is small, 
entrepreneurial businesses which have created the most new 
jobs, invested the greatest percentage of their assets in new 
equipment, and provided the greatest percentage of 
technological breakthroughs and new products for each dollar 
invested. The entrepreneurial effort, resourcefulness, and 
creativity which characterize American small businesses have, 
over the years, spurred the growth of our economy. Today, small 
businesses are leading the way down the information 
superhighway, and they are in the forefront of biotech research 
that will improve the quality of life for us, our children, and 
our children's children by providing cures to devastating 
diseases, alleviating our most painful and life-destroying 
maladies, and halting or even reversing the aging process.
    Starting and promoting small businesses is an integral part 
of the American Dream. One need only think of how Edison's 
inventions and Henry Ford's first assembly line changed the 
world forever, or, more recently, of how Ray Kroc went from 
selling multimixers from the back of his station wagon to build 
McDonalds, or how Bill Gates' first software program mushroomed 
into Microsoft, and you begin to get an idea of the billions of 
dollars of goods and services and the millions and millions of 
jobs that exist today thanks to past investment in developing 
companies. We as a people are amazingly good at developing new 
technologies and new products--better than anyone else in the 
world--and this is where we can shine competitively and truly 
excel. And this is precisely the area where the roll over is 
focused by providing incentives to invest in new and small 
businesses.
    Every day, workers are being laid off by large 
corporations. In most cases, those jobs are gone forever. It's 
only the new smaller companies that can create the needed new 
jobs. Already, more than a third of America's workers are 
employed by businesses with fewer than 100 employees, and that 
percentage continues to rise, and more than 80% of all 
businesses in America have fewer than 50 employees.
    Simply put, new and smaller firms create the overwhelming 
majority of new jobs and economic growth. Thus, any legislation 
which seeks to promote economic growth must foster the growth 
of small companies.
    Numerous studies have concluded that small and newly 
created firms play an important role not only in job creation 
but in the process of technological innovation and new product 
development, processes critical to future U.S. competitiveness.
    A U.S. Commerce Department study pointed out that from 1982 
to 1989 large United States multi-national corporations 
generated a domestic employment gain of less than 1%, while the 
nation's total non-agricultural payrolls rose approximately 
21%. Our large corporations, which in 1982 represented 
approximately 21% of the nation's employment, accounted for 
less than one tenth of 1% of the job growth from 1982-1989. 
These corporations' share of total employment fell from 21% to 
17% during the same period. Additionally, these major 
corporations contributed less than 15% of the country's total 
gross national product growth from 1982 to 1989.
    A 1989 study completed by the National Association of 
Securities Dealers, Inc. and the Economic Research Bureau of 
the State University of New York at Stony Brook, ``The Economic 
Impact of IPOs on U.S. Industrial Competitiveness,'' provided 
startling data as to job and technology advances provided by 
companies publicly raising money for the first time. The study 
covered 426 initial public offerings in 1983, 1984, and 1985 
and tracked the performance of these companies through 1987. 
These offerings related to companies which are typically start 
up or small companies.
    In short, the NASD/SUNY-Stony Brook study demonstrated 
that: (a) industry employment by all public companies dropped 
at an average annual rate of 6.5% while the IPO firms increased 
their employment at a rate of 29.8%; (b) IPO firms grew more 
than three and half times faster than industry in general, 
increasing their sales at an average annual rate of 34.6% 
compared with 9.4% for industry as a whole; (c) while IPO firms 
could be expected to increase their invested capital faster 
than industry in general, the margin of difference was more 
significant than would have been expected--IPO firms grew at an 
average annual rate of 51.8%, or more than seven times faster 
than the industry average of 7.2%; and (d) IPO firms increased 
their capital spending more than 10 times faster than industry 
in general, or 62.7% versus 6.0%.
    A third study, ``Tax Incentives For Investing in Emerging 
Firms; A Strategy for Enhancing U.S. Competitiveness,'' by 
Robert J. Shapiro of the Progressive Policy Institute concluded 
that ``emerging firms create most of the new jobs in the U.S., 
generate more technological advances than other companies and 
generally provide more of the innovations that are critical to 
U.S. competitiveness.'' The study further stated that ``by 
definition, a new company creates employment; in fact the data 
[discussed in this study] show that new and young companies are 
primary forces in new job creation.'' Mr. Shapiro in his study 
also concluded that small corporations outpaced established 
companies in their rates of expenditures, especially for 
research and development and commercialization of new products 
and services.
    Yet another study, by the Massachusetts Institute of 
Technology, reported that from 1982 to 1986 the total number of 
Americans working increased by 9.3 million. Firms which were 
organized during this period, however, created nearly 14.2 
million jobs, and another 4.5 million new jobs were created by 
companies with less than 100 employees. Thus the new jobs 
created during this period by these newly organized businesses 
exceeded the entire job growth during this period. The Fortune 
500 companies actually decreased their total employment by 
approximately 20% in the 1980s and early 1990s.
    In a June 1996 article in Worth magazine, Peter Lynch 
observed, ``Younger, more aggressive companies are challenging 
the older companies or starting new industries from scratch. 
The jobs lost when the older companies falter are made up and 
then some in the younger companies that succeed.'' In support 
of that conclusion, Mr. Lynch presented data which indicated 
that 25 of the nation's largest companies shed a total of 
360,000 jobs between 1985 and 1995, while 25 new companies, 
many of which barely existed a decade ago, added over one 
million jobs over the same period.
    My own experience, gained over 30 years of raising equity 
capital for hundreds of new and emerging small companies, 
overwhelmingly supports this statistical evidence.
    Even larger U.S. corporations acknowledge the crucial role 
of smaller companies in forging important technological 
advances. This is evident in the increasing number of instances 
in which large U.S. corporations enter into joint research and 
development efforts with small entrepreneurial companies or 
acquire or make substantial equity investments in these 
companies to gain access to their technology base. These 
actions reflect a recognition that these smaller companies--
with their more dynamic, pioneering, entrepreneurial, non-
bureaucratic structure--are responsible for much of the 
nation's growth and are better able to find creative solutions 
to problems, which is necessary in the creation of new 
technology and new products.

   Tax Relief for Capital Gains Reinvested in Small Businesses Would 
  Create Jobs and Build the Pool of Capital Available for Productive 
                               Investment

    In assessing the various capital gains tax cut proposals 
now before Congress, lawmakers should seek to determine the 
best means to achieve three goals:
     Create new jobs
     Stimulate capital investment
     Promote the development of new products and 
technologies which will producer an ever-improving quality of 
life for our citizenry and enable United States' businesses to 
compete effectively in world markets
    Targeted capital gains tax relief for small businesses in 
the form of tax-deferred ``roll overs,'' such as those included 
in H.R. 1033 and S. 20, would contribute mightily to achieving 
each of these objectives.
    Deferring taxes on capital gains which are reinvested is a 
proven means of promoting savings and investment. Several tax 
code provisions already provide for tax-deferred roll overs, 
most notably that afforded homeowners who sell their primary 
residence and purchase another within two years. The concept 
would apply just as well to the reinvestment of capital gains 
realized upon the sale of small business stock.
    Both Republicans and Democrats have recognized the merits 
of a small business capital gains ``roll over'' provision. 
Generally, Democrats favor enacting the proposal in lieu of 
broad-based capital gains cuts. Senate Minority Leader Daschle 
has taken such an approach in S. 20. Republicans, on the other 
hand, generally support the targeted small business capital 
gains ``roll over'' proposal as part of a larger package of 
broad-based capital gains tax relief. I believe either approach 
would greatly benefit the economy.
    Targeted capital gains tax relief for small businesses 
effectively complements broad-based capital gains tax cuts, and 
should be a part of any capital gains tax relief package which 
is enacted by the 105th Congress. I wish to underscore that 
passage of broad-based capital gains relief in no way 
eliminates the need for a ``roll over'' provision. The two 
proposals are not redundant. They differ in four principal 
ways:
     First, a ``roll over'' provision would defer the 
entire capital gains tax on covered transactions. Thus, 100 
cents of every dollar of gain would be available for 
reinvestment. The most common broad-based capital gains tax cut 
proposals would provide for an effective rate of between 14% 
and 19.8%, thus leaving only 80-86 cents for reinvestment after 
the tax is assessed.
     Second, the tax deferral afforded by ``roll over'' 
legislation would be available only if the gain was reinvested, 
while the broad-based cuts would apply even to gains which were 
built up in prior years and are cashed in for purposes of 
consumption. Thus, the ``roll over'' legislation is a more 
effective means of addressing the tax code's general bias 
against savings and investment in favor of consumption.
     Third, a ``roll over'' specifically would promote 
capital formation for small, entrepreneurial ventures, which 
create the most jobs and have the most pressing capital 
requirements.
     Fourth, ``roll over'' legislation is vastly less 
expensive than broad-based capital gains. As discussed below, 
the Joint Committee on Taxation has estimated that ``roll 
over'' legislation introduced in the 104th Congress which is 
very similar to H.R. 1033 and S. 20 would cost a total of $100 
million over seven years. The broad based capital gains cuts 
included in the Balanced Budget Act of 1995 would cost $35 
billion over the same period.
    In short, the targeted ``roll over'' provisions of H.R. 
1033 and S. 20 should be a key component of any legislative 
effort to spur economic growth. It doesn't reward money stuffed 
in a mattress or blue chip stock certificates locked in bank 
vaults. It doesn't reward the substitution of equity for debt 
incurred for the leveraged buy outs of large corporations, a 
class of transactions which do little to encourage new 
investment in equipment, research, and job formation. What it 
does reward is risk taking--taking risks in the emerging growth 
businesses which create new jobs and new technologies--the same 
risk taking that made America great, and the same risk taking 
that can make America great again.

 The Joint Tax Committee has stated that Small Business Capital Gains 
   ``Roll Over'' Legislation Would Have a Very Modest Impact on Tax 
                                Revenues

    The Joint Committee on Taxation has concluded that providing 
targeted capital gains tax relief to small businesses by deferring 
taxes on capital gains realized from direct investments in small 
companies so long as those gains are reinvested in similar companies 
would have a very modest impact on federal tax revenues relative to 
other capital gains tax proposals.
    Specifically, the Joint Committee estimated that H.R. 1785, a bill 
introduced in the 104th Congress which is very similar to the ``roll 
over'' provisions of H.R. 1033 and S. 20, would result in a tax revenue 
loss to the federal treasury of a total of $100 million over seven 
years. Significantly, the revenue estimate for H.R. 1785 even included 
losses attributable to a provision which would eliminate, only for 
investments in small businesses, the current law cap on the amount of 
capital losses which could be offset against ordinary income. The 
latter provision would particularly benefit middle income investors who 
do not have extensive portfolios which they can manipulate to produce 
capital gains to match against capital losses.
    Relative to other capital gains tax proposals, the cost of the 
targeted roll over proposal is de minimis. For example, the Joint 
Committee scored the capital gains tax reforms passed by the 104th 
Congress as part of the Balanced Budget Act of 1995 as costing over $35 
billion over seven years.

Capital Gains Legislation Should Be Drafted to Facilitate, Not Impede, 
                         Productive Investment

    If capital gains tax relief is to be effective, it must facilitate, 
not impede, productive investment. Specifically, the market, not the 
artificial constraints of the Internal Revenue Code, must be permitted 
to allocate capital to where it will do the most good. Because holding 
period requirements impede the flow of capital, they must be imposed 
only where they serve legitimate policy ends.
    Based on my decades of experience as an investor, I believe there 
are two legitimate reasons for imposing holding periods. First, 
preferred investors who are granted special access to initial offerings 
of securities should not be afforded any tax benefits for selling those 
interests for an immediate windfall. Quite often, a security sold in an 
initial public offering spikes up in value over the original offering 
price within hours of hitting the market. No public policy interest is 
served by encouraging sales at that point; such ``flipping'' does 
nothing to promote productive investment. However, those ``spikes'' 
tend to last as little as a few hours, and in my experience, almost 
never more than a few weeks, after which the stock value tends to 
plateau. Thus, I believe a holding period of as little as three months 
would address the ``flipping'' issue effectively.
    The second legitimate reason for imposing a holding period 
requirement is to impede disinvestment, that is, the cashing in of 
capital gains which are not reinvested productively, but instead used 
for purposes of consumption. To achieve that goal, holding periods of 
nearly any length may be justified, although a simpler, and more 
effective approach would be to impose a significant tax on consumption, 
that is, capital gains which are not reinvested, and impose little tax 
or, better still, defer the entire tax on those gains which are 
reinvested.
    The ``roll over'' provisions of H.R. 1033 and S. 20 provide that 
stock in a small company must be held for a minimum of six months in 
order for gains realized upon the sale of such stock to be eligible for 
tax deferrals upon reinvestment. I believe such a holding period is 
sound: it prevents ``flipping'' but does not impede legitimate 
reinvestment. Moreover, it has strong historic precedent: from 1942 
through 1988, except for a single eight year period, the Internal 
Revenue Code required stock to be held for six months to be eligible 
for tax treatment as long-term capital gains. (More recently, the Code 
requires a one year holding period for long term capital gains.) The 
robust economic growth of the first several decades of the post-war 
era, growth which was characterized by the creation of vast numbers of 
new businesses and GDP increases far exceeding those of recent years, 
conclusively rebuts the notion that a six-month holding period renders 
entrepreneurs excessively vulnerable to the vicissitudes of capital 
markets.
    Section 1202 of the Code, the small business capital gains 
provision enacted in 1993, provides for a five-year holding period. 
Five years is simply too long: I have observed that investors have 
almost ignored section 1202 because they are unwilling to tie up 
capital long enough to qualify for the tax benefits it confers.
    Significantly, Congressman Matsui, the lead House sponsor of the 
legislation which ultimately became section 1202, has introduced 
legislation which would both reduce the five year holding period 
requirement for gains which would qualify for a reduced tax rate and 
provide for the deferral of capital gains which are realized on 
investments in small companies which are ``rolled over'' into similar 
investments. Yet Congressman Matsui's bill, H.R. 420, requires that 
small business stock be held for three years in order to qualify for 
both a reduced rate and tax-deferred roll over. As noted, it may be 
appropriate to impede disinvestment by imposing a lengthy holding 
period for those seeking to disinvest their gains and use those 
resources for consumption. However, the tax code should not present a 
barrier to reinvestment of capital gains. Thus, the three year holding 
period set forth in H.R. 420 may be appropriate for the rate reduction 
component, but the six month holding period set forth in H.R. 1033 and 
S. 20 constitutes more sound tax policy with respect to the roll over 
component.
    We cannot afford to introduce impediments and disincentives to 
investments in small emerging businesses. As long as the investment 
serves to launch a new company or expand an existing business with the 
vitally important attendant creation of new jobs, we should not require 
capital to be ``locked in'' for years. Indeed, ample testimony before 
the Committee correctly notes that ``capital lock'' is among the 
biggest problems created by the high capital gains rates currently in 
force. A number of commentators have called for the tax code to 
encourage ``patient capital.'' They are correct. Yet from the 
standpoint of the company in which the investment is made, equity 
capital is the most patient capital of all--it is permanent capital. 
And only gains on original issues of equity would be eligible for a 
tax-deferred ``roll overs'' under H.R. 1033 or S. 20.
    An excessive holding period--in my view, anything beyond six 
months--would drastically limit the pool of potential investors to 
those who can afford to tie up their funds for a long time. An 
excessive holding period also would significantly lessen the incentive 
by removing the possibility of a relatively prompt gain, and as a 
result of such reduced incentive, necessarily would reduce the number 
of persons willing to risk investing in small entrepreneurial 
companies. I emphasize that it is the possibility of a quick gain that 
is important. In fact, the investment will almost always be held for 
more than six months. Yet holding out the possibility of an early gain, 
and having taxes on those gains deferred, is what will create the real 
incentive for investors to take the extra risk of funding new and small 
businesses.
    What we need to do is to encourage investments in small businesses 
so as to achieve the positive results which derive from such 
investments. Locking in capital for a predetermined period is counter 
to the purpose of promoting investment in small companies. The sooner 
the money is reinvested, the sooner it can go to work again. This 
multiplier effect increases the pool of investment capital, and permits 
it to be reinvested where it does most good.
    In sum, targeted capial gains tax relief for small businesses in 
the form of tax-deferred ``roll overs,'' such as those included in H.R. 
1033 and S. 20, are the single most effective legislative means to help 
new and small companies and to promote savings and investment in the 
economy as a whole. Such legislation deserves the support of this 
Committee, the Congress, the President, and all Americans, and should 
be a part of any capital gains tax relief package which is enacted by 
the 105th Congress.
    Mr. Chairman, thank you again for the opportunity to testify today.
      

                                

    Chairman Archer. Mr. Davis, thank you for your testimony, 
and without objection, your entire written statement will be 
included in the record, as will be true for all of the witness.
    Mr. Rangel, would you like to inquire?
    Mr. Rangel. Thank you.
    Mr. Davis, did I understand you to say that the cost of 
this is de minimis?
    Mr. Davis. Yes. The Tax Committee headed, I believe, by Mr. 
Kies, whom I saw here earlier, after some time developed the 
scoring on this, and on a static scoring, it was their advice 
to us and to the Congress that the cost would be $100 million 
over 7 years on a static basis. That is not considering that 
many of these companies, these new and small businesses, 
entrepreneurs, will be hiring employees that will be paying, 
and certainly, within 7 years, in a dynamic situation, the 
companies themselves will be developing and growing and paying 
taxes. So it is $100 million over 7 years, yes, very correctly.
    Mr. Rangel. Well, I have heard this type of optimistic 
report. Certainly, it sounds more favorable when you are 
dealing with small businesses because in America that is truly 
where the jobs are. I will be interested in having Mr. Kies 
share the result of the Joint Committee's work on this so that 
I will be able to share it with other Members. Maybe the 
Chairman might want to comment on that because it would seem 
like those very new figures are rather low. Perhaps they are 
using his new method of scoring, which is creative, but not 
accepted at this time.
    Let me thank all of you, but especially you, Mr. Davis.
    Mr. Davis. I always appreciate your brilliance of wisdom, 
and the Chairman's as well. You are two of the greatest 
statesmen in the history of our country. Thank you again.
    Chairman Archer. Mr. Davis, after what you have said about 
both of us, I think maybe you might be preparing to run for 
public office.
    Mr. Davis. No, I just want to support great people like 
you. You guys do a great job.
    Chairman Archer. Thank you very much.
    Ms. Collins, do you wish to inquire?
    Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman. I appreciate the 
opportunity to ask a couple of quick questions here.
    Mr. Davis, I appreciate the leadership you have had in 
small business issues and job creation as a professional and 
attracting investment.
    I note with great interest and, of course, am proud to 
cosponsor legislation referred to in your testimony.
    I noticed toward the end of your written testimony, you 
make a point regarding excessive holding periods.
    Mr. Davis. The what?
    Mr. Weller. The excessive holding periods.
    Mr. Davis. Yes.
    Mr. Weller. Requiring to hold assets for a long period of 
time.
    I was wondering if you can explain to me, just so I can 
better understand, how you feel that by having longer holding 
periods, how that would discourage investment and the creation 
of small business and entrepreneur activity.
    Mr. Davis. Well, something that is decidedly desirable, you 
don't want to introduce any disincentives to the success of 
such a program, and I think if you are familiar with the 
history, Bumpers-Matsui or Matsui-Bumpers introduced a bill 
several years ago that said if you held an investment for 5 
years, I think you pay half the prevailing capital gains, and 
if you hold it 10 years, I think you pay no capital gains tax.
    That bill was such a disincentive that I think, even though 
it is in effect several years, nobody has even asked for the 
regulations.
    If it is useful, first of all, equity capital, as 
distinguished from debt capital or any other capital, equity 
capital is permanent capital. You can't take it back. If I give 
a company some money to put into the business, they have it 
forever. I can seek to fund another buyer, but from the 
company's point of view, it is permanent capital. So this idea 
of having somebody hold it 2 years, 3 years, 4 years, or 5 
years serves little or no purpose. I don't see any purpose, and 
we do insist--we have introduced as we have refined this--to 
avoid people that maybe get into issue and kick it out 2 hours 
later, the free riders or flippers, as they call them on Wall 
Street. We have introduced something in discussing with 
Treasury. We have to hold it at least 6 months or you avoid 
that kind of thing, but to the extent that somebody is 
successful and selling it to somebody else, from the company's 
point of view, it is permanent capital, and then he can turn 
around and use that money and has to use that money within 6 
months, reinvest it in another new company, otherwise he is 
taxed.
    It is an incentive to build a large formation of capital 
for that segment of the economy that hasn't got the 
availability, as big companies do, and it is important for 
women, it is important for minorities. It is important for all 
of us because that is this segment of this country that has 
produced the largest growth over the last decade and beyond. I 
hope that answers your question.
    Mr. Weller. Yes, it surely does. Essentially, you are 
saying that the opportunity for fairly quick gain actually 
attracts more investment than new activity.
    Mr. Davis. Congressman, we have an evergrowing pool, as a 
guy has made a profit, and he has to reinvest the corpus, plus 
the profit, again, in a new or entrepreneurial or a small 
business, the ones that are creating all the jobs.
    As I pointed out, the Fortune 500 have been downsizing, and 
I am sure you are well aware of that. All the new jobs have 
come from these small companies, and all the women are going to 
new businesses at an accelerated rate. We have to make capital 
available to that group, and that is where all the great new 
ideas come from.
    We often fund guys right out of MIT and Harvard and 
Stanford, and if they didn't have access to this kind of 
capital, they would never get funded.
    I am sure you know friends that try to start businesses. 
They run around addressing their friends, scrambling around, 
and it is very, very hard to get that kind of capital.
    So we have to say, in response for your taking the bigger 
risk, that if you have a gain, you can reinvest that gain, and 
other companies of the same nature. That helps the growth of 
our country.
    Mr. Weller. Thank you. Thank you, Mr. Davis.
    Mr. Davis. Thank you very much.
    Mr. Weller. Thank you, Mr. Chairman. That concludes my 
questions.
    Chairman Archer. Gentlemen, thank you very much. The 
Committee will benefit from your testimony, each of you.
    The Committee has no further business today. The Committee 
will stand adjourned.
    [Whereupon, at 4:05 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]
      

                                

Statement of John W. Cox, BMC Software, Inc.; on Behalf of American 
Alliance for Software Exports

    I am John W. Cox, Tax Director for BMC Software, Inc. 
headquartered in Houston, Texas. BMC is a member of the 
American Alliance for Software Exports (AASE), on whose behalf 
this statement is submitted in support of H.R. 143, The 
Software Export Equity Act, and the Administration's FY 1998 
Budget proposal to clarify the application of Foreign Sales 
Corporation (FSC) incentives to exports of software licenses.
    The AASE applauds the leadership of Representatives Dunn 
and Matsui in introducing H.R. 143, which clarifies that the 
export of software that is accompanied by the right to 
reproduce qualifies for FSC incentives. We are pleased that 
similar legislation (S. 387) has been introduced in the Senate 
by Senators Hatch, Nickles, Baucus and Breaux. The fact that 
three-quarters of the members of the Ways and Means Committee 
have co-sponsored this legislation clearly demonstrates that 
this legislation has broad, bipartisan support. We commend the 
Ways and Means Committee for their support of this legislation.
    The AASE also applauds the Administration for recognizing 
the importance of providing FSC incentives to software exports 
by including, and funding, a proposal to resolve this issue in 
their Fiscal 1998 Budget. The Administration's proposal, 
however, is effective only for software licenses granted after 
the date of enactment. Because many software licenses with 
third-party distributors are multi-year agreements, relating 
the effective date to licenses granted after a certain date 
will force software companies to renegotiate these licenses. We 
would appreciate the opportunity to work with the Committee on 
drafting a more appropriate effective date.
    I would like to be clear. The U.S. software industry is not 
seeking any new benefit or special treatment. As I will outline 
in this statement, all the industry is seeking is equal 
treatment under existing law. We believe Congress always 
intended for software to be included as part of the FSC 
statute. We find no evidence Congress ever intended to exclude 
software. To the contrary, we find strong evidence that 
Congress intended to include such industries as software.
    The AASE is a group of high technology companies and state, 
local and national trade associations representing every region 
of the country. AASE members include the Alaska Division of 
Trade & Development; Alaska Hi-Tech Business Council; American 
Electronics Association; Arizona Software Association; 
Association of Information Technology Professionals; Austin 
Software Council; Business Software Alliance; Capitol Region 
Software Alliance, New York; Chicago Software Association; 
Colorado Software Association; Computer Software Industry 
Association, California; Computing Technology Industry 
Association; Connecticut Technology Council; Council for 
Entrepreneurial Development, North Carolina; Eastern Technology 
Council, Pennsylvania; Electronic Industries Association; 
Greater Baltimore Committee Technology Council; Independent 
Computer Consultants Association; Independent Computer Services 
Association of America; Indiana Software Association; 
Information Industry Association; Information Technology 
Association of America; Information Technology Business Center, 
Pennsylvania; Information Technology Training Association; 
Interactive Digital Software Association; Interactive 
Multimedia Association; International Compact Disc Interactive 
Systems; Maine Software Developers Association; Massachusetts 
Software Council; Michigan Technology Council; Minnesota 
Software Association; NASDAQ Stock Market; National Multimedia 
Association of America; National Venture Capital Association; 
New Hampshire High Technology Council; New Orleans Technology 
Council; Niagara Software Executives, New York; North Carolina 
Electronic & Information Technology Association; Northeast 
Software Association, Connecticut; Northern Virginia Technology 
Council; NPES, the Association for Suppliers of Printing and 
Publishing Technologies; Pittsburgh High Technology Council; 
Research Triangle Software Developers Roundtable, North 
Carolina; Rhode Island Economic Development Corporation; Rhode 
Island Software Association; San Diego Software Industry 
Council; Silicon Prairie Technology Association, Missouri; 
Silicon Valley Software Industry Coalition, California; 
Software Association of Oregon; Software Council of Southern 
California; Software Executives Group of Central & Western New 
York, Software Forum, California; Software Industry Coalition, 
California; Software Publishers Association; Software Valley 
Corporation, West Virginia; Southeastern Software Association; 
Suburban Maryland High Technology Council; Technology Council 
of Central Pennsylvania; United States Council for 
International Business; Utah Information Technology 
Association; Virginia Department of Business Assistance; 
Washington Software & Digital Media Alliance; Western 
Massachusetts Software Association.
    BMC is a worldwide developer and vendor of software 
solutions for automating application and data management across 
host-based and open system environments. As is typical of 
members of AASE, exports comprise a substantial portion of 
BMC's sales; more than 40 percent of BMC's over $500 million in 
revenues is from exports.
    High technology industries are important to the future 
economic strength of the United States. In the 1980's, the high 
technology industry focused on advancements in hardware. In the 
past few years, however, attention has turned to software. 
Software includes both the system software and applications 
software that enable computers and other electronic products to 
perform faster and more varied functions. Today, the United 
States is a world leader in software development and employs 
approximately 600,000 people in the United States in high-
skilled software development and servicing jobs, including 
BMC's nearly 1,000 employees in Texas. The Commerce Department 
estimates that every $1 billion of export trade is worth 19,000 
domestic jobs.

                              Introduction

    The tax code, through the FSC rules, currently provides a 
tax incentive to U.S. exporters of goods developed in the 
United States. AASE members are unified in their objective to 
clarify that the FSC rules apply to all software exports.
    Due to a narrow IRS interpretation of the FSC rules, the 
export of software products that is accompanied by a right to 
reproduce the software is barred from receiving this export 
incentive. This interpretation unfairly discriminates against 
exports of software since virtually all other U.S. produced 
exports, from airplanes to toothpaste, are eligible for FSC 
incentives. The IRS interpretation is particularly unfair 
because master recordings of motion pictures or music for 
reproduction outside the United States, which are distributed 
with reproduction licenses in the same manner software is 
distributed, are eligible for FSC incentives. The FSC rules 
provide an important incentive for U.S. companies to produce 
their products in the United States for sales overseas. Given 
many of the high-skilled jobs associated with software 
development, it should be equally, if not more, important to 
provide FSC incentives to software as it is to provide these 
incentives to airplanes, toothpaste, motion pictures, musical 
recordings or any other U.S. produced exports.
    In addition, the FSC rules are extremely important to 
smaller businesses because the FSC incentives help reduce the 
costs of entering the export market. In fact, the FSC statute 
includes specific rules which make it easy for small companies 
to quality for FSC incentives. Since software companies have 
the opportunity to enter the export market at a very early 
stage in their life cycle, it would be especially helpful if 
they could utilize the FSC rules, as all other industries can.

    Contributions of the U.S. Software Industry to the U.S. Economy

The U.S. software industry makes significant contributions to the U.S. 
economy.

    1. The U.S. software industry employs thousands of high-
skilled programmers to develop the software that is its 
product. Software companies create thousands of new jobs each 
year. These high-skilled jobs are the type of jobs that 
Congress and the Administration have emphasized they want to 
encourage through their economic policies.
    2. The U.S. software industry invests heavily in research 
and development to create new products for world markets. This 
helps both to create new technologies and advance existing 
technologies, resulting in the United States being a world 
leader in the development of new technologies.
    3. The U.S. software industry produces products that are in 
high demand both in the United States and abroad. The demand 
for U.S.-developed software outside the United States has led 
to a surge in the exports of U.S. software. These exports 
reduce the trade deficit of the United States and help expand 
the markets for American-made goods, resulting in more U.S. 
research and development and high-skilled jobs for software 
programmers and others in the United States.
    The U.S. software industry is currently a world leader. 
However, like other U.S. exporters, FSC incentives will serve 
to further enhance the industry's competitiveness. The FSC 
incentives will particularly assist small and medium-sized 
software companies in entering the world market, by enabling 
them to reduce the cost of exporting. Moreover, all software 
companies must weigh the net cost of exporting from the U.S. 
against the cost of developing foreign products in foreign 
jurisdictions. It is important to note that many foreign 
governments have realized the many economic benefits associated 
with the fast growing software industry. These foreign 
governments are actively working to attract software companies 
to their countries by offering substantial tax and other 
financial incentives.

            How the U.S. Software Industry Conducts Business

    Software programmers conduct research and development 
activities in the United States for the development of software 
products. These software programmers are highly-skilled 
employees who add significant value to the software product. 
U.S. software companies license their software to customers in 
both the United States and abroad.
    A U.S. software company that markets its software to 
foreign customers usually licenses a master copy of the 
software to foreign customers, including third-party 
distributors, original equipment manufacturers (OEMs) and 
value-added resellers (VARs). Distributors and VARs may 
translate the software into the language of the local country 
and reproduce it for license to customers in that country. In 
addition, software is routinely licensed through OEMs who 
install the software on their hardware and sell the bundled 
package of software and hardware. In other cases, software may 
be licensed to VARs, who add their own software to the licensed 
software and then reproduce the combined software for sale. 
These are all important distribution networks for exports of 
software and greatly enhance the industry's ability to export 
its products efficiently and effectively. Because software 
programs are constantly being updated and improved, large 
physical inventories of software are impractical and very 
expensive to maintain. The licensing of an updated master copy 
through OEMs, VARs, and third-party distributors is the most 
efficient and cost-effective method for the U.S. software 
industry to export its products.
    Software publishers are increasingly entering into ``site 
licenses'' with some of their larger customers. A site license 
is the licensing of a master copy of the software directly to 
the customer. A site license enables the customer to make as 
many individual copies of the master copy as required to meet 
its needs. Also, in some instances, large foreign customers 
prefer to do business with local companies (i.e., foreign 
subsidiaries of U.S.-owned companies). In these instances, the 
U.S. company will transfer the master copy to its foreign 
subsidiary that will, in turn, enter into a site license with 
the foreign customer.

Legislative History of the Application of the FSC Rules to 
Software and Later IRS Interpretations

    In 1971, Congress enacted the Domestic International Sales 
Corporation (DISC) legislation to encourage the export of U.S. 
produced goods in order to help U.S. companies compete in 
overseas markets and so improve the nation's balance of 
payments. Additionally, by encouraging the export of U.S. 
produced goods, Congress hoped to keep manufacturing jobs in 
the United States as well as create new jobs. In 1984, the DISC 
provisions were replaced by the FSC rules. The FSC rules had 
the same purpose as the DISC rules, but eliminated some of the 
provisions in the DISC rules that our trading partners found 
objectionable under GATT.
    Under the FSC provisions, the export of certain intangibles 
is ineligible for FSC incentives. Section 927(a)(2)(B). 
Specifically excluded are ``patents, inventions, models, 
designs, formulas, or processes, whether or not patented, 
copyrights (other than films, tapes, records, or similar 
reproductions, for commercial or home use), goodwill, 
trademarks, trade brands, franchises, or other like property.'' 
This language is identical to the language contained in the 
DISC statute written in 1971 (see section 993(c)(2)(13)). 
Neither the statute nor the legislative history contains any 
language that specifically precludes software from qualifying 
for DISC or FSC incentives. The legislative history to the FSC 
provisions provides no explanation of this section of the bill. 
The legislative history to the DISC provides the following 
explanation of this section of the bill.
    Although generally, the sale or license of a copyright does 
not produce qualified export receipts (since a copyright is 
generally not export property), the sale or lease of a 
copyrighted book, record, or other article does generally 
produce qualified export receipts. House Report No. 92-533, 
92nd Cong., 1st Sess. 69 (1971), 1972-1 C.B. 498, 535; Senate 
Report No. 92-437, 92nd Cong., 1st Sess. 102 (1971), 1972-1 
C.B. 559, 616.
    Treasury regulations interpreting the DISC statute rely on 
this legislative history in providing that a copyrighted 
article (such as a book), if not accompanied by a right to 
reproduce it, is export property. The regulations also state 
that a license of a master recording tape for reproduction 
outside the United States is qualified export property.
    Export property does not include any patent, invention, 
model, design, formula, or process, whether or not patented, or 
any copyright (other than films, tapes, records, or similar 
reproductions, for commercial or home use), goodwill, 
trademark, trade brand, franchise, or other like property. 
Although a copyright such as a copyright on a book does not 
constitute export property, a copyrighted article (such as a 
book) if not accompanied by a right to reproduce it is export 
property if the requirements of this section are otherwise 
satisfied. However, a license of a master recording tape for 
reproduction outside the United States is not disqualified 
under this subparagraph from being export property. Reg. 
Sec. 1.993-3(f)(3).
    The eligibility of software for DISC incentives was first 
addressed in 1985 when the IRS National Office was requested to 
provide technical advice on whether so-called ``box top'' or 
``shrink-wrap'' software sold or leased outside the United 
States on a mass market basis qualified for DISC benefits. In 
Technical Advice Memorandum 8549003, the IRS stated:
    The ``films, tapes records, or similar reproductions'' 
language of section 993(c)(2)(B) is not limited as to subject 
matter. Since copyrighted computer software is marketed on 
magnetic tapes for commercial use, such tapes seem to 
specifically qualify based on the Code language. However, it is 
unclear whether Congress intended this provision to apply to 
other than entertainment industry tapes. Based upon the earlier 
drafts of section 993(c)(2)(B), it could be argued that 
Congress intended qualification for only tapes that are like 
films or records, i.e., videotapes or musical tapes. See H.R. 
18392, 91st Cong., 2d Sess. (1970) and H.R. 18970, 91st Cong. 
2d Sess. (1970), in which the proposed version of the 
parenthetical exception of finally enacted section 993(c)(2)(B) 
only applied to films and tapes produced by the entertainment 
industry. However, one could also argue that since the finally 
enacted provision does not seem to be solely limited to the 
entertainment industry, such provision should not be 
interpreted in a restrictive manner. [Emphasis added]
    Without concluding whether software on magnetic tape was 
meant to be within the parenthetical exception to section 
993(c)(2)(B), the IRS concluded that the software at issue was 
eligible for DISC incentives because the provisions seemed to 
include as export property finished products or inventory 
items.
    In a later technical advice memorandum, the IRS more 
decisively reached the conclusion that the parenthetical 
exception in section 993(c)(2)(B) did not seem to be limited to 
the entertainment industry, and, therefore, the provision 
should not be interpreted in a restrictive manner. However, in 
ruling that the software, tapes in this case, which were 
produced in the United States and sold or licensed outside the 
United States on a mass market basis, were qualified property, 
the IRS relied on the regulations under the DISC rules, which 
permitted copyrighted books to qualify for DISC. (TAM 8652001).
    Although it seems clear that software tapes qualify as 
``tapes'' under sections 993(c)(2)(B) and 927(a)(2)(B), the 
phrase ``similar reproductions'' clearly is broad enough to 
include the licensing of software. This is because the 
production of a master software tape, and the medium and the 
manner in which it is reproduced and distributed, are very 
similar to the manner in which the entertainment industry 
produces and distributes its products. For example, it is 
common for both films and software master tapes to be exported 
to distributors who will translate the tape into the local 
language and reproduce it for distribution in that country. 
Additionally, today more and more music and software are 
reproduced on compact disks, using almost identical equipment 
and production processes. Furthermore, the direction the 
technology is taking is that distribution of films, tapes, 
records, videos, software and any other type of digital 
information will be done electronically rather than by shipping 
physical copies. Finally, the explosion of entertainment 
software, which include films and music recordings, provides 
strong evidence for consistent treatment. Thus, we believe the 
language chosen by Congress for the parenthetical exception was 
intended to be broad enough to encompass exports, like 
software, that are exported in the same manner as films and 
records.
    Despite these IRS opinions and the broad language of the 
statute, the temporary FSC regulations issued in 1987, 
interpreting language identical to that interpreted by these 
opinions, adopted a narrow interpretation of the parenthetical 
exception that the IRS interprets as denying any FSC benefits 
for the license of software if the license is accompanied by 
the right to reproduce the software. (TAM 9344002).
    The FSC regulations substantially parallel the DISC 
regulations. However, regulation writers in 1987, now cognizant 
of the existence of the U.S. software industry, decided to 
specifically address software in regulations promulgated under 
FSC. The regulation writers made a determination to treat mass 
marketed software as a copyrighted article that is eligible for 
FSC benefits. They also made a decision not to treat a license 
of a software program for reproduction outside the United 
States like a master recording tape, which is also eligible for 
FSC incentives. In these regulations, the IRS effectively 
narrowed the scope of property eligible for FSC incentives to 
exclude a major portion of software exports--licenses of 
software with the right to reproduce. Temporary Regulation 
Sec. 1.927(a)-1T(f)(3), which defines intangible property that 
is excluded from the definition of FSC export property, states:
    Export property does not include any patent, invention, 
model, design, formula, or process, whether or not patented, or 
any copyright (other than films, tapes, records, or similar 
reproductions, for commercial or home use), goodwill, 
trademark, trade brand, franchise, or other like property. 
Although a copyright such as a copyright on a book or computer 
software does not constitute export property, a copyrighted 
article (such as a book or standardized, mass marketed computer 
software) if not accompanied by a right to reproduce for 
external use is export property if the requirements of this 
section are otherwise satisfied. Computer software referred to 
in the preceding sentence may be on any medium, including, but 
not limited to, magnetic tape, punched cards, disks, 
semiconductor chips and circuit boards. A license of a master 
recording tape for reproduction outside the United States is 
not disqualified under this paragraph from being export 
property. Temp. Reg. Sec. 1.927(a)-1T(f)(3). [Emphasis added]
    IRS effectively narrowed the scope of property eligible for 
FSC incentives to exclude a license of software with the right 
to reproduce.
    The narrowing of the definition of export property to 
exclude software licenses that permit reproduction of the 
software has no basis in the statute or legislative history to 
the DISC or FSC rules, but was based on an administrative 
decision by the FSC regulation writers at the IRS that software 
tapes were neither ``tapes'' nor ``similar reproductions'' 
within the meaning of the statute. Despite the fact that the 
legislative history provides no basis for limiting these terms 
within section 927(a)(2)(B)'s parenthetical to the 
entertainment industry, the IRS regulation writers made a 
decision to do so. Not only does this ignore the way that 
software is exported, it ignores the similarities between the 
film, record and software industries. The future direction, 
driven by technology, is that all digital information, whether 
it be music, video, or software, will be distributed in the 
same way. No logical distinction has ever been made between 
these different products.
    AASE strongly believes that Congress' statute, specifically 
allowing for ``similar reproductions'' to qualify for DISC and 
FSC treatment, recognized the need for the legislation to 
address developing industries and new means of doing business 
like software. We do not believe that Congress in enacting the 
FSC rules intended to deny incentives to the software industry. 
Indeed, the Administration recognizes that software licenses 
should be provided FSC incentives, as they have included a 
legislative proposal to address this issue in their FY 1998 
Budget. AASE strongly supports the Administration's legislative 
proposal to provide FSC incentives to software licenses.

                                Summary

    The software industry is an important contributor to the 
economy of the United States today and will continue to be in 
the future. The software industry creates many new high-skilled 
jobs in the United States, helps the United States to maintain 
its position as a world leader in the high technology field and 
is a large and growing source of U.S. exports, the revenue from 
which reduces the U.S. trade deficit. The failure to permit 
exports of software to qualify for FSC incentives is 
counterproductive to the continued growth of this industry. In 
addition, there is no tax policy reason for denying exports of 
software the same FSC incentives that are available to 
virtually all other U.S. exporters.
    We are on the brink of an explosion in the global use of 
information technology. The United States is well-situated to 
turn that economic reality into immense growth and job 
opportunities for the United States. In times of tight budgets 
and tough choices, we are not looking for handouts or special 
treatment. We are looking for a clarification in existing law, 
so that the U.S. software industry can continue to do what it 
does best, create and market high-value, job creating products 
across the globe. AASE strongly supports the Administration's 
budget proposal to provide a legislative solution to this 
problem, and urges Congress to enact H.R. 143, the Software 
Export Equity Act, which would clarify that the definition of 
FSC export property includes the license of software to 
distributors and customers with the right to reproduce.
      

                                

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 savings and investment provisions of the 
Administration's fiscal year 1998 budget proposal.
    The ABA brings together all elements of the banking 
community to best represent the interests of this rapidly 
changing industry. Its membership--which includes community, 
regional, and money center banks and holding companies, as well 
as savings associations, trust companies, savings banks and 
thrifts--makes ABA the largest banking trade association in the 
country.
    The Administration's 1998 revenue plan contains several 
significant proposals of interest to banking institutions 
which, with modification, would provide much needed tax relief, 
as set out more fully below.

                     Individual Retirement Accounts

    The Administration's proposal to expand the availability of 
individual retirement accounts (IRAs) is of particular interest 
to ABA. The banking industry fully supports efforts to 
revitalize IRAs, and we are particularly pleased that the 
concept of tax-advantaged retirement savings has garnered long-
standing bi-partisan support. In this regard, we note that ABA 
fully supports the expanded IRA proposed by Representatives 
William Thomas (R-CA) and Richard Neal (D-MA) in H.R. 446. That 
legislation would provide a model IRA vehicle designed to 
address the nation's need to increase retirement savings.
    By way of background, the personal savings rate in this 
country has trended down over the past several decades. During 
the 1970s, individuals saved 7.8 percent of their disposable 
income; in the 1980s, the personal savings rate declined to 6.5 
percent; for the first half of the 1990s, individuals saved 
only 4.7 percent of their disposable income. This declining 
trend means that individuals will be less prepared to meet the 
variety of financial needs they are likely to encounter during 
their lives--including buying a home, paying for college, 
covering medical emergencies and providing an adequate 
retirement income. Since savings and investment are critical 
ingredients in economic growth, a declining savings rate also 
has negative implications for the future of our economy and for 
our ability to create new jobs.
    The primary appeal of the IRA concept to individuals is 
based upon the tax advantage associated therewith. That tax 
advantage is often viewed as a supplement to savings, making 
the IRA an appealing product for an individual's long-term 
savings growth. Individuals concerned about the availability of 
retirement funds can appropriately complement social security 
and other retirement savings vehicles with IRAs. Once an IRA 
has been established, the tax penalties that accompany early 
withdrawals provide further encouragement to save for the long-
term.
    The challenge, then, is to develop a viable IRA product 
with sufficient appeal to attract a wide range of individuals 
to participate. We believe that, to be successful, an IRA must 
meet three criteria:
     first, it must be simple enough to be easily 
understood by consumers;
     second, eligibility criteria must be sufficiently 
inclusive to permit broad participation; and
     third, it must be flexible enough to be responsive 
to the financial needs of today's consumers.
    If such criteria are met, we believe that individuals will 
view the new and improved IRAs as valuable tools for long-term 
savings, and the product will be far more successful than the 
IRA vehicle that is currently available.

Simplicity

    One problem that has diminished the effectiveness of the 
current version of the IRA for bank customers is its 
complexity. Particularly, the rules for determining eligibility 
for today's IRAs are simply too difficult to understand. 
Millions of consumers have been so confused about the tests, 
eligibility determinations, and income limitations, that even 
when they are eligible, many individuals do not participate in 
IRAs. The problem has been exacerbated by the changes, and by 
constant discussions of changes, in IRAs. We recommend that any 
new proposal be simple to understand in its terms and 
conditions.

Eligibility

    In 1981, almost all working Americans were eligible for IRA 
coverage, and IRAs became immensely successful. However, after 
the 1986 tax reform act, the eligibility rules were changed 
dramatically--individuals covered by private pension plans were 
no longer eligible and the income limits established ($25,000 
for individuals and $40,000 for couples) significantly reduced 
eligibility. Participation declined dramatically and 
contributions have continued to shrink every year since 1986--
40 percent of the eligible taxpayers are not currently using 
IRAs.
    Inflation also contributed to the decline in the 
effectiveness of IRAs. Many of those in the low to middle 
income bracket who remained eligible after the 1986 tax act 
have gradually been forced out of eligibility simply because of 
inflation-based pay increases. In the near future, inflation 
will continue to shrink the base of those eligible to invest 
unless some type of indexing is permitted under the statute.
    For a tax-favored savings incentive to be effective in 
generating new savings, the pool of those eligible to 
participate in the plan should be as wide as possible. The 
Administration's plan would, inter alia, raise and index the 
income limitations on deductible IRAs. The proposal represents 
an important first step in resolving the eligibility problem of 
the currently available IRA vehicle. It could be further 
improved by eliminating income phaseout limits altogether, 
which would allow a much greater number of individuals and 
households to participate in the expanded IRA vehicle.

Flexibility

    If there is any single reason why people have been 
reluctant to establish IRAs, it is probably the lack of 
flexibility. Individuals are understandably concerned about 
sinking their money into a totally illiquid account from which 
funds can not be retrieved without significant penalties--
except by crossing the retirement age threshold. For a savings 
incentive to work, people need to have a certain comfort level 
that their savings can be accessed for emergencies and for 
certain other important expenditures.
    We also believe that a plan should be flexible in offering 
a range of options to the customer. The current savings 
proposals differentiate between whether the IRA is ``front-
loaded'' or ``back-loaded.'' With a front-loaded IRA, the 
taxpayer may take a tax deduction for the amount of the 
contribution. Alternatively, with a back-loaded IRA, there is 
no tax deduction for the contribution; instead, all earnings 
and contributions from the investment can be withdrawn tax-free 
for qualifying expenditures, as well as at retirement age. A 
tax-favored savings plan should be flexible enough to offer 
both options to customers, since the decision as to which plan 
would be preferred may differ among individuals. An IRA plan 
should also protect the contribution limits from erosion by the 
effects of inflation so that contribution limits will not need 
to be adjusted by law in the near future.

Economic Benefits of an Expanded IRA

    A properly designed retirement savings instrument will 
result in higher usage by individuals and more long-term 
savings. One of the most important long-term issues for this 
country is inadequate savings. Savings promote capital 
formation, which is essential for job creation, opportunity and 
economic growth.
    The Administration's proposal represents an important first 
step in resolving the eligibility problem of the current IRA 
vehicle. It could be further improved by eliminating income 
phaseout limits altogether, which would allow a greater number 
of individuals and households to participate in the expanded 
IRA vehicle.

                              Capital Gains

    We would like to commend Representatives Philip English (R-
PA) and Robert Matsui (D-CA) for introduction of the 
``Enterprise Formation Act of 1997,'' (H.R. 420). We would also 
like to commend Representative Jennifer Dunn (R-WA) for 
introducing H.R. 1033, the ``Return Capital to the American 
People (ReCAP) Act.'' The bills would provide much needed 
improvements to existing small business stock investment tax 
incentives. The ReCAP Act would also provide a broad-based 
capital gains tax cut and index the basis of capital assets for 
inflation.
    ABA is pleased that the subject of capital gains rate 
reduction has garnered bi-partisan support. We fully support 
the enactment of tax legislation that incorporates targeted 
investment incentives for small business along with a broad-
based capital gains cut.

Broad-Based Capital Gains

    The current tax regime essentially discourages investment 
in the most efficient, highest return opportunities. A broad-
based capital gains rate cut would reduce the cost of capital 
and encourage the use of equity financing, rather than debt, 
for business activities. It would benefit a wide variety of 
income groups and economic sectors, including retirees, middle 
income families, large and small investors, businesses, 
farmers, and entrepreneurs. According to the 1996 Congressional 
Budget Office report, in 1989, thirty-one percent of families 
with incomes under $20,000 owned capital assets, not including 
their personal residences. For families with incomes between 
$20,000 and $50,000, the figure was fifty-four percent. Also, 
according to the Investment Company Institute, approximately 
sixty-percent of households earning $50,000 or less own mutual 
fund investments.
    Capital gains tax relief is necessary in order to increase 
capital formation, stimulate saving and investment, raise 
domestic wages, and to boost domestic economic growth. 
Accordingly, a broad-based tax cut would impact virtually every 
sector of the American economy.

Venture Capital

    Under the present law, venture capital investment of 
corporations is effectively taxed at three levels: (1) the 
earnings of the recipient of the capital are subject to the 
regular corporate income tax, (2) the gains earned by the 
venture capital subsidiary are subject to the corporate income 
tax, and (3) distributions to individual stockholders of the 
investing corporation or the bank holding company parent are 
once again taxed. Reducing the capital gains tax rate is 
expected to ``unlock'' capital assets, lower interest rates and 
spur the economy, resulting in raising federal revenues. It 
would also encourage venture capital investments by financial 
institutions by lowering the excessively high cost of capital.
    The banking industry is actively involved in the venture 
capital business and is a vital source of venture capital 
funding. Banks represent a stable source of venture capital 
that has provided a cushion during periods when other sources 
of capital have contracted. By obtaining funds from the parent 
holding company, banks provide consistent, long-term support 
for the venture firms. Bank venture capital subsidiaries are 
also less subject to the fluctuations of the availability of 
venture capital funds and may also diversify their portfolios 
across industries and geographic regions to reduce risk.
    Many of the larger U.S. commercial banks have non-bank 
venture capital subsidiaries which obtain funding from a parent 
bank holding company. In recent years, commercial banks have 
provided between 6 and 13 percent of all new venture capital 
invested each year and have more than $5 billion invested in 
venture capital.
    Generally, investment in the stock of young entrepreneurial 
firms is among the most productive of investments. According to 
the Small Business Administration, a new job is created for 
every $17,000 of venture capital invested. These high risk, 
innovative and usually highly technical enterprises often must 
rely on investor purchase of stock to finance their operations. 
Most venture companies have little or no operating history and 
virtually no sales. A very large percentage of them produce 
losses or fail. However, successful venture businesses are 
among the fastest growing domestic companies. A reduction in 
the rate of capital gains tax on corporate venture capital 
investments is not only appropriate but sorely needed to 
stimulate continued job growth and development. We urge you to 
include a broad-based capital gains tax cut in the budget 
bill's tax package along with targeted venture capital 
investment incentives.

                  Estate tax relief for small business

    Under the current law, a unified credit of $192,800 is 
provided against the estate and gift tax, which effectively 
exempts the first $600,000 in taxable transfers from tax. If 
the estate tax is imposed, it is due within nine months of a 
decedent's death. Internal Revenue Code section 6166 provides 
that an executor generally may elect to pay the Federal estate 
tax attributable to an interest in a closely held business in 
installments over, at most, a 14-year period. If the election 
is made, the estate pays only interest for the first four 
years, followed by up to 10 annual installments of principal 
and interest. A special 4-percent interest rate applies to the 
amount of deferred estate tax attributable to the first 
$1,000,000 in value of the closely-held business. A special 
estate tax lien applies to property on which the tax is 
deferred during the installment payment period. Interest paid 
on the deferred estate tax is allowed as a deduction against 
either the estate tax or the estate's income tax.
    Financial institutions routinely serve as corporate 
fiduciaries for trust administration or as personal 
representatives for estate administration. According to the 
Federal Financial Institutions Examination Council's 1995 
report, entitled, ``Trust Assets of Financial Institutions,'' 
approximately 2,700 financial institutions are currently 
engaged in trust activities which include estate 
administration. Said institutions hold approximately $21 
billion in estate assets in either a discretionary or non-
discretionary capacity, representing approximately 49 million 
estate administration accounts.
    Banks, through their trust departments, provide a variety 
of personal fiduciary services, such as settling an estate 
following the death of a client. Settling an estate may involve 
a series of actions from the admission of a will to probate 
court to the final distribution of assets to the estate 
beneficiaries. By way of example, in an estate settlement, the 
bank would serve as either executor or administrator of the 
estate. As personal representative, the bank's responsibilities 
would include providing legally required notice to heirs, 
beneficiaries, and interested persons; collecting and 
appraising assets; drawing up a budget for payment of estate 
obligations and, if necessary, selling assets to meet 
outstanding debts; safekeeping assets; making tax elections; 
settling all tax obligations (income taxes and state and 
federal estate taxes); assessing claims filed against the 
estate; making a final accounting to the probate court; and 
finally, distributing any remaining assets to the 
beneficiaries.

The Need for Estate Tax Relief

    The present law often causes family businesses to be sold , 
at the worst possible time, in order to pay estate tax. More 
than 70% of family businesses and farms do not survive through 
the second generation, and 87% do not survive through the third 
generation. Indeed, the White House Conference on Small 
Business Commission called for repeal of the estate tax because 
it was considered one of the paramount threats to family-owned 
inherited businesses and a disincentive to growth.
    We agree with the Conference's Report. We also believe that 
the Internal Revenue Code--particularly with respect to estate 
and gift taxation--has become overly complex. Taxpayers expend 
significant resources on compliance activities. Similarly, 
banking institutions expend significant resources on training 
trust department employees in estate planning and 
administration. Thus, estate tax simplification would benefit 
customers as well as banking institutions. Of course, any 
change should not sacrifice simplicity in exchange for vitally 
needed estate tax relief.
    We note that the estate tax has also had an inordinate 
impact on farmers. In this connection, we would respectfully 
call to your attention the February 25, 1997 testimony of Keith 
Collins, Chief Economist, Department of Agriculture before the 
House Committee on Agriculture. In that testimony Mr. Collins 
pointed out that over 75 percent of a farm's assets (such as 
real estate) can not be easily liquidated to pay the estate tax 
without disruption of the farm as a going business. A quick or 
``distress'' sale to raise cash would probably result in sale 
of the farm at a lower than market rate, with harmful results 
to the taxpayer and any lenders involved.

Recommended Solutions

    The ABA supports the legislative proposals to increase the 
unified credit amount. This much needed modification would both 
simplify the Code and reduce the estate tax for small business 
owners and farmers. The credit amount, set in 1981, is not 
indexed for inflation and has not been increased. Indexed for 
inflation, the $600,000 value exemption would be $830,000 in 
1997 dollars. Today, taxpayers may easily exceed $600,000 in 
value by simply owning a home, a modest investment portfolio, 
life insurance (the face amount of the policy is subject to 
estate tax), and retirement benefits. A family business will 
greatly increase the odds of exceeding the tax-free limit.
    Further, the relief provided by Code section 6166 may, as a 
practical matter, be unavailable to many taxpayers. By 
subjecting the business property to a tax lien, credit 
availability may be limited and the day-to-day operations may 
be impeded. Further difficulties may arise if the value of the 
property or business declines during the installment period. In 
the event of a bankruptcy, the estate tax would remain due, 
with the bank-fiduciary required to continue payment 
irrespective of the absence of cash from the estate. Moreover, 
the fees due to the bank for such services would not be paid. 
Also, the installment method involves complex rules and 
prevents a quick and simple closing of the estate.
    The Administration's proposal would make several 
modifications to Code section 6166: increasing the amount of 
value for eligible business from $1,000,000 to $2,500,000; 
providing that interest paid on the deferred estate tax would 
not be deductible; reducing the 4 percent rate to 2 percent; 
and subjecting the deferred estate tax on any value of a 
closely held business in excess of $2,500,000 to interest at a 
special rate. It would also authorize the Secretary of the 
Treasury to accept security arrangements in lieu of the special 
estate lien. The Administration's proposal would do much to 
remedy the problems faced by small businesses owners and 
farmers; but it would not simplify the estate tax laws. It 
would still necessitate extensive estate planning and add 
complexity to the administration of estates.
    We note that Senate Finance Committee Chairman William Roth 
(R-DE) has introduced the ``American Family Tax Relief Act,'' 
S.2, which would increase the unified estate and gift tax 
credit over an eight-year period beginning in 1997 from an 
effective exemption of $600,000 to an effective exemption of 
$1,000,000. The bill would provide special estate tax treatment 
for ``qualified family-owned business interests'' if such 
interests comprise more than 50 percent of a decedent's estate. 
It would exclude the first $1,500,000 in value of qualified 
family-owned business interest from the decedent's estate and 
would also exclude 50 percent of the remaining value of 
qualified family-owned business interests. The bill would also 
extend the Code section 6166 installment period from 14 years 
to a maximum of 24 years, with the estate paying only interest 
for the first four years, followed by up to 20 installments of 
principal and interest. There would be no interest on the 
amount of deferred estate tax attributable to the first 
$1,000,000 in value of the closely held business.
    Although we believe that the estate tax relief provisions 
of S. 2 may be a step in the right direction, we are concerned 
that compliance with the qualified family-owned business rules 
would require adherence to an overly complex set of rules, 
which, due to their long-term application, may prove to be more 
problematic than the current installment rules. Additionally, 
the American Family Tax Relief Act is unclear with respect to 
the treatment of qualified family-owned businesses held within 
trusts.
    Accordingly, we would urge you to include provisions 
pertaining to ``death tax'' relief in the form of raising the 
unified credit amount in the fiscal year 1998 budget.

                               Conclusion

    We appreciate having this opportunity to present our views 
on these issues. We look forward to working with you in the 
further development of solutions to our above-mentioned 
concerns.
      

                                

Statement of David Rhodes, President, School of Visual Arts, New York, 
New York; Chair, Federal Advocacy Committee, Association of Proprietary 
Colleges

    I am David Rhodes, President of the School of Visual Arts 
in New York City and Chairman of the Association of Proprietary 
Colleges' (APC) Committee on Federal Advocacy. On behalf of 
APC, I want to thank Chairman Archer and Members of the House 
Committee on Ways and Means for holding these hearings and 
permitting our Association to submit testimony regarding the 
Savings and Investment Provisions in the Administration's 
Fiscal Year 1998 Budget Proposal.
    We commend both the Administration and numerous Members of 
Congress for recognizing that the education of our population 
should be a federal priority and for proposing many new and 
creative ideas to assist parents and students with obtaining 
the education, training and retraining they will need to lead 
productive lives and become active knowledgeable citizens in 
our rapidly-changing world.
    The Association of Proprietary Colleges is a group of 31 
degree-granting colleges located in the State of New York. Most 
of our members' colleges offer associate degree programs. My 
own institution, the School of Visual Arts, confers 
baccalaureate degrees and master of fine arts degrees. Many of 
our members' colleges are small family-owned businesses, some 
of which have been in existence for more than 100 years. Even 
our youngest member was established more than 20 years ago. The 
average placement rate for our students exceeds 90 percent. Our 
graduation rates exceed those of other educational sectors in 
the State.
    In order to remain competitive, we must and do maintain a 
close working relationship with the marketplace, expose our 
students to the latest technology, and equip our graduates with 
the advanced conceptual skills required for entry into the 
business world. Because we receive no public subsidies to 
attract, retain and graduate students in a world which changes 
as rapidly as ours does, we have developed structures and 
mechanisms which allow for unusual flexibility in tailoring 
curricular and support services to better educate our students 
for a society whose pace of change is increasing. We are 
mindful that our times call for multiple careers, for we know 
that the average student today can anticipate eight different 
jobs in a lifetime.
    New York State recognizes and separately regulates two 
kinds of postsecondary institutions: non-degree granting trade, 
technical or business schools and degree granting institutions 
of higher education. For the State of New York, the type and 
level of the program offered by an institution are paramount. 
Corporate structure is not a factor in the State regulatory 
apparatus. Proprietary colleges are institutions of higher 
education whose programs are evaluated using the same 
regulations and staff as all other institutions of higher 
education. Trade schools, whether for-profit, not-for-profit, 
or public are governed by a separate set of regulations that 
are administered by a different staff. Only institutions of 
higher education, for example, may grant credit-hours while 
postsecondary trade, technical and business schools must use a 
contact-hour format to measure the length of their programs.
    Although New York State has been regulating education for 
more than 200 years, and has therefore been able to take the 
time to refine its practices with unusual precision, the 
difference between postsecondary nondegree training and higher 
education at the associate, baccalaureate or postbaccalaureate 
level is clear throughout the country. Since the regulation of 
education is a state and local matter, it seems to us that 
those states which have permitted qualified proprietary 
institutions to become institutions of higher education should 
not have their considered judgments preempted at the federal 
level.
    Unfortunately, the Department of Education categorizes 
institutions by their corporate structure and not by the 
quality or level of education their students receive. Within 
the Higher Education Act, there are basically two definitions 
of ``institutions of higher education.'' Section 1201(a) of the 
Higher Education Act of 1965 defines only public and nonprofit 
institutions as those ``institutions of higher education'' 
eligible for institutional aid. Approximately 2,500 
institutions nationwide are included in this definition.
    Section 481 of the same Act defines ``institutions of 
higher education'' that are eligible participants in student 
financial aid programs. This is a much broader definition and 
includes diverse institutions providing a wide range of 
programs: public, nonprofit, for-profit, short-term programs, 
foreign medical schools, foreign graduate medical schools, etc. 
We estimate that approximately 6,000 institutions are included 
under this definition.

                                Concerns

    Our primary concern is that our students receive the same benefits 
from the federal government as students who attend private and 
nonprofit institutions. Since proprietary colleges meet the same state 
standards as public and nonprofit institutions, we believe our students 
should receive equal treatment.
    Many of the new proposals, particularly those favoring expanded 
uses of Individual Retirement Accounts (IRAs) to encourage parents to 
save for college, cite Section 135(c)(3) of the Internal Revenue Code 
of 1986 in defining ``institution of higher education.'' This 
definition, in turn, refers to Section 1201(a) of the Higher Education 
Act of 1965, as amended through 1988. Students attending our two-year, 
and (as in my own case) four-year degree-granting proprietary 
institutions would not be permitted to pay tuition from money their 
parents were encouraged to set aside in an IRA.
    In addition, the 1201(a) definition will present some enormous 
administrative burdens. Program quality and reputation are the 
significant determining factors in choosing an institution of higher 
education for most families, not corporate structure. The only way to 
ensure compliance with the section 1201(a) definition would be through 
an Internal Revenue Service audit years after the funds have been 
spent. We find it difficult to believe that you would sanction such 
intrusions by the Federal Government into these most intimate family 
decisions.

                               Solutions

    We urge the Committee on Ways and Means to revise the tax code to 
make higher education more affordable for parents and students. 
Students attending those proprietary institutions which have been 
authorized by their appropriate state regulating agency to confer 
degrees should have the same right as students attending other public 
and nonprofit institutions. The Committee should define ``institution 
of higher education'' as it is defined under Section 481 of the Higher 
Education Act of 1965.
    Although we have not seen the final Hope Scholarship proposal 
submitted by the Administration, we support the concept behind this 
initiative to extend study for two additional years beyond high school. 
However, if the proposed Hope Scholarship is offset dollar-for-dollar 
by a student's Pell Grant, state financial aid, and/or with private 
scholarship aid, we fail to see how access to higher education is 
enhanced by this proposal. This is particularly true in states, such as 
New York, that maintain extensive financial aid programs. Therefore, we 
would urge the members of the Ways and Means Committee to permit needy 
students to receive the full benefits of Pell Grants, state financial 
assistance, and private scholarships in addition to the Hope 
Scholarship.
    I appreciate the opportunity to submit written testimony on behalf 
of the Association of Proprietary Colleges. If I or the Association can 
provide additional information, please contact us.
      

                                

Statement of the Independent Bankers Association of America

    Mr. Chairman, Members of the Committee: The Independent 
Bankers Association of America (IBAA) appreciates the 
opportunity to submit its views on the Clinton Administration's 
tax proposals to the House Ways & Means Committee, which under 
the Constitution is the starting point for tax legislation.
    IBAA represents more than 5,500 locally-owned community 
banks nationwide, and is the only trade association that 
exclusively represents the interests of such independent banks. 
Our median bank holds about $50 million in assets, has about 25 
employees and two branches. The core business of these banks is 
financing small businesses, farms, ranches, and local 
consumers.
    Our Association wishes to commend this Committee, for 
getting under way a hearing that will explore the vital areas 
of savings, investment, and family business continuity, and the 
Administration for submitting proposals in each of these areas. 
These initiatives, by President Clinton and Members of Congress 
offer possible avenues to common ground, which could promote 
enactment of critical and long-delayed tax relief that would 
benefit the U.S. economy as a whole over the long term.

        Proposals for Increasing Retirement Savings Are Aligned

    IBAA agrees with the Treasury Department's warning, earlier 
this month that the U. S. personal savings rate--critical for 
the retirement security of an aging American population is 
disturbingly low, having declined from 7.7 percent over the 
1960-86 period to 4.9 percent in 1996 (Statement of Deputy 
Secretary of the Treasury Lawrence Summers before the Senate 
Finance Committee, March 6, page 2).
    We also recall the conclusion of Federal Reserve Chairman 
Alan Greenspan before this Committee in 1991, that increasing 
individual savings and national investment are the highest 
economic priorities. IBAA so testified before this committee on 
January 31, 1995, in favor of enhancing tax-favored savings 
products. Since then, bipartisan efforts have succeeded in 
enacting the Spousal IRA provision in 1996. However, Secretary 
Summers confirmed that the U.S. savings rate remains 
significantly below the average of industrialized countries 
with which the U.S. competes.
    In this context, we feel the renewal of the President's 
four-part proposal to double the income eligibility for 
deductible contributions, create a ``back-loaded, nondeductible 
IRA as an alternative, index eligibility and contribution 
levels and broaden withdrawal privileges under certain 
circumstances, is very constructive. Broadening IRA's has a 
respectable lineage for both Democrats and Republicans--before 
it was a Lott-Roth bill, it was Roth-Breaux bill, and, before 
that, a Bentsen-Roth bill.
    We believe opening the most attractive type of Individual 
Retirement Account investment to a larger population would be a 
powerful incentive to both prospective savers and the 
institutions holding, administering (and marketing) these 
funds.
    For example, financial statistics reflect that three-
fourths of all U.S. banks hold IRA or other retirement 
accounts. So, the banking system, among other service 
providers, is ready, willing and able to expand retirement 
account services to the public. Banks believe they have 
something special to offer, in that bank-IRAs are insured 
against loss up to $100,000.
    Before IRAs were cut back in 1986, they were attracting 
approximately $38 billion of retirement savings. In the past 
few years, the annual total has hovered around $10 billion. So, 
there appears to be a potential for sizable increases in IRA 
savings. It is encouraging that President Clinton's proposals 
and the Congressional proposals of Representatives Thomas and 
Neal (H.R. 446) in the House and of Senators Lott-Roth-Breaux 
(Title IV of S. 2 and S. 197) in the Senate are similar in 
outlook and direction. Great benefits to the economy would 
result if these proposals were blended and enacted.

             Capital Gains Proposal Advances the Discussion

    In the capital gain area, the Clinton Administration, which 
advanced a proposal favoring small business and venture capital 
in 1993 (that became law), has taken another worthwhile 
initiative with its proposal to exempt $500,000 of value in the 
sale of a residence.
    We believe the homeowner exemption is based upon at least 
three principles: (1) the value of a residence accumulates over 
a long period, (2) it is often a family's primary asset, and 
(3) it seems unfair to most Americans to tax a family on a 
nest-egg of a reasonable amount.
    What seems most promising to us is that these principles 
also apply to family farms and small businesses. One problem in 
cross-applying this limitation directly was discussed at the 
Senate Agriculture hearings of February 26, by IBAA witness 
John Dean. Most farmers live modestly, and would not be able to 
take full advantage of a residence exemption at that level. 
However, if such a concept can be applied generally to the 
build-up of farm and small business assets, there appears to be 
a significant opportunity to make progress in the closely 
related areas of capital gains and estate taxes, the 
interaction of which does much to determine whether farms and 
small businesses to pass from one generation to another.

                      Estate Tax Problem Is Raised

    In the estate tax area, the Administration's deferral-of-
payment proposal recognizes that there is a problem, but not 
what the problem really is. A fraction of U.S. businesses (30 
percent) are passed down to a second generation and only 13 
percent make it to a third generation, according to the SBA, 
despite the American Dream of family business succession. 
Federal estate taxes, that rise steeply to 55 percent and were 
last adjusted by 1981 legislation, are a prime cause of this 
attrition.
    This impact of estate tax is basically unfair to family and 
small commercial and agricultural enterprises. Importantly, the 
income tax exemption is adjusted for inflation, but the estate 
tax exemption is not. Also, as federal estate taxes are 
structured, the most enterprising elements of our population 
are frequently taking a triple-hit. First, all business income 
is taxed as it is earned. Second, business assets are subject 
to tax again at death, at a very high rate. Third, many farm 
and business estate must sell part of the enterprise to pay 
these taxes, often at distressed prices because they are 
``forced sales.'' Other heirs must mortgage their farms or 
businesses to the hilt for 20 or more years to literally buy 
them back from the federal government.
    The maximum estate tax rate was scheduled to fall from 55 
percent to 50 percent after 1993, but the reduction was 
postponed to raise more revenue. Some argue that estate tax 
reductions should not take place until the budget is balanced. 
Our customers can't wait indefinitely; half of U.S. farmers are 
age 57 or older.

                         Common Budget Context

    At the beginning of this year, there seemed to be an 
agreement in concept between the Executive and Legislative 
Branches that the budget should be balanced within the next 
five years in a way that would accommodate tax reductions 
decided to be most in the public interest.
    Effective reform of estate tax, as well as savings and 
investment enhancements, would strengthen the common foundation 
of the American economy. These are the kind of tax reductions 
that should be compatible with efforts to balance the budget, 
because all are long-term projects. Estate tax relief, 
especially, can be phased in over a considerable length of 
time, as was done between 1981 and 1986.
    Moreover, there appears to be a realistic possibility that 
these tax measures will encourage increased investment, that 
will, in turn, boost federal and state tax revenues. If 
improvements in these three areas are reported from the Ways 
and Means Committee, there will be an opportunity, under the 
new rules, to obtain a dynamic revenue estimate to provide a 
concrete test of this proposition.

              Estate Tax Structure Is a Particular Problem

    However, to freeze the estate tax structure for the 
indeterminate future would compound the problems for farm and 
business owners, and be, literally, counterproductive not only 
for these entrepreneurs, but for their communities across the 
country, and for our national economy.
    The problems created by federal and state death taxes are a 
very serious and legitimate set of problems for the American 
small business community that need to be addressed. Our bankers 
have a world of first-hand experience with the adverse impact 
of federal estate on small and family firms. This experience 
impels us to strongly favor structural reform of federal estate 
taxes ``to make possible orderly succession of ownership in key 
community-based businesses (including) financial institutions 
(and) agriculture `` (IBAA Resolution, 1996).
    We also support further reduction of capital gain taxes, 
but in ways that promote long-term investment in community 
businesses. To fulfil these objectives, we believe that capital 
gain tax reductions should be done in tandem with estate tax 
reduction and achievement of a balanced budget over the near 
term.
    IBAA believes these two areas of taxation on tightly 
linked. The relative levels of capital gains and estate taxes 
powerfully influence the decisions of small businesses and 
farmers about whether to sell out or to keep their enterprises 
in the family.
    The current maximum federal rates are 28 percent for 
capital gains and 55 percent for estate taxes. So, there can be 
as much as a 2:1 financial advantage in selling a business 
property. If the maximum capital gains tax is reduced, say to 
20 percent, the differential might, in some cases, approach 
almost 3:1 unless some comparable adjustments are made in 
federal estate taxes.

                The Role of Family Farms and Businesses

    For more than 200 years in this country, entrepreneurs have 
been able to start farms and businesses and pass them along 
from one generation to another. These enterprises put down 
roots in their communities. Their owners come to know and care 
about their employees, their customers, their schools, churches 
and hospitals. They and family members volunteer at local 
charities and are a significant part of the cement of American 
life. Family stewardship of the land and other productive 
assets has worked well in this country.
    Because of the fixed threshold of federal estate taxes, and 
the steeply graduated rates above that threshold, there is a 
real threat that federal estate taxes will destroy the system 
of existing family farms, businesses, and banks by taxing it 
out of existence. Giving substance to this threat is the fact 
that, since federal estate taxes were last adjusted 
legislatively in 1981, revenues from this tax have increased 
150 percent, from $6.389 billion in 1980 to an estimated 
$15.924 billion in 1996.
    This increase vastly out paced inflation, and is an 
indication that estate taxes are a growing source of revenues 
for the range of federal expenditures.

                 Limited Value of a Deferral Provision

    When a farm or small business owner dies, typically federal 
estate taxes are due, within 9 months. IBAA believes that the 
estate tax installment payment privilege, under section 6166, 
is of very limited value, because the Internal Revenue Service 
acquires a ``special lien'' on the farm or business until the 
tax is fully paid. Conventional lenders are wary of extending 
credit to a business where the federal government is a senior 
creditor.
    For this reason, section 6166 is little used now, and 
extending it to somewhat larger estates, as the Treasury 
Department recommends, would be almost entirely symbolic.

                The Future of Many Communities in Peril

    No wonder that, in most cases, farm acreage or business 
assets must be sold off to pay the taxes, or the heirs must 
take out a mortgage, payable over 20 or more years.
    The U.S. Department of Agriculture has estimated that 
500,000 farmers over the age of 57 will retire in the next 10-
20 years. That total could represent as much as one-quarter of 
U.S. family farms. How many of these farms and small businesses 
are going to make it over the next estate tax hurdle?
    Two types of commercial businesses predominate in this 
country--local, family businesses and chain stores (e.g. Wal-
Mart, K-Mart, Sears). The former pay estate taxes; the latter 
do not. So, across the economy, taxes discourage family 
ownership, pushing enterprises toward larger units that often 
are transferred to absentee owners who have few ties to the 
communities in which they operate.
    Full interstate banking takes effect in the U.S. on June 1, 
1997. Banks across the country must develop strategic plans 
that include whether they wish to continue as independents or 
whether they will seek to sell their franchise to another 
financial institution. Federal and state death taxes occupy a 
very significant role in this decision.
    Today, community banks with less than $100 million in 
assets--typical IBAA banks--make more small business loans than 
any other size category of bank. Studies show that these 
financial institutions (which hold about 10 of U.S. deposits) 
make almost 30 percent of small business loans of less than 
$100,000. Often, a community bank is the only financial 
institution in a small town or rural area.
    Banks as small as 8 employees and $15 million in assets 
have experienced estate tax problems. Should current IBAA 
owners plan to increase their investment, to better serve their 
customers, and incur greater estate tax risks, or should they 
plan to sell out? If owners are replaced with less experienced 
branch managers, business and farm loan applications may be 
sent to distant cities for evaluation by specialists who are 
probably not well acquainted with either the owners or their 
communities.

                Estate Tax Structure Should Be Modified

    IBAA urges, in the strongest terms, that the current grim 
reaping machine of the federal estate tax be thoroughly 
reexamined, for both economic and social reasons.
    These taxes discourage investment where we need investment 
to remain world-competitive. They separate our most 
enterprising people from the enterprises their families have 
built, where our nation needs to preserve traditional family 
enterprise.
    An extensive study by the Heritage Foundation in 
Washington, D.C. concluded as follows: ``the economic cost of 
the estate tax is many times greater than the revenue it 
produces, and its reach into American households extends far 
beyond those few who pay it . . . The hardest hit by the tax 
are small businesspeople who work hard to pass on an enterprise 
of value to their children. And its bias against saving and 
wealth generation is the antithesis of the American Dream.'' 
(August 21, 1996, pages 3, 29).
    Fortunately, estate tax problems are increasingly being 
recognized. For example, in Iowa, Governor Branstad, on 
February 17, signed into law a bill that abolishes the state 
inheritance tax for lineal descendants. The combined vote of 
the Iowa House and Senate was 137-9.

     Senate Majority and Minority Bills Excellent Departure Points

    Now that there is recognition, there should be action. On 
the federal level, IBAA supports the increase in the filing 
threshold from current $600,000 as a desirable first step. But, 
this will not help many family businesses and farms. We believe 
it is important to note that, in IBAA's view, increasing the 
Unified Credit alone is not a cost-effective way of assuring 
the transfer of farms and businesses from one generation to 
another. It is more expensive because it applies to all assets, 
rather than just productive assets. Because of this, it is 
difficult, especially in the present budget climate to increase 
the Unified Credit enough to help production farms and modest 
sized community businesses.
    To get the job done, recognition needs to be given to the 
family and small business character of these assets, and the 
fact that they build up over a lifetime of effort, and the 
continuous risk of the market. The Senate Leadership bills, 
authored by Majority Leader Lott and Finance Committee Chairman 
Roth (S. 2), and by Minority Leader Daschle (S. 20), are 
excellent points of departure for crafting appropriate 
legislation.

              Administration Proposal Offers Common Ground

    As noted above, President Clinton proposal a homeowners' 
exemption for the first $500,000 of value in a residence may 
provide an avenue toward common ground. Since the same 
principles apply to a farm and a small business. We therefore 
hope, as Senator Lott has indicated, that there can be a 
convergence of interest that can lead to bipartisan legislation 
that will really work to permit the transfer of family assets, 
while guarding against abuse.

          Importance of Enacting Legislation That Is Effective

    It is thus vital that the 105th Congress get estate tax 
reform right, because if the 1997-98 legislation falls short, 
there will be many more horror stories from farm and small 
business families before Congress comes around to this issue 
again. And, in the meantime, the character of American life may 
be changed permanently for the worse.
    We hope that a bridge can be built between the President's 
proposals and the House and Senate Leadership proposals, so 
that legislation bringing about both a balanced budget and 
needed tax reductions, can be enacted sooner rather than later.
    Thank you again for this opportunity to express our views. 
IBAA would be pleased to work with this Committee and the 
Congress to improve these areas of the tax laws, so they can 
truly promote the economic well-being of small independent 
enterprises, their communities and the national economy.
      

                                

Statement of the Investment Company Institute

                            A. Introduction

    The Investment Company Institute (``Institute''),\1\ the 
national association of the American investment company 
industry, appreciates this opportunity to present its views on 
the Administration's proposal to expand IRAs. We commend the 
Committee for holding hearings on a topic so vital to our 
economy and the retirement security of millions of Americans.
---------------------------------------------------------------------------
    \1\ The Institute's membership includes 6,266 open-end investment 
companies (``mutual funds'') with assets of about $3.627 trillion, 
approximately 95% of total industry assets, and over 59 million 
individual shareholders.
---------------------------------------------------------------------------
    The U.S. mutual fund industry serves the needs of American 
households saving for their retirement and other long-term 
financial goals. By permitting millions of individuals to pool 
their savings in a diversified fund that is professionally 
managed, mutual funds provide an important financial management 
role for middle-income families. An estimated 37 million 
households, representing 37 percent of all U.S. households, 
owned mutual funds in 1996.\2\ Mutual funds serve as the 
investment medium for retirement programs, including IRAs and 
employer defined contribution plans (the largest type being 
401(k) plans). As of December 31, 1995, mutual funds held over 
$1 trillion in retirement plan assets, about 19 percent of the 
retirement market's total assets of $5.21 trillion. The 
remaining 81 percent is managed by such institutions as 
corporations, pension firms, insurance companies, banks and 
brokerage firms Of the retirement plan assets held by mutual 
funds, about half are IRA investments.\3\
---------------------------------------------------------------------------
    \2\ See Brian Reid, ``Mutual Fund Developments in 1996,'' 
Perspective, Vol. 3, No. 1 (Investment Company Institute March 1997).
    \3\ 1996 Mutual Fund Fact Book, Investment Company Institute.
---------------------------------------------------------------------------
    The Institute has a long history of supporting legislative 
efforts to enhance individual retirement saving. For instance, 
we supported the establishment of the universal deductible IRA, 
as well as legislation creating the SEP, SARSEP and SIMPLE 
IRAs. We strongly opposed the 1986 Tax Act's restrictions on 
IRA eligibility. Moreover, we continue to support efforts, such 
as the AdAs and legislation introduced by Congressmen Thomas 
and Neal, H.R. 446, that would substantially expand IRA 
eligibility and simplify the tax rules associated with IRAs. 
Such legislation is both necessary and appropriate, because--
     First, Americans are not preparing adequately for 
retirement and need more opportunities to do so;
     Second, simple, universally-available IRAs will 
work to increase retirement saving; and
     Third, such IRAs will generate new additional 
saving that would not be made absent such legislation.

         B. America Is Not Preparing Adequately for Retirement

    Stanford University Professor Douglas Bernheim found that 
members of the Baby Boom generation are saving at only about 
one-third the rate they need to maintain their pre-retirement 
living standards in retirement.\4\ Along that same vein, an 
Institute study of the ``baby boom'' generation similarly found 
that more than 6 out of every 10 ``boomers'' state that they 
are not saving for retirement even though more than half 
expressed concern about the inability to meet their financial 
needs after retirement.\5\
---------------------------------------------------------------------------
    \4\ Bernheim, B. Douglas, ``The Merrill Lunch Baby Boom Retirement 
Index'' (July 14, 1994).
    \5\ ``The Baby Boom Generation, A Financial Portrait,'' Investment 
Company Institute (Spring 1991).
---------------------------------------------------------------------------
    USA Today, on March 26, 1997, reported that 78% of retirees 
wish they had financially planned better for retirement; 42% of 
retirees wished they have saved more in retirement plans, while 
37% wished they had opened IRAs or contributed to employer 
salary reduction plans.

 C. A Simple, Universal IRA Effectively Increases Personal Retirement 
                                 Saving

    Our long time national experience with the IRA teaches that 
saving incentives work best if the rules are simple and 
consistent. In order for the IRA to be useful to Americans, it 
must be universally accessible, easy for the average American 
to understand, and easy to administer.
    When Congress introduced universal deductions for IRAs in 
1982, Americans took advantage of the opportunity. IRA 
contributions rose from less than $4 billion in 1980 to 
approximately $38 billion in both 1985 and 1986. At the IRA's 
peak in 1986, about 29% of all families with a head of 
household under age 65 had IRA accounts. Contrary to what IRA 
critics said at the time, these IRA contributions were not 
mainly ``wealthy'' families using IRAs as ``tax shelters.'' In 
1986, 75% of all IRA contributions were from families with 
annual incomes less than $50,000.\6\ Moreover, the median 
income of those making IRA contributions (expressed in 1984 
dollars) dropped by 24 percent, i.e., from over $41,000 in 1982 
to below $29,000 in 1986.\7\ The program was, indeed, effective 
and was being used by middle-class Americans and encouraging 
them to save for retirement.
---------------------------------------------------------------------------
    \6\ Venti, Steven F., ``Promoting Savings for Retirement 
Security,'' Testimony prepared for the Senate Finance Subcommittee on 
Deficits, Debt Management and Long-Term Growth (December 7, 1994).
    \7\ Hubbard, R. Glenn ands Incentives: A Review of the Evidence'' 
(January 19, 1995).
---------------------------------------------------------------------------
    When Congress restricted the deductibility of IRA 
contributions in the Tax Reform Act of 1986, the level of IRA 
contributions fell sharply and has never recovered. In 1986, 
IRA contributions totaled $38 billion; they were $15 billion in 
1987, but only $8.4 billion by 1995.\8\ While it is true that 
as a result of the 1986 restrictions, many families are no 
longer able to deduct their IRA contributions, they still may 
take advantage of the tax deferral for earnings on non-
deductible IRA contributions. This incentive, however, has 
proved extremely complicated and insufficient to induce 
continued participation in the IRA program. The 1986 changes 
introduced a level of complexity in an otherwise simple program 
that proved overwhelmingly oppressive to its success as a 
savings incentive program. Even among families not affected by 
the 1986 Act and who retained eligibility for fully deductible 
IRA contributions, IRA participation declined on average by 40% 
between 1986 and 1987, despite the fact that the change in law 
did not affect them.\9\
---------------------------------------------------------------------------
    \8\ Internal Revenue Service, Statistics of Income.
    \9\ Venti, supra at note 7.
---------------------------------------------------------------------------
    The lessons of the past are clear. First, deductibility 
matters to people. Although non-deductible IRAs are available 
to all working Americans, without the deductibility feature, 
there are insufficient incentives to save. A front-end tax 
incentive gives households an immediate incentive to save. It 
is our view that this immediate incentive is a powerful 
alternative to the usual preference for current consumption of 
income.\10\
---------------------------------------------------------------------------
    \10\ Hubbard and Skinner, supra at note 8.
---------------------------------------------------------------------------
    Second, confusing rules undermine even the powerful 
incentive of deductibility. When the tax rules are not simple, 
individuals are confused as to their eligibility. The post-1986 
IRA with multiple limits, set offs, exceptions, exclusions and 
other technicalities cannot be understood by most Americans. 
American Century Investments recently surveyed 534 ``savers'' 
with respect to the rules governing eligibility, contribution 
levels and tax deductibility have left a majority of retirement 
investors confused.''\11\ It is no wonder: today, IRS 
Publication 590, which deals solely with taxpayer use of IRAs, 
contains 70 (seventy) pages of explanations, examples, and 
worksheets on the subject. Simply put, individuals stop 
investing and financial institutions cease marketing activity 
when the product cannot be readily understood and easily 
explained.\12\
---------------------------------------------------------------------------
    \11\ American Century Investments asked survey participants, who 
were self-described ``savers,'' ten general questions regarding IRAs. 
One-half of them did not understand the current income limitation rules 
or the interplay of other retirement vehicles with IRA eligibility. 
``American Century Discovers IRA Confusion,'' Investor Business Daily 
(March 17, 1997). Similarly, even expansive changes in IRA eligibility 
rules, when approached in piecemeal fashion, require a threshold public 
education effort and often generate confusion. See, e.g., Crenshaw, 
Albert B., ``A Taxing Set of New Rules Covers IRA Contributions,'' The 
Washington Post (March 16, 1997) (describing 1996 legislation enabling 
non-working spouses to contribute $2,000 to an IRA beginning in tax 
year 1997).
    \12\ For this reason, the Institute opposes the addition of any 
offset of IRA contributions against those of a 401(k) plan. Such a rule 
would add unnecessary complication to the IRA, confuse the public, 
place additional burdens on 401(k) plan sponsors, and create 
disincentives to save.
---------------------------------------------------------------------------
    Experience clearly demonstrates that Americans respond 
enthusiastically to appropriately designed tax incentives aimed 
at increasing retirement savings. For example, last year 
Congress enacted legislation creating the SIMPLE, a simplified 
retirement plan for small businesses that (because of the 
administrative burden) could not offer a pension program for 
their workers. The Institute's members report immediate, strong 
employer interest in the SIMPLE. One member in particular 
reports that it has sold over 1,000 SIMPLE-IRA plans to small 
employers since the program's inception on January 1, 1997. The 
reasons for such a high response rate are clear. First, the 
SIMPLE offers significant tax incentives. Second, the program's 
rules are indeed ``simple,'' easy to understand and easy to 
communicate. Prior to 1986, the universal IRA had similar 
success and for precisely these same reasons.

                  D. IRAs Create New Retirement Saving

    A great deal of research has been done on the effectiveness 
of IRAs as incentives for increased personal saving. Many 
studies have focused on whether the IRA tax incentive produces 
new saving or merely reshuffles existing saving from taxable to 
tax-favored accounts. Put differently, the issue is whether 
IRAs serve merely as a windfall to higher income taxpayers.
    In study after study of this issue, economists have 
concluded that a substantial portion of IRA contributions in 
fact constitute new saving that otherwise would not have 
occurred. For example, extensive analyses of IRA contributors 
essors Steven Venti of Dartmouth and David Wise of Harvard. 
They estimate that 66% of the increase in IRA contributions 
come from current consumption, 31% from the tax subsidy and 
only 3% from reshuffled assets (emphasis added).\13\ Similar 
conclusions--that a substantial majority of IRA contributions 
represent new savings--has been reached in separate papers by 
Professor Hubbard of Columbia, Professor Skinner of the 
University of Virginia and Professor Thaler of University of 
Chicago.\14\ The IRA has resulted in additional saving in both 
tax-favored IRA accounts and non-tax-favored accounts. This is 
the kind of long-term saving that is essential to capital 
formation and economic growth.
---------------------------------------------------------------------------
    \13\ Venti, Steven F. and Wise, David A. ``The Evidence on IRAs,'' 
38 Tax Notes 411 (January 1988).
    \14\ Skinner, Jonathan, ``Individual Retirement Accounts: A Review 
of the Evidence,'' 54 Tax Notes 201 (January 1992); Hubbard, R. Glenn 
and Skinner, Jonathan, ``The Effectiveness of Savings Incentives: A 
Review of the Evidence'' (January 19, 1995); and Thaler, Richard H., 
``Self-Control, Psychology, and Savings Policy, `` Testimony before the 
Senate Finance Subcommittee on Deficits, Debt Management, and Long-Term 
Growth'' (December 7, 1994).
---------------------------------------------------------------------------

                             E. Conclusion

    Today's targeted individual retirement vehicles help 
millions of Americans secure their future retirement through 
long-term investment. By simplifying the IRA eligibility rules, 
making deductible IRAs available to as many Americans as 
possible and expanding IRA options, Congress can empower 
millions more Americans to save for their own long-term 
financial security.
    Our recommendation: make the IRA available as broadly as 
possible; keep it simple; make it permanent.
      

                                

                                         Thedford, Nebraska
The Honorable Mr. 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

    Dear Sirs,

    My name is Craig Miles, son of Sam and Charlotte Miles, of Thedford 
Nebraska. We own and operate a beef cattle ranch in the Sandhills of 
north central Nebraska.
    Unlike some other ranchers in other regions or states that have 
extra resources, such as oil or mining for a diversified income, 
Sandhills ranchers survivability normally rest upon the beef industry. 
With this in mind, you can understand how important the beef industry 
is to us and our livelihood.
    Although Estate taxes may be a key issue for some folks, it is not 
one for us, as my folks have unselfishly thought about the continuation 
of the business on down to the next generation and have taken the 
necessary steps to see that this is fulfilled. So at this time, I would 
like to explain to you why Capital Gains Tax is such a critical issue 
for us.
    My father is physically ready to retire but feels like he can't 
afford to do so. He's 66 years old and has worked hard to all these 
years building the ranch's land base and cow herd. Operating expenses 
as well as property and other taxes have continued to rise dramatically 
while cattle prices are at an all time low in years. Thus, my father 
had to put most of his equity back into the ranch. In recent years he 
has tried to put something away for his retirement but it was too late 
to have enough liquid assets for this. What he would like to do is 
liquidate part of the cow herd in order to fund his retirement, but 
after paying the capital gains tax there wouldn't be enough in reserve 
for this. In short he wants out but can't get there. What I would like 
to see is a break in capital gains for retirement age agricultural 
people if not the elimination of it.

            Sincerely,
                                                Craig Miles
      

                                

Statement by National Apartment Association and National Multi Housing 
Council

    We greatly appreciate the opportunity to speak in strong 
support of efforts by the committee to encourage savings and 
investment in America through changes in our Federal Tax Code 
and proposals to enact a broad-based reduction in capital gains 
taxes.
    A reduction in capital gains taxes beyond those proposed 
for the sale of a personal residence, should be enacted only if 
the reduction is truly broad-based. Of particular concern is 
discussion in certain quarters that real estate should only 
receive the new lower capital gains tax rate on gain above 
original purchase price. Such a change in tax law would go 
against current tax policy that correctly recognizes real 
estate as a long-term wasting asset that should not be subject 
to depreciation recapture rules. As we will expain below, there 
are no sound tax policy reasons for changing the real estate 
depreciation recapture rules. Additionally, removing the 
benefit of lower capital gains taxes from commercial and 
residential real estate will result in fewer new jobs created 
and could seriously impact real estate investment and values; 
not unlike what happened to real estate in the post-1986 
period.
    The National Multi Housing Council (NMHC) and the National 
Apartment Association (NAA) represent the majority of the 
nation's firms participating in the multifamily rental housing 
industry. Our combined memberships are engaged in all aspects 
of the development and operation of apartments, including 
ownership, construction, finance, and management. The National 
Multi Housing Council represents the apartment industry's 
largest and most prominent firms. NMHC members are the 
principal officers of these organizations. The National 
Apartment Association is the largest nat of state and local 
associations of apartment industry professionals including 
developers, owners, investors and property managers. NAA is 
comprised of 150 affiliates and represents more than 25,000 
professionals who own and/or manage more than 3.3 million 
apartments.
    Job creation, an expanded economy, and the efficient flow 
of capital are often stated as the principal reasons for 
lowering the rate of capital gains taxation. To achieve these 
goals, it is necessary to provide a broad-based reduction in 
the tax. Using Department of Commerce data, it has been 
estimated by the National Association of Realtors that 27 new 
jobs are created for every $1 million spent in upgrades to 
commercial and residential buildings. At present, many needed 
upgrades are not occurring because of the ``lock-in'' effect 
caused by the lack of flow of capital to various real estate 
properties where existing investors are unable to sell to new 
investors because of the high rate of the capital gains tax.
    A recent study by the firm of Price Waterhouse LLP shows 
that a majority of real estate will remain locked-in if 
previously taken depreciation must be recaptured at the current 
capital gains rate of 28 percent. This study analyzed the price 
that an owner received for selling a building after 1994 with 
the price the owner had earlier paid to acquire the building at 
some time after 1985. The Price Waterhouse data shows, ``60 
percent of multifamily buildings sold for less than the owners 
had paid for them earlier, and the median decline was 30 
percent.'' Obviously a change in tax law that would place real 
estate at a disadvantage versus other investments would 
significantly reduce any hoped for benefits of job creation 
from the reduction of capital gains taxes.
    Tax policy arguments are equally compelling for not 
subjecting previously taken real estate depreciation to any tax 
rate that is inconsistent with the capital gains tax rate. On 
March 11, 1997, the E&Y Kenneth Leventhal Real Estate Group of 
Ernst & Young LLP prepared a Tax Policy Memorandum and 
Executive Summary on the Tax Policy Arguments for Full Capital 
Gains Tax Relief for Real Estate. The significant points of 
this memorandum are summarized as follows:

                           Executive Summary

 Tax Policy Arguments For Full Capital Gains Tax Relief for Real Estate

Background

    During last year's budget negotiations and presidential 
campaign, options were explored to change current tax policy 
regarding recapture of depreciation on sales of real estate as 
part of a broad-based capital gains tax relief proposal. Under 
current law, all gain on the sale of investment real estate is 
taxed as capital gain unless accelerated depreciation is taken; 
only the excess of accelerated over straight-line depreciation 
(``excess depreciation'') is ``recaptured'' and taxed at 
ordinary income rates. Some recent broad-based capital gains 
tax relief proposals would lower the capital gains tax rate on 
sales of real estate only for sales price in excess of original 
cost. The tax rate on the gain attributable to previously 
deducted straight-line depreciation would not be reduced, and 
the gain attributable to current law excess depreciation would 
remain subject to tax at full ordinary income rates.

Conclusions

    We have conclusions concerning broad-based capital gains 
tax relief proposals that do not offer full capital gains tax 
relief for sales of real estate:
    1. These proposals ignore the fact that real estate is a 
long-lived wasting asset, and a sale of depreciable real estate 
is a sale of only what remains of the original asset, not of 
that which has wasted away. Any gain from a sale of the 
remaining asset--to the extent not created by excess 
depreciation deductions--is of a nature properly subject to 
full capital gain treatment.
    2. The current tax policy of taxing only excess 
depreciation at ordinary rates, and taxing gains due to 
inflation and other economic factors at full capital gain 
rates, is the only tax policy that maintains horizontal equity 
in taxation among competing capital investments. Any effort to 
provide broad-based capital gains tax relief should as a matter 
of tax policy fully include the elements of capital gain 
inherent in sales of depreciable real estate--gains due to 
inflation and other economic factors--in order to maintain 
horizontal equity among competing forms of capital investment.
    3. It would be inappropriate to change the definition of 
excess depreciation in a manner that would take away incentives 
previously offered by Congress to owners of ACRS real property. 
However, should Congress decide to change the computation of 
excess depreciation for these assets, it should do so only for 
depreciation deductions taken after enactment of an amending 
statute, as Congress has done every time it has changed the 
recapture rules in the past.
    4. The combination of indexing with any broad-based capital 
gains relief proposal that changes current depreciation 
recapture tax policy highlights the inequities of denying full 
capital gain tax relief to sales of real estate. Considering 
that real estate would have its economic gains in excess of 
inflation taxed at 28% to the extent of previous straight-line 
depreciation taken, real estate would be at a serious and 
obvious disadvantage compared to other investments. Basis 
indexing combined with capital gains tax relief would not 
correct the inequity that changes in depreciation recapture tax 
policy would cause.

 Tax Policy Arguments For Full Capital Gains Tax Relief for Real Estate

I. Introduction

    In the past year, there has been some discussion as well as 
some actual legislative proposals to change current tax policy 
regarding recapture of depreciation on sales of real estate as 
part of a broad-based capital gains tax relief proposal. These 
proposed changes to current tax policy seem largely the result 
of unsound tax policy arguments designed primarily to lower the 
cost of a capital gains tax bill. These kinds of broad-based 
capital gains tax relief proposals would lower the capital 
gains tax rate on sales of real estate only for sales price in 
excess of the tax rate on the gain equal to previously deducted 
straight-line depreciation would not be reduced, and the gain 
attributable to current law excess depreciation would remain 
subject to tax at full ordinary income rates.
    This paper examines the current tax policy applicable to 
sales of real estate--taxing only excess depreciation at 
ordinary rates, and taxing gains due to inflation and other 
economic factors at full capital gain rates--and demonstrates 
that these tax policy considerations mandate retention of full 
capital gain treatment for gains from the sale of real estate 
(in excess of current law IRC Sec.  1250 recapture) in the 
context of a broad-based capital gains tax relief proposal in 
order to preserve horizontal equity in taxation among competing 
capital investments. This paper also examines basis indexing, 
and demonstrates that combining basis indexing with a broad-
based capital gains tax relief bill that does not provide full 
capital gains tax relief for real estate would not solve this 
fundamental issue of horizontal equity, but would in fact 
highlight it.

II. Depreciation--Real Estate as a Wasting Asset

    IRC Sec. 167 allows taxpayers as a depreciation deduction 
an allowance for ``exhaustion, wear and tear (including a 
reasonable allowance for obsolescence) of property used in the 
trade or business.'' Real estate is properly included in those 
assets subject to the allowance for depreciation due to its 
wasting nature.\1\
---------------------------------------------------------------------------
    \1\ See Even Realty Co. v Comm., 1 BTA 355 (1925).
---------------------------------------------------------------------------
    The allowance for depreciation is one of the oldest 
standing tax provisions, first appearing in the Corporation Tax 
Act of 1909.\2\ The purpose of the statute is to create a fund 
to restore the property to the extent of the investment of the 
taxpayer at the end of its useful life.\3\ The Supreme Court 
has stated that ``the theory underlying this allowance for 
depreciation is that by using up the plant, a gradual sale is 
made of it. The depreciation charged is the measure of the cost 
of the part which has been sold. When the plant is disposed of 
after years of use, the thing then sold is not the whole thing 
originally acquired.'' \4\ Because of the difficulty of 
attributing to each article sold or to the sales in a taxable 
year an exact sum representing the proportion of basic value of 
machinery, buildings, patents, etc., entering into such sale, 
the statutes have consistently provided for a reasonable 
allowance.\5\ Accordingly, it has never been necessary to 
conduct an exhaustive engineering study to determine just how 
much a building has wasted during the year in order to claim a 
deduction for depreciation.
---------------------------------------------------------------------------
    \2\ 1909 Act, Sec 38.
    \3\ Detroit Edison Co. v. Comm., 131 F2d 619 (CA6 1942), affd 319 
US 98, 87 L Ed 1286, 63 S Ct 902 (1963).
    \4\ United States v. Ludey, 274 U.S. 295 (1927).
    \5\ Even Realty Co. v, Comm., supra, page 359.
---------------------------------------------------------------------------
    It is instructive to consider the fundamental distinction 
between the taxation of depreciation and appreciation with 
respect to a given asset. This important distinction was 
eloquently discussed in the Even Realty case: There is no 
reason why wear and tear, purely intrinsic matters, need be 
tied up to appreciation resulting from extrinsic causes. The 
two can go on simultaneously and no provision of law requires 
the one to be offset against the other.
    The above discussion summarizes the tax policy behind the 
allowance for depreciation. This allowance is meant to 
approximate the degree to which a depreciable asset has wasted 
away over time. The deduction for depreciation for real estate 
is properly allowed against ordinary income because it is 
incurred in producing ordinary income. The courts have 
recognized that a sale of a depreciable asset is a sale of only 
what remains of the original asset purchased or constructed, 
not of that which has wasted away. This remaining asset may be 
subject to economic factors which increase or decrease its 
value, but that does not in any way suggest the asset did not 
physically deteriorate. Such increases or decreases in value of 
the remaining asset are of a nature normally subject to capital 
gain treatment. Current tax policy properly recognizes that 
real estate has an operational aspect (the production of 
ordinary income) and a capital aspect (the eventual sale of the 
remaining asset), and taxes each aspect accordingly: the 
operational aspect is taxed at ordinary rates and the capital 
aspect is taxed at capital gain rates.
    It is this deduction against ordinary income and the 
corresponding basis adjustment to the remaining capital asset 
which gives rise to the potential for converting ordinary 
income into capital gain when depreciation deductions are 
excessive. The depreciation recapture rules were enacted to 
address the concept of excess depreciation.

 III. Components of Taxable Gain on the Sale of Depreciated Real Estate

A. In General

    When depreciated real estate is sold at a price in excess 
of its adjusted tax basis, the gain can be broken down into 
three distinct components:
     Gains caused solely by excess depreciation,
      Inflationary gains, and
      Gains due to other economic factors.
    The first component, gains created solely by excess 
depreciation, is properly taxable at ordinary income rates. The 
second two elements, gains due to inflation and other economic 
factors, are properly taxable at full capital gain rates, not 
just for real estate but for all capital investments. This has 
been the tax policy embodied in IRC Sec. 1250 for the past 32 
years, and remains the only viable tax policy today for sales 
of depreciable real estate that puts real estate on a parity 
with competing investment vehicles.

B. Excess Depreciation

    Currently, IRC Sec.  1250 defines ``additional 
depreciation'' for sales of real estate, which is subject to 
tax at ordinary rates. In general, ``additional depreciation'' 
subject to recapture under IRC Sec.  1250 is equal to the 
lesser of a) the excess of depreciation taken over straight 
line or b) the gain on sale. Excess depreciation is a concept 
unique to depreciable assets as compared with other forms of 
capital investment. Arguably, various depreciation methods 
afforded taxpayers over time have allowed for depreciation in 
excess of ``actual'' wear and tear, and to the extent this is 
the case, tax policy should not allow capital gain treatment of 
gain resulting solely from excess depreciation. IRC Sec.  1250 
is merely a correction to the measurement of the operational 
aspect of real estate from a tax policy standpoint.
    The potential for excess depreciation does not exist with 
respect to nondepreciable capital investments, but there is the 
potential for ``under amortization'' of market discount (as 
opposed to original issue discount) on a bond that gives rise 
to ordinary income ``recapture'' to the extent this under 
amortization is realized at sale or maturity.\6\ Both recapture 
provisions--the excess depreciation recapture provision 
applicable to depreciable real estate, and the accrued market 
discount re to discount bonds--can be said to properly prevent 
the conversion of ordinary income into capital gains, thereby 
preserving parity in taxation among competing investments.
---------------------------------------------------------------------------
    \6\ See IRC Sec. 1276 through 1278.

---------------------------------------------------------------------------
1. IRC Sec.  1245--The Revenue Act of 1962

    The historical debate surrounding the enactment of IRC 
Sec.  1245 highlights the distinctions between the various 
elements of gain from the sale of real estate, and shows that 
this code section is the product of careful deliberation and 
thoughtful public testimony. First proposed in 1961, IRC Sec.  
1245 originally included real estate along with personal 
property as an asset subject to full depreciation recapture 
upon sale.\7\
---------------------------------------------------------------------------
    \7\ President's Tax Message, April 20, 1961, page 40.
---------------------------------------------------------------------------
    However, testimony before the Ways and Means Committee 
demonstrated that IRC Sec. 1245 as originally proposed would 
inappropriately tax major components of gains on the sale of 
real estate. For instance, it was pointed out that ``the forces 
of inflation and market action inevitably result in prices 
which are usually in excess of [adjusted] basis,'' \8\ and 
``gains due to factors such as these are generally taxed at 
capital gains rates.'' \9\ In other testimony, it was pointed 
out that under IRC Sec. 1245 as originally proposed,
---------------------------------------------------------------------------
    \8\ Statement of Alan J.B. Aronshon, Esq.--1961 Testimony before 
Ways and Means on the President's Recommendations on Tax Revision at 
page 1167.
    \9\ Id at 1169.
---------------------------------------------------------------------------
    ``the ordinary income on sale [of real estate] would not be 
limited to depreciation in excess of that which the taxpayer 
should have deducted. That could be the case if it's applied 
only when the taxpayer had used an unrealistically short life 
expectancy, or some form of artificial ``accelerated'' 
depreciation. Instead, it would apply even if the taxpayer had 
used straight line depreciation over a conservative life 
expectancy.
    It would therefore apply even though the property has 
actually depreciated as much as the taxpayer has deducted, and 
the additional value was attributable to inflation, to change 
in location, to increased costs of replacement, or to any of 
the other factors which traditionally create capital gain on 
property.''\10\
---------------------------------------------------------------------------
    \10\ Statement of Mark H. Johnson, Representing the Commerce & 
Industry Association of New York--1961 Testimony before Ways and Means 
on the President's Recommendations on Tax Revision at page 1242.
---------------------------------------------------------------------------
    ``In common with every investor, a builder hopes that his 
property will increase in value. Such increase may result from 
negotiation of favorable leases, from economies in management, 
from adjacent construction or other improvement in the 
neighborhood, or from a variety of other factors. Such increase 
in value may also, as we have all learned, represent merely a 
counteraction against further inflation.''
    Leslie Mills, Chairman of the AICPA's Committee on Federal 
Taxation in 1961, offered similar testimony about the basic 
relationship between depreciation and gains on sales of real 
estate:
    ``Statutory depreciation, and depreciation in the 
accounting sense, is not a measure of decline in the value of 
property, but is a technique for prorating the original cost of 
property having a useful life extending over a period of years. 
Changes in market value of depreciable property are not 
pertinent factors in determining annual depreciation allowances 
since the asset is not bought for resale, but for use in the 
taxpayer's business.
    In the case of particular properties, specific 
circumstances such as opportunities for greater usefulness of 
the property, changes in economic circumstances,s in markets, 
and so forth, may result in increases in fair market value of 
the properties. Such gains realized by taxpayers are correctly 
classified as capital gains since they are not caused by 
miscalculation of prior depreciation deductions.
    In a great many cases, particularly concerning depreciable 
properties with long useful lives, the increase in value is 
basically attributable to a decline in the purchasing power of 
the dollar. We believe that any element of gain which can be 
attributed to this ``inflationary'' effect is true capital gain 
and, consistent with the general philosophy expressed elsewhere 
in our tax laws, this portion of the gain should not be treated 
as ordinary income.'' \12\
---------------------------------------------------------------------------
    \12\ Statement of Leslie Mills, Chairman, Committee on Federal 
Taxation, AICPA,--1961 Testimony before Ways and Means on the 
President's Recommendations on Tax Revision at page 1098.
---------------------------------------------------------------------------
    Richard Swesnik, Chairman of the Subcommittee of Federal 
Taxation of the National Association of Real Estate Boards in 
1961, offered the following testimony distinguishing the 
portion of the asset used up versus the portion of the asset 
sold:
    ``Depreciation represents the actual wearing out of the 
asset It is true that in any one year the rate of actual wear 
and tear of the property may vary somewhat from the straight 
line or other rate now permitted by law for computing 
depreciation. This variation does not justify either the 
assumption that the asset is not in fact being subjected to 
wear and tear, or the assumption that the entire amount of the 
depreciation is an improper deduction which should be 
recaptured as ordinary income when the property is sold. The 
property is in fact being used up, and depreciation at some 
consistent rate should be allowed, even though the remaining 
property (that is, the property remaining after wear and tear) 
may be subject to economic factors which vary from year to 
year, and which may increase or decrease the value of the 
remaining asset. Gain from the sale of the remaining asset is 
attributable to these economic factors, and is of the same 
nature as other gains now subject to capital gains treatment.'' 
\13\
---------------------------------------------------------------------------
    \13\ Statement of Richard Swesnik, Chairman of the Subcommittee of 
Federal Taxation of the national Association of Real Estate Boards,--
1961 Testimony before Ways and Means on the President's Recommendations 
on Tax Revision at page 1058.
---------------------------------------------------------------------------
    Testimony was also presented on administrative expediency 
and the complexity of separating out gain attributable to non-
depreciable land and gain attributable to the depreciable 
building:
    ``This committee will recall that, for the period between 
1938 and 1942, the tax law experimented with the rule that gain 
or loss on depreciable property be treated as ordinary income 
or loss. This committee stated, in introducing the Revenue Act 
of 1942:
    The present law not only results in unfairness to the 
taxpayer but also in considerable administrative difficulty. 
For example, if an apartment house is sold, under the present 
law, it is necessary to separate the land from the building for 
income tax purposes. This is because the gain allocable to the 
building is subject to the normal and surtax rates, while the 
gain allocable to the land is subject to the capital gains 
rate. *** It is very difficult to allocate the capital gain or 
loss between the land and the buildings. Accordingly, your 
committee has changed the rule of existing law, so that both 
the building, or similar real estate improvements, are treated 
as capital assets (77th Cong., 2d sess., H. Rept. No. 2333 
(1942) 52).
    That comment is surely as appropriate today as it was [55] 
years ago. The present proposal would require the 
reintroduction of precisely the complication which this 
committee so sensibly eliminated a long time ago.'' \14\
---------------------------------------------------------------------------
    \14\ Statement of Mark H.Johnson, supra, at 1244.
---------------------------------------------------------------------------
    As a result of this and other testimony, depreciable real 
property was exempted from full recapture under IRC Sec.  1245. 
In doing so, the House of Representatives in its report on the 
Revenue Act of 1962 said ``your committee decided not to apply 
this treatment to buildings or structural components of 
buildings at this time because testimony before your committee 
indicated that this treatment presents problems where there is 
an appreciable rise in the value of real property attributable 
to a rise in the general price level over a long period.'' \15\
---------------------------------------------------------------------------
    \15\ House of Representatives Report No. 1447, at page 471.
---------------------------------------------------------------------------
2. IRC Sec. 1250--The Revenue Act of 1964 and Amending Acts 
Through 1981

    After it was decided to exempt depreciable real estate from 
full ordinary income recapture in 1962, and apparently in 
response to the 1961 debate, President Kennedy proposed in 1963 
to restrict depreciation methods on real estate to the straight 
line method, and to recapture depreciation on the sale of real 
estate in full for property held less than 6 years, on a 
sliding scale between years 6 and 14, and not at all for 
property held more than 14 years.\16\ Congress did not enact 
the President's exact proposal, but did in 1964 enact the first 
recapture provision affecting real estate--IRC Sec. 1250.
---------------------------------------------------------------------------
    \16\ Summary of the President's 1963 Tax Message at page 67.
---------------------------------------------------------------------------
    In doing so, Congress explicitly recognized that not all 
depreciation should be subject to ordinary income recapture as 
a matter of tax policy. Congress said that in 1962, they ``did 
not include real property in the recapture provision applicable 
to depreciable personal property because [they] recognized the 
problem in doing so where there is an appreciable rise in the 
value of real property attributable to a rise in the general 
price level over a long period of time. The bill this year 
[1964] takes this into account. It makes sure that the ordinary 
income treatment is applied upon the sale of the asset only to 
what may truly be called excess depreciation deductions. It 
does this first by providing that in no event is there to be a 
recapture of depreciation as ordinary income where the property 
is sold at a gain except to the extent the depreciation 
deductions taken exceed the deduction which would have been 
allowable had the taxpayer limited his deductions to those 
available under the straight line method of depreciation. 
Secondly, a provision has been added which in any event tapers 
off the proportion of any gain which will be treated as 
ordinary income so that it disappears gradually over a 10-year 
holding period for the real estate. As a result, under the 
bill, no ordinary income will be realized on the sale of real 
estate held for more than 10 years.'' \17\
---------------------------------------------------------------------------
    \17\ Senate Report No. 830 on the Revenue Act of 1964, at page 636.
---------------------------------------------------------------------------
    In 1969, Congress repealed the 10 y for post 1969 
depreciation except for low income housing, and lengthened it 
to 18 years and 4 months from 10 years for new residential 
housing. In 1976, Congress repealed the burn off of recapture 
for new residential housing. These and other subsequent 
amendments were merely adjustments to what Congress felt were 
accurate measurements of excess depreciation properly subject 
to ordinary income recapture, but they were not repudiations of 
the basic tax policy embodied in the original enactment of IRC 
Sec. Sec. 1245 and 1250.

3. The 1981 Economic and Recovery Tax Act

    In 1981, Congress enacted a major overhaul of the 
depreciation and recapture rules. The purpose behind these 
changes were stated to be as follows:
    ``The Congress concluded that prior law rules for 
determining depreciation allowances and the investment tax 
credit needed to be replaced because they did not provide the 
investment stimulus that was felt to be essential for economic 
expansion The real value of depreciation deductions allowed 
under prior rules has declined for several years due to 
successively higher rates of inflation. Reductions in the real 
value of depreciation deductions diminish the profitability of 
investment and discourage businesses from replacing old 
equipment and structures with more modern assets that reflect 
recent technology. The Congress agreed with numerous witnesses 
who testified that a substantial restructuring of depreciation 
deductions and the investment tax credit would be an effective 
way of stimulating capital formation, increasing productivity, 
and improving the nation's competitiveness in international 
trade. The Congress, therefore, concluded that a new capital 
cost recovery system was required which provides for the more 
rapid acceleration of cost recovery deductions and maintains or 
increases the investment tax credit.'' \18\
---------------------------------------------------------------------------
    \18\ General Explanation of the Economic Recovery Tax Act of 1981, 
Prepared by the Staff of the Joint Committee on Taxation, 67-86 (12/29/
81), page 75.
---------------------------------------------------------------------------
    The more generous depreciation deductions granted in 1981 
were not accompanied by a tightening of the recapture rules 
(except for non-residential real property depreciated using the 
accelerated rates, which was subjected to the Sec.  1245 
recapture rules), presumably because as stated above in the 
committee report the purpose of the 1981 Act was to stimulate 
the economy. Subjecting this new accelerated depreciation to 
increased ordinary income recapture would have been 
counterproductive.
    It can be argued that real property depreciated under the 
rules in effect between 1981 and 1986 have generated excess 
depreciation in an economic sense, and this excess depreciation 
should be subject to recapture. However, it was the express 
intention of Congress that in order to stimulate the economy, 
Congress would not require recapture of excess depreciation 
caused by the shortened recovery periods, if any. Sound tax 
policy dictates that once an inducement is offered through the 
tax code to influence investment decisions, those inducements 
should remain in place through the life of the investment. 
Congress should now honor the tax incentives that were offered 
to these investors to get them to risk their capital at a time 
when the country was in bad economic straits, and not take them 
away when times are better, in a large part, due to the 
investments they made at that time. It should also be noted 
that every time the recapture rules have been changed in the 
past, the changes only applied to depreciation deductions taken 
after the amending statute. The recapture rules have never been 
changed with respect to deductions already taken.

4. The Tax Reform Act of 1986 Through the Present

    In 1986, Congress passed the Modified Accelerated Cost 
Recovery System (MACRS). By virtue of mandating use of the 
straight-line method of depreciation for real estate placed in 
service after 1986, there is effectively no depreciation 
recapture with respect to post-1986 real estate. The 
lengthening of recovery periods to 27.5 years for residential 
real estate, and 31.5 years for non-residential real estate 
(later increased to 39 years in 1993) has arguably eliminated 
excess depreciation with respect to these assets from an 
economic standpoint.

5. Comparison of IRC Sec.  1250 with Personal Property 
Recapture Rules

    Excess depreciation for personal property is computed 
differently than for real estate, because personal property has 
a much shorter useful life, has no non-depreciable component 
susceptible to inflationary gains (land), and has no provision 
for salvage value. Accordingly, most (but not necessarily all) 
of the gain from a sale of personal property is properly 
considered excess depreciation from a tax policy standpoint, 
taxable at ordinary rates to the extent of previous 
depreciation taken.

                          C. Inflationary Gain

    Any broad-based capital gain tax relief proposal that 
changes the current tax policy for depreciation recapture on 
sales of real estate would to a significant degree withhold 
capital gain tax relief for gains solely attributable to 
inflation. No comparable provision would exist with respect to 
the inflationary gains of other forms of investments. Such a 
proposal would place real estate investment at a competitive 
disadvantage with other forms of investment to the extent it 
excludes inflationary gains from full capital gain tax relief.
    This type of broad-based capital gain tax relief proposal 
would exclude a real estate investor's inflationary gains from 
capital gain tax relief at a time where there is a debate 
whether to tax these gains at all. On January 26, 1994, current 
Ways and Means Chairman Bill Archer of Texas introduced the 
Capital Formation and Jobs Creation Act, which would have 
indexed the basis of assets for inflation. In introducing this 
bill, he stated:
    ``my bill would end the current practice of taxing 
individuals and corporations on gains due to inflation. 
Currently, taxpayers must pay capital gains taxes on the 
difference between an asset's sales price and its basis--the 
asset's original purchase price, adjusted for depreciation and 
other items--even though much if not all of that increase in 
value may be due to inflation. The bill would increase the 
basis of capital assets to account for inflation occurring 
after 1994. Taxpayers would be taxed only on the real--not 
inflationary--gain.'' [emphasis added] \19\
---------------------------------------------------------------------------
    \19\ Congressional Record entry 7 of 100, January 26, 1994, page 
E35.
---------------------------------------------------------------------------
    At a time when there is a legitimate debate as to the 
propriety of taxing illusory inflationary gains from a tax 
policy standpoint, it makes absolutely no sense to subject the 
inflationary gains of only one class of investment, real 
estate, to discriminatory tax rates.

          D. Gain due to Economic Factors Other Than Inflation

    The element of gain from the sale of real estate which is 
arguably the most difficult to measure of the threeconomic 
factors other than inflation--offers the strongest argument for 
retention of current tax policy regarding depreciation 
recapture in the context of a broad-based capital gains relief 
proposal. This paper has demonstrated through careful analysis 
of pertinent authorities that depreciation relates to the 
operational aspect of real estate, and that the sale of 
depreciated real estate--the capital aspect of real estate--is 
a sale of ``not the whole thing originally acquired.'' \20\ As 
to the remaining real estate asset sold, this paper has talked 
about the concept of excess depreciation and Congress's 
attempts over the last 36 years to properly measure this 
amount, along with the concept of inflationary gain and the 
ease at which this amount can be measured. Assuming that after 
36 years Congress has a pretty good idea of what constitutes 
excess depreciation, and assuming that the CPI is an accurate 
measure of relative purchasing power over time, any taxable 
gain in excess of these first two elements of gain must be an 
accurate measure of the increase in value of the remaining 
physical property and land due to other economic factors, as 
measured by the free market. The only method of taxation of 
this element of gain that preserves horizontal equity in the 
taxation of income among competing capital investment vehicles 
is taxation at full capital gains rates.
---------------------------------------------------------------------------
    \20\ See United States v. Ludey, supra.
---------------------------------------------------------------------------
    Economic factors which commonly add to the value of 
depreciated real estate include the following:
      Negotiation of favorable leases
      Scarcity of comparable development sites
      Adjacent development / improvement of the 
neighborhood
      Improvement of market demographics
      Increased replacement costs
      Economies in management
      Infrastructure improvements
    These and other economic factors which typically increase 
the value of the remaining asset can be categorized into two 
broad categories: favorable market trends and strong 
management. The values of other forms of capital investment are 
subject to these same market forces, yet the resulting 
increments in value are taxed at full capital gains rates. It 
would be unfair and discriminatory to enact a broad-based 
capital gains tax relief proposal that would tax the gains of 
real estate due to these types of economic factors any 
differently than other forms of capital investment, yet some 
recent proposals would do just that.

     IV. Basis Indexing in Combination With Depreciation Recapture

    One of the broad-based capital gain tax relief proposals 
introduced last year would have indexed the basis of capital 
assets for inflation, starting with assets purchased in 2001. 
This proposal would have reduced capital gains taxes to a top 
rate of 14%, but would have exempted real estate to the extent 
of depreciation previously taken not already recaptured under 
IRC Sec.  1250.
    The combination of these two provisions, once fully phased 
in, would have had the effect of:
      Taxing excess depreciation at full ordinary 
rates,
      Not taxing inflationary gains at all, and
      Taxing gains due to other economic factors at a 
discriminatory 28% rate to the extent of depreciation not 
already recaptured, and at a 14% rate thereafter.
    The combination of basis indexing with broad-based capital 
gains tax relief highlights the inequities of denying full 
capital gains tax relief to sales of real estate. Considering 
that other have all of their economic appreciation taxed at the 
reduced capital gain rate, real estate would be at a serious 
and obvious disadvantage compared to other investments. Basis 
indexing would not correct the inequity that a change in 
depreciation recapture tax policy would cause.

                             V. Conclusion

    Sound tax policy dictates that similarly situated taxpayers 
be treated the same under the tax code. Real estate must 
compete with other forms of investment for scarce capital, and 
should not, as a matter of tax policy, be discriminated against 
by the tax code unless there is a public policy reason to 
discourage such investment. No such public policy argument has 
been advanced by those who would change current tax policy 
regarding depreciation recapture on sales of real estate as 
part of a broad-based capital gain relief proposal. Rather, the 
rationale behind such a policy change seems to be to lower the 
cost of a broad-based capital gains relief proposal, at the 
expense of real estate and sound tax policy. Any effort to 
provide broad-based capital gains tax relief should as a matter 
of tax policy fully include the elements of capital gain 
inherent in sales of depreciable real estate -gains due to 
inflation and other economic factors -in order to maintain 
horizontal equity among competing forms of capital 
investment.''

                          Concluding Statement

    The economic evidence noted by Price Waterhouse LLP and the 
strong reasons for retaining present tax policy as advanced by 
Ernst & Young LLP give clear and compelling arguments for 
including real estate fully in any broad-based capital gains 
tax reduction legislation. A fair capital gains tax cut, that 
neither discriminates against real estate nor against existing 
investments in favor of new investments, would unlock real 
estate capital and bring in new investment for job creation. 
Through the redeployment of existing capital, real estate 
assets will more likely be recapitalized and reengineered for a 
very dynamic and fast-changing marketplace.
    Present federal tax law recognizes the key difference 
between rapidly wasting assets like fork-lift trucks and 
stamping machines, and longer-lived assets such as an apartment 
building. In the one case, there is little, if any, value left 
when a piece of machinery is sold. In the case of real estate, 
the remaining value is primarily due to an increase in land 
value, the extrinsic value of the property, and the long-term 
rate of inflation. Thus previously taken building depreciation 
should not be ``recaptured'' at ordinary income rates or at 28 
percent if the capital gains tax rate is reduced below 28 
percent; the capital gains tax rate should be applied to the 
full gain above adjusted basis.
    Three reasons are usually given by those who favor changing 
the recapturication No. 1: ``We need the $7-10 billion this 
would raise in order to help fund the reduction in capital 
gains tax rates.'' Justification No. 2: ``Since real estate now 
pays a 28 percent capital gains tax rate, its taxes would not 
be going up. They have not lost anything. No harm, no foul.'' 
Justification No. 3: ``Real estate has an unfair advantage 
versus investment in machinery and equipment.''
    Let's take the argument that more money is needed to help 
pay for the capital gains tax cut and juxtapose this with the 
argument that there is ``no harm, no foul.'' Anything that 
brings in $10 billion must have some economic bite. If changing 
the depreciation recapture rules for real estate brings in this 
much, it will all but negate any benefit of a capital gains tax 
reduction; the Price Waterhouse study shows this to be true. 
Real estate overall has not appreciated considerably in value 
and thus would remain ``locked-in'' by a capital gains tax cut 
that includes full real estate depreciation recapture at 28 
percent or higher.
    Looking forward, a change in the recapture rules would 
place real estate investment at a significant disadvantage 
compared to other investments. So there indeed is a ``foul'' 
caused by changing the rules. Finally, the so-called double 
standard argument that compares machinery to buildings is 
inappropriate. The fact is there is not a tax policy fairness 
problem to begin with, since these are two fundamentally 
different assets. Real estate is a long-lived wasting asset. 
Any gain upon sale does not result from having taken 
depreciation in prior years.
    Most real estate is held for longer periods of time, has 
not appreciated significantly in value, and is still held 
primarily by individual investors. The vast majority of 
investors and properties would not receive any benefit from a 
capital gains tax cut that has a depreciation recapture 
provision.
    A broad-based reduction in capital gains taxes would 
clearly benefit investors and free up dollars for new 
investment. However, the use of the term ``broad-based'' should 
be discontinued if the proposal also includes a change in the 
depreciation recapture rules that would tax previously taken 
depreciation at a non-capital gains tax rate. That type of 
legislation is truly not broad-based and might cause 
significant harm to future real estate values. For tax policy 
reasons and sound economic reasons, a broad-based cut in the 
capital gains tax that does not change the recapture rules 
should be the proposal that our lawmakers pursue.
      

                                

Statement of Patrick Brennan, Vice President, Pericom Semiconductor 
Corp., San Jose, California; on Behalf of the R&D Credit Coalition

    Mr. Chairman and members of the Committee, my name is 
Patrick Brennan, and I am the Vice President of Pericom 
Semiconductor Corporation of San Jose, California. I thank you 
for the opportunity to submit this statement on behalf of the 
R&D Credit Coalition on the importance of making permanent the 
research and experimentation tax credit (commonly referred to 
as the ``R&D'' credit), as recently modified by the Small 
Business Job Protection Act of 1996. The R&D Credit Coalition 
is a broad-based coalition of eighteen trade associations and 
approximately 600 small, medium and large companies, all united 
in seeking the permanent extension of the R&D credit. The 
members of the R&D Credit Coalition represent many of the most 
dynamic and fastest growing companies in the nation and include 
the entire spectrum of R&D intensive industries: aerospace, 
biotechnology, chemicals, electronics, information technology, 
manufacturing, pharmaceuticals and software. (I have attached 
to this statement a letter from the members of the R&D Credit 
Coalition to President Clinton concerning including the R&D 
credit in the Administration's FY 1998 Budget.)
    Pericom Semiconductor Corporation, founded in 1990, is a 
privately owned semiconductor company located in San Jose, 
California. The company designs, develops and markets high 
performance digital and mixed signal integrated circuits for 
the personal computer, workstation, peripherals and networking 
markets. Pericom's expertise in design and system technologies 
has created over 200 products and the company delivers large 
quantities of vital components to major customers worldwide. 
Rapid new product development is essential to success in our 
industry. Pericom's advanced design and engineering expertise 
and continued commitment to research and development provides 
users with innovative products which offer immediate measurable 
benefits. The company has grown to over 125 employees and 
spends approximately 15% of each revenue dollar on research and 
development of new products. The company is an ISO registered 
facility and is recognized for the quality of its products.
    I want to commend Representatives Nancy Johnson and Bob 
Matusi, and the original cosponsors of H.R. 947, and Senators 
Hatch and Baucus, and the original cosponsors of S. 405, for 
introducing legislation to permanently extend the R&D credit, 
as enacted last year in the Small Business Job Protection Act 
of 1996. Senators Gramm and Hutchinson are also to be commended 
for introducing legislation (S. 355) to permanently extend the 
R&D credit. I also want to commend President Clinton for 
including, and funding, an extension of the R&D tax credit, as 
enacted in the Small Business Job Protection Act, in the 
Administration's FY 1998 Budget.
    I hope the Congress will take swift action to permanently 
extend the R&D credit by enacting the provisions of H.R. 947--
S. 405 before the credit expires once again on May 31, 1997.

                   I. R&D Credit Legislative History

    The R&D credit was enacted in 1981 to provide an incentive 
for companies to increase their U.S. R&D activities. As 
originally passed, the R&D credit was to expire at the end of 
1985. Recognizing the importance and effectiveness of the 
provision, Congress decided to extend it. In fact, since 1981 
the credit has been extended seven times. In addition, the 
credit's focus has been sharpened by limiting both qualifying 
activities and eligible expenditures, and altering its 
computational mechanics. The credit has been the focus of 
significant legislative activity and has undergone refinement 
many times since its inception.
    In 1986, the credit lapsed, but was retroactively extended 
and the rate cut from 25 percent to 20 percent. In 1988, the 
credit was extended for one year. However, the credit's 
effectiveness was further reduced by decreasing the deduction 
for R&D expenditures by 50% of the credit. In 1989, Congress 
extended the credit for another year and made changes that were 
intended to increase the incentive effect for established as 
well as start-up companies. In the 1990 Budget Reconciliation 
Act, the credit was extended again for 15 months through the 
end of 1991. The credit was again extended through June 30, 
1992, by the Tax Extension Act of 1991. In OBRA 1993, the 
credit was retroactively extended through June 30, 1995.
    In 1996, as part of the Small Business Job Protection Act 
of 1996, the credit was extended for eleven months, through May 
31, 1997, but was not extended to provide continuity over the 
period July 1, 1995 to June 30, 1996. This one-year period, 
July 1, 1995 to June 30, 1996, was the first gap in the 
credit's availability since its enactment in 1981. In 1996, the 
elective Alternative Incremental Research Credit (``AIRC'') was 
added to the credit, expanding the availability of the credit 
to R&D intensive industries which could not qualify for the 
credit under the regular criteria. The AIRC adds flexibility to 
the credit to address changes in business models and R&D 
spending patterns which are a normal part of a company's life 
cycle.
    According to the Tax Reform Act of 1986, the R&D credit was 
originally limited to a five-year term in order ``to enable the 
Congress to evaluate the operation of the credit.'' While it is 
understandable that the Congress in 1981 would want to adopt 
this new credit on a trial basis, the credit has long since 
proven over the sixteen years of its existence to be an 
excellent investment of government resources to provide an 
effective incentive for companies to increase their U.S.-based 
R&D.
    The historical pattern of temporarily extending the credit, 
combined with the first gap in the credit's availability, has 
reduced the incentive effect of the credit. The U.S. research 
community needs a stable, consistent R&D policy in order to 
optimize its contribution to the nation's economic growth and 
sustain the basis for ongoing technology competitiveness in the 
global arena.

                    II. Why Do We Need a R&D Credit?

A. Credit offsets the tendency for under investment in R&D

    The single biggest factor behind productivity growth is 
innovation. As stated by the Office of Technology Assessment in 
1995: ``Much of the growth in national productivity ultimately 
derives from research and development conducted in private 
industry.'' Sixty-six to eighty percent of productivity growth 
since the Great Depression is attributable to innovation. In an 
industrialized society R&D is the primary means by which 
technological innovation is generated.
    Companies cannot capture fully the rewards of their 
innovations because they cannot control the indirect benefits 
of their technology on the economy. As a result, the rate of 
return to society from innovation is twice that which accrues 
to the individual company. This situation is aggravated by the 
high risk associated with R&D expenditures. As many as eighty 
percent of such projects are believed to be economic failures.
    Therefore, economists and technicians who have studied the 
issue are nearly unanimous that the government should intervene 
to bolster R&D. A 1994 study, Extending the R&D Credit: The 
Importance of Permanence (November 1994), conducted by the 
Policy Economics Group of KPMG Peat Marwick, concluded that 
``...[A] tax credit for research and experimentation was 
enacted with the goal of offsetting the tendency to under 
invest in industrial research. The R&D tax credit has been an 
effective-and cost-effective tool for stimulating private R&D 
activity.'' Stimulating private sector R&D is particularly 
critical in light of the decline in government funded R&D over 
the years. Direct government R&D funding has declined from 57% 
to 36% of total R&D spending in the U.S. from 1970 to 1994. 
Over this same period, the private sector has become the 
dominant source of R&D funding, increasing from 40% to 60%.

B. The credit helps U.S. business remain competitive in a world 
marketplace

    The R&D credit has played a significant role in placing 
American businesses ahead of their international competition in 
developing and marketing new products. It has assisted in the 
development of new and innovative products; providing 
technological advancement, more and better U.S. jobs, and 
increased domestic productivity and economic growth. This is 
increasingly true in our knowledge and information-driven world 
marketplace.
    Research and development must meet the pace of competition. 
In many instances, the life cycle of new products is 
continually shrinking. As a result, the pressure of getting new 
products to market is intense. Without robust R&D incentives 
encouraging these efforts, the ability to compete in world 
markets is diminished.
    Continued private sector R&D is critical to the 
technological innovation and productivity advances that will 
maintain U.S. leadership in the world marketplace. Since 1981, 
when the credit was first adopted, there have been dramatic 
gains in R&D spending. Unfortunately, our nation's private 
sector investment in R&D (as a percentage of GDP) lags far 
below many of our major foreign competitors. For example, U.S. 
firms spend (as a percentage of GDP) only one-third as much as 
their German counterparts on R&D, and only about two-thirds as 
much as Japanese firms. This trend must not be allowed to 
continue if our nation is to remain competitive in the world 
marketplace.
    Moreover, we can no longer assume that American companies 
will automatically choose to site their R&D functions in the 
United States. Foreign governments are competing intensely for 
U.S. research investments by offering substantial tax and other 
financial incentives. An OECD survey of sixteen member 
countries found that thirteen offer R&D tax incentives. Of the 
sixteen OECD nations surveyed, twelve provide a R&D tax credit 
or allow a deduction for more than 100% of R&D expenses. Six 
OECD nations provide accelerated depreciation for R&D capital. 
According to the OECD survey, the U.S. R&D tax credit as a 
percentage of industry-funded R&D was third lowest among nine 
countries analyzed. Even without these tax incentives, the cost 
of performing R&D in many foreign jurisdictions is lower than 
the cost to perform equivalent R&D in the U.S. In light of this 
international trend, Congress and the Administration must make 
a strong and permanent commitment to attracting and retaining 
R&D investment in the United States. The best way to do that is 
to permanently extend the R&D credit.

C. The credit provides a targeted incentive for additional R&D 
investment, increasing the amount of capital available for 
innovative and risky ventures.

    The R&D credit reduces the cost of capital for businesses 
that increase their R&D spending, thus increasing capital 
available for risky research ventures.
    Products resulting from R&D must be evaluated for their 
financial viability. Market factors are providing increasing 
incentives for controlling the costs of business, including 
R&D. Based on the cost of R&D, the threshold for acceptable 
risk either rises or falls. By reducing the costs of R&D, you 
make it possible to increase R&D efforts. In most situations, 
the greater the scope of R&D activities, or risk, the greater 
the potential for return to investors, employees and society at 
large.
    The R&D credit is a vital tool to keep U.S. industry 
competitive because it frees-up capital to invest in leading 
edge technology and innovation. It makes available additional 
financial resources to companies seeking to accelerate research 
efforts. It lowers the economic risk to companies seeking to 
initiate new research, which will potentially lead to enhanced 
productivity and overall economic growth.

D. Private industrial R&D spending is very responsive to the 
R&D credit, making the credit a cost effective tool to 
encourage economic growth

    Economic studies of the credit, including the KPMG Peat 
Marwick 1994 study referenced above, and B. Hall, ``R&D Tax 
Policy in the 1980s: Success or Failure?'' Tax Policy and the 
Economy (1993), have found that a one-dollar reduction in the 
after-tax price of R&D stimulates approximately one dollar of 
additional private R&D spending in the short-run, and about two 
dollars of additional R&D in the long run. That in turn, 
implies long-run growth in GDP. In addition, the KPMG Peat 
Marwick study concluded, ``The credit has been a public policy 
success... The best available evidence now indicates that the 
increase in R&D due to the tax credit equal or exceed the 
credit's revenue costs.''

E. Research and Development is About Jobs and People

    Investment in R&D is ultimately an investment in people, 
their education, their jobs, their economic security, and their 
standard of living. Dollars spent on R&D are primarily spent on 
salaries for engineers, researchers and technicians.
    When taken to market as new products, incentives that 
support R&D translate to salaries of employees in 
manufacturing, administration and sales. Of exceptional 
importance to Pericom Semiconductor Corporation and the other 
members of the R&D Credit Coalition, R&D success also means 
salaries to the people in our distribution channels who bring 
our products to our customers as well as service providers and 
developers of complementary products. And, our customers 
ultimately drive the entire process by the value they put on 
the benefit to them of advances in technology. Benefits that 
often translate into improving their ability to compete. By 
making other industries more competitive, research within one 
industry contributes to preserving and creating jobs across the 
entire economy.
    My experience has been that more than 75 percent of 
expenses qualifying for the R&D credit go to salaries for 
researchers and technicians, providing high-skilled, high-wage 
jobs to U.S. workers. Investment in R&D, in people working to 
develop new ideas, is one of the most effective strategies for 
U.S. economic growth and competitive vitality.

F. The R&D credit is a market driven incentive

    The R&D credit is a meaningful, market-driven tool to 
encourage private sector investment in research and development 
expenditures. Any taxpayer that increases their R&D spending 
and meets the technical requirements provided in the law can 
qualify for the incentive. Instead of relying on government-
directed and controlled R&D spending, businesses of all sizes, 
and in all industries, can best determine what types of 
products and technology to invest in so that they can ensure 
their competitiveness in the world marketplace.

III. The R&D Credit Should Be Made Permanent To Have Optimum Incentive 
                                 Effect

    Research projects cannot be turned off and on like a light 
switch. If corporate managers are going to take the benefits of 
the R&D credit into account in planning future research 
projects, they need to know that the credit will be available 
to their companies for the years in which the research is to be 
performed. Research projects have long horizons and long 
gestation periods. Furthermore, firms generally face longer 
lags in adjusting their R&D investments compared, for example, 
to adjusting their investments in physical capital.
    In order to increase their R&D efforts, businesses must 
search for, hire, and train scientists, engineers and support 
staff. They must often invest in new physical plant and 
equipment. There is little doubt that a portion of the 
incentive effect of the credit has been lost over the past 
seventeen years as a result of the constant uncertainty over 
the continued availability of the credit.
    If the credit is to provide an effective incentive for 
increased R&D activity, the practice of periodically extending 
the credit for short periods, and allowing it to lapse, must be 
eliminated, and the credit must be made permanent. Only then 
will the full potential of its incentive effect be felt across 
all the sectors of our economy.

                             IV. Conclusion

    Making the existing R&D credit permanent best serves the 
country's long term economic interests as it will eliminate the 
uncertainty over the credit's future and allow R&D performing 
businesses to make important long-term business decisions 
regarding research spending and investment. Private sector R&D 
stimulates investment in innovative products and processes that 
greatly contribute to overall economic growth, increased 
productivity, new and better U.S. jobs, and higher standards of 
living in the United States. Moreover, by creating an 
environment favorable to private sector R&D investment, jobs 
will remain in the United States. Investment in R&D is an 
investment in people. A permanent R&D credit is essential for 
the United States economy in order for its industries to 
compete globally, as international competitors have chosen to 
offer direct financial subsidies and reduced capital cost 
incentives to ``key'' industries. The R&D Credit Coalition 
strongly supports the permanent extension of the R&D credit and 
urges Congress to enact the provisions of H.R. 947--S. 405 
before the credit expires on May 31, 1997.

Attachment: Letter from members of R&D Credit Coalition to 
President Clinton
      

                                

                                                  December 18, 1996

The Honorable William Jefferson Clinton
President of the United States
The White House
Washington, D.C. 20500

    Dear Mr. President:

    We urge you to include a permanent extension of the Research and 
Experimentation tax credit (commonly referred to as the R&D Credit), as 
recently enacted in the Small Business Job Protection Act, including 
the elective alternative incremental research credit, in your Fiscal 
Year 1998 Budget. As you know, the R&D Credit was allowed to lapse for 
the first time since its inception and is set to expire again in only a 
few short months; it is now more critical than ever that your 
Administration demonstrate its continuing commitment to the R&D Credit 
by including, and funding, a permanent extension in your FY 98 Budget.
    The R&D Credit enjoys broad, bipartisan support and provides a 
critical, effective and proven incentive for companies to maintain and 
increase their investment in U.S. based research and development. The 
continued encouragement of private sector R&D is particularly important 
in light of the substantial tax and other financial incentives offered 
by many of our major foreign trade competitors and the budgetary 
pressures to reduce Federal Government investment in basic and applied 
research. Moreover, targeted primarily at salaries and wages paid to 
employees engaged in U.S.-based R&D activities, the credit supports the 
creation of valuable new, high-skilled jobs for American workers.
    For these reasons, we strongly urge you to make an investment in 
the future economic growth of our country by funding a permanent 
extension of the R&D Credit in your FY 98 Budget.
    We thank you for your consideration of our strong interest in a 
permanent R&D Credit and look forward to working with you toward this 
goal.

            Sincerely,
                                     (Attached Signatories)

cc: Honorable Robert E. Rubin
      Honorable Franklin D. Raines
      Honorable Erskine Bowles

                                

Aerospace Industries Association of America, Inc.
American Automobile Manufacturers Association
American Electronics Association
Biotechnology Industry Organization
Business Software Alliance
Chemical Manufacturers Association
Computing Technology Industry Association
Electronic Industries Association
Information Technology Association of America
Information Technology Industry Council
National Association of Manufacturers
Pharmaceutical Research & Manufacturers of America
Semiconductor Equipment and Materials International
Software Publishers Association
Telecommunications Industry Association
U.S. Chamber of Commerce
US Telephone Association
Utah Information Technologies Association
3Com Corporation
3M Company
3M Health Information Systems
Abbott Laboratories, Inc.
Absolute Time Corporation
Academedia Multimedia Solutions
AccelGraphics
Accel Technologies, Inc.
Access The West
AccSys Technology, Inc.
Accurel Systems International Corporation
ACT Teleconferencing
Active Power
Action Instruments, Inc.
Adastra Systems Corporation
Adobe Systems, Inc.
Advanced Energy Industries, Inc.
Advanced Micro Devices, Inc.
Advance Technology, Inc.
Advent Systems, Inc.
AG Associates
Air Products and Chemicals, Inc.
Airtouch Cellular
Alcatel NA Cable Systems, Inc.
Alex Systems
Allen Communication
Alliance Semiconductor Corporation
Allied Signal
Alpnet, Inc.
America-Net
American Computer Hardware Corporation
American Home Products Corporation
American Telecorp, Inc.
Ameritech Library Services
Amgen, Inc.
AMP
Analogic, Inc.
Ancestry, Inc.
Angle Technologies, Inc.
Apple Computer, Inc.
Applied Computer Techniques, Inc.
Applied Materials
Arcanvs, Inc.
Arcom Architectural Computer Services
Artnet
Asante' Technologies, Inc.
Ashton, Harker, Bingham, Inc.
Associates & Blair
Associated Components Technology, Inc.
Astra USA, Inc.,
AT&T
AT&T Wireless Services
Atmel Corporation
Attachmate Corporation
Autocon, Inc.
Autodesk, Inc.
Autosimulations, Inc.
Auto-Soft Corporation
Autosplice, Inc.
Avid Technology, Inc.
Axiom Technologies, L. C.
Aztek Engineering, Inc.
Banyan Systems, Inc.
Bay Networks, Inc.
Bell Atlantic
Bell & Howell Lightspeed
Berger & Co.
Best Consulting
BFGoodrich Company
BI Incorporated
Bison Group
BMC Software, Inc.
Boehringer Ingelheim Pharmaceuticals, Inc.
Bolder Technologies Corporation
Bolt Beranek & Newman
Bonneville International Corporation
Borland International
Boston Technology, Inc
Bristol-Myers Squibb Company
Broderbund Software, Inc.
Burton Group
Bybee Printed Circuit Design
C-COR Electronics Inc.
Caldera, Inc.
Calex
California Healthcare Institute
California Instruments Corporation
Calimetrics, Inc.,
Call Business Systems, Inc.
Call Dynamics
Callware Technologies
Cambric Graphics, Inc.
Cambridge Technology Partners, Inc.
Candescent Technologies Corporation
Capsoft Development Corporation
Carco Electronics
Carlisle Wilkins, L.C.
Cartwright Communications
Caseware Technology, Inc.
Catapult Communications
CASCADE Communications Corp.
CDI Information Services, Inc.
Centre Technologies
Centric Engineering Systems, Inc.
Century Software
Certified Management Software, Inc.
Charles Industries, Ltd.
CHI Squared Software, Inc.
Chrysler Corporation
Circuit Technology Corp.
Cirque Corporation
Cirris Systems Corporation
Cisco Systems, Inc.
Citizens Telecom
Citrix Systems, Inc.
Claris Corporation
Clark Development Company, Inc.
Codar Technology, Inc.
Cognex Corporation
Coherent Technologies,
Coleman's
Companion Corporation
COMPAQ Computer Corporation
Compass Data Systems, Inc.
Computer Consultants Corporation
Computer Management Systems, Inc.
Computer Sciences Corporation
Computer Task Group, Inc.
Comspec Corporation
Connecting Point Computer Center
Connective Solutions, LLC
Consultnet
Copley Controls
Corel, Inc.
Correct Knowledge
Cray Research, Inc.
Create-A-Check, Inc.
Creative Computer Solutions, Inc.
Creative Insight, Inc.
Creative Media
Crystal Canyon Interactive
Cyberamerica
CyberSym Technologies
Cygnus Solutions
Darbick Instructional Software Systems
Data Systems International
Dataflow Services
Datamatic, Inc.
Dataware Technology
Datum Inc.
Dayna Communications, Inc.
Decision Systems Technologies, Inc.
Desktop Visual Products
Digital Equipment Corporation
Digital Radio Communications Corp.
Digitran Systems, Inc.
Digivision
Dimensions/Computer Advisors, Inc.
Dionex Corporation
Directell, Inc.
DOCU Prep, Inc.
Document Control Systems
DS Technologies, Inc.
Duplication Group
Dupont Merck Pharmaceutical Company
DVT Corporation
E. I. Dupont Nemours and Company, Inc.
Eastman Kodak Company
Eckersley Associates DP+R
Edge Semiconductor Incorporated
EDS
EFI Electronics Corporation
Electro Scientific Industries, Inc.
Electronic Cottage
Electronic Decontamination Specialists
Electronic Expressway Connections
Elpac Electronics, Inc.
Embedded Performance, Inc.
EMC Corporation
Engineering Geometry Systems, Inc.
Equis International
Ernest & Young LLP
ESCO Electronics Corporation
Eskay Corporation
Evans & Sutherland Computer Corporation
Expersoft
Eyring Corporation
Fiber Optic Technologies, Inc.
Fibernet
FileNet Corporation
Fisher Berkeley Corporation
Floppy Copy, Inc.
Folio Corporation
Ford
Four Corners Technology, Inc.
Franklin Estimating Systems
Frequency Products
FTP Software, Inc.
Future Active Industrial Electronics
Galapagos Software, Inc.
GECAP
Genentech, Inc.
General Dynamics Corporation
General Motors Corporation
Genetics Institute
GENZYME CORPORATION
Geometrics, Inc.
GLASPAC--Total Solutions
Glaxo Wellcome, Inc.
Global Ergonomic Technologies, Inc.
Gold Systems, Inc.
GSE Erudite Software
H. Rel Laboratories, Inc.
Hall-Mark Computer
Harding & Harris Behavioral Research
Harris Corporation
Harry Sello and Associates
Headway Research, Inc.
HEC Software, Inc.
Hemasure, Inc.
HNC Software, Inc.
Hoffman-LaRoche
Home Financial Network, Inc.
Honn Enterprises
Horix Manufacturing Company
Hurricane Electronics Lab., Inc
Hutchinson Telephone Company
HY-Tech Business Services
IBM Corporation
IC One
ICIS, Inc.
I-EIGHTY
IES, Inc.
Individual, Inc.
Industry West Electronics
Indyme Electronics, Inc.
Infobusiness, Inc.
Infonational, LLC
Information Builders, Inc.
Information Enabling Technologies (IET)
Information Plus Corporation
Information Technologies
Infosphere
Innerworks
Inno Cal
Innovative Telecom
Innovax Concepts Corporation
Innovus Multimedia, Inc.
Insight Software Solutions, Inc.
Inso Corporation
INSTRON Corporation
INTA
Intel Corporation
Intelli Media, Inc.
Intelliquest Technologies, Inc.
Intellitrends
Interactive Services
Interated Systems, Inc.
Interconnect West
Interim Technology
Interlake Software Solutions
Interlynx Technology Corporation
Internet Magic, Inc.
Intuit Inc.
InVINCIBLE Enterprises
I-O Corporation
IOMEGA Corporation
IPM/Management 2000, LC
I*SIM Corporation
ITC Companies
ITPARTNERS, Inc.
J. R. Firestack & Assciates
Jason Associates Corporation
JH Associates
Johnson & Johnson
Kaiser Electroprecision
KAMP--Data
KCE
Keane, Inc.
Kenex Systems, Inc.
Kenter Information Systems, Inc.
Keylabs, Inc.
Kiva
Kofax Image Products
Komag Inc.
KV Communications, Inc.
Laser Mail
Laser Supply of Utah, Inc.
Laser Systems
Latin Connection, Inc.
Lexmark International, Inc.
Liconix
Lifeline Systems, Inc.
Eli Lilly and Company
Lockheed Martin Tactical Communication Systems
Logic Works, Inc.
Logical Services Incorporated
Loronix Information Systems, Inc.
Lucent Technologies, Inc.
McAfee Associates
McData Corporation
McDonnell Douglas
Macromedia
Majesco Software, Inc.,
Mark Communications
Marketing Ally Teleservices
Marshall Contractors
Maxon America, Inc.
MCI Communications
MCI Telecommunications Corporation
Meeting Ware International, Inc.
Megg Associates, Inc.
Mentor Graphics Corporation
Merck & Company, Inc.
Metastorm, Inc.
Metcam, Inc.
Metronerles Corporation
Micro Automation Enterprise
Micro Choice, Inc.
MicroHelp, Inc.
MicroSim Corporation
Microsoft Corporation
Microsurge, Inc.
Microsystems Software
MIS LABS
Mitel Semiconductor, Inc.
MKS Instruments, Inc.
Monsanto-Searle Company
Motorola
Mountain View Software Corp.
Multiling International, Inc.
Napersoft, Inc.
National Applied Computer Technologies, Inc.
National Semiconductor Corporation
National Software Testing Laboratories
Net Dynamics, Inc.
Nets, Inc.
Netscape Communications, Inc.
NetSoft
Network Centre
Network Computer Systems
Network Information Research Corp.
Network Integration, Inc.
Network Publishing, Inc.
Network Technical Services
New Client Software, Inc.
Newbridge Networks Inc.
Newport Corporation
Northridge Systems, LLC
Northrop Grumman
Northern Telecom Inc.
Novell, Inc.
NYNEX
OEC Medical Systems, Inc.
Omnidata International, Inc.
One-Off CD Shops--Division of Software Duplicators
ONYX Graphics, Corp.
Open Highways, LLC
Optek Technology, Inc.
Optical Data Systems, Inc.
Optionomics Corporation
Oracle Corporation
Organogenesis, Inc.
Ortho-Graphics, Inc.
Oryx Technology Corporation
Outsource Engineering and Manufacturing
Outsource Solutions
Outsource Technologies
Ovid Technologies, Inc.
Oxford & Associates
Pacific Telesis Group
Palomar Systems, Inc.
Paragraph International
Parametric Technology
ParcPlace-Digitalk, Inc.
Park City Group
Pasteur Merieux Connaught
PC Software Systems, LLC
PCD, Inc.
Pembroke's, Inc.
Pen Interconnect, Inc.
Pericom Semiconductor Corporation
Pfizer
Pharmacology Data Management Corporation
Pharmacia & Upjohn
Philips Electronics
Phoenix Fiberlink, Inc.
Phonex Corporation
Pivotpoint, Inc.
Planet Software
Pleiades Software Dev., Inc.
Polatomic, Inc.
PowerQuest Corporation
Power Stream Technology, Inc.
POWERTEX INC.
Pragmatic Data Quest
Precision Assembly, Inc.
Precision Cable Corporation
Premier Laser Systems
Primavera Systems, Inc.
Prime Technological Services, Inc.
Printronix, Inc.
Process Software Corporation
Procopy
Prodigy, Inc.
Programart Corporation
Progressive Solutions, Inc.
Project Software & Development, Inc.
Promodel Corporation
Protel
Prototype & Plastic Mold Co. Inc.
Procter & Gamble Company
Pulizzi Engineering, Inc.
Qlogic Corporation
QLP Laminates
QSI Corporation
Quality Education Data
Quantum Leap
Questar Infocomm, Inc.
R. R. Donnelley & Sons Company
Racore Computer Products, Inc.
Rainbow Technologies, Inc.
RAM Software Systems, Inc.
Rapid, LLC
Raptor Systems, Inc.
Rascom, Inc.
Raster Graphics, Inc.
Raytheon Company
Red Rock Technologies
Redcon, Inc.
Relationship Software, LLC
Reliability Incorporated
Rhyse Development, Inc.
Rockwell International Corp.
Rocky Mountain Hardware Company
Rohm & Haas Company
Router Ware
Saffire Corporation
Salt Lake Cellular
Saville Systems, Inc.
SBC Communications
SBE, Inc.
Schering-Plough Corporation
SCHOTT Corporation
Science Applications International Corp. (SAIC)
Scientific-Atlanta, Inc.
Scientific Technologies, Inc.
Scitex America, Inc.
Scopus Technology, Inc.
Seer Technologies, Inc.
Semiloa Semiconductors
Sepracor, Inc.
Sequent Computer Systems, Inc.
Sequoia Group, Inc.
ShareData Inc
Shelby Industries, Inc.
Silicon Graphics
Silicon Valley Group, Inc.,
Siemens Corporation
Siemens Rolm Communications, Inc.
Sierra Semiconductor
Simates, Inc.
SIMCO Electronics
Singletrac Entertainment Technologies, Inc.
Skipstone, Inc.
SkyHook Technologies, Inc.
Smart Communications
Smartdial/Information Access Technology, Inc.
Smarttalk, Inc.
Smartware Systems, Inc.
SmithKline Beechman Corporation
Softset International, Inc.
Software Forum
Software Development Corp.
Software Magic
Software Publishing Corporation
Software Studios
Solid Design & Analysis, Inc.
Source Services
Spatial Technology Inc.
Spiricon, Inc.
Sprint
SRC Computers, Inc.
Stac, Inc.
Sterling Wentworth Corporation
Storage Technology Corporation
Strata, Inc.
Stratedge Corporation
Strategic Marketing
Stream International, Inc.
Streamlined Information Systems
Stuart & Co.,
Subscriber Computing, Inc.
Summit Consulting Group
Summit Technology, Inc.
Sun Microsystems, Inc.
Sun Remarketing, Inc.
Surfware, Inc.
Sybase, Inc.
Symantec Corporation
Synergy, Inc.
Systems West Computer Resources, Inc.
Tandem Computers Incorporated
Target Software, Inc.
TCG--Teleport Communications Group
TCI Caglevision Of Utah, Inc.
Teal Electronics Corporation
Technology Advancement Corporation
Technology Sales, Inc.
Tecknowledgez, Inc.
Tekana Corporation
Tel0ecom Strategies, Inc.
Telect, Inc.
Telesensory Corporation
Telesync, Inc.
Tels Corporation
Teltrust, Inc.
Teltrust, Com
Tenth Planet
Teradyne, Inc.
T.H.E., LLC
The Automatic Answer
The Directorate, Inc.
THE LEARNING COMPANY
The VALIS Group, Inc.
The Video Call Company
Theoretics, Inc.
Thiokol Corporation
Thunderbird Technologies, Inc.
Tomax Technologies, Inc.
TRW Inc.
Tranquility Systems
Transoft International, Inc.
Traveling Software
Trebor International
TSI International
U'S West Communications
United Technologies Corporation
Union Carbide Corporation
Unisys Corporation
Unitrode Corporation
Usability Center
Utah Education Network
Utah Scientific, Inc.
Value Added Software, Inc.
Varian Associates
Venture Advisory Group
Venture Engineering Corporation
Verite' Multimedia
Versant Object Technology
Vertex Pharmaceuticals Incorporated
VideoServer, Inc.
Viewpoint Datalabs
Viewsoft, Inc.
Vinca Corporation
Visicon, Inc.
Visio Corporation
Vitrex Corporation
Voicestream Wireless
Voiceteck Corporation
VZ Corporation
Wall Data, Inc.
Warever Corporation
Warner-Lambert
Watkins-Johnson Company
Western Digital Corporation
Western Midrange Corporation
Western Telematic, Inc.
Westin Technology Center
Wicat Systems, Inc.
Wiltel Technology Ventures, Inc.
Wind River Systems
Winward Telecommunications
Wydah Corporation
Xerox Corporation
XILINX, Inc.
Z Microsystems, Inc.
Zebra Technologies VTI, Inc.
ZZ Soft
ZZ Software Systems, Ltd.

Any inquiries concerning this letter may be directed to Donna 
Siss Gleason, Director, Government Relations, Electronic 
Industries Association (703) 907-7587.

                                

                                Addendum

    The listed company names below were received after the 
letter was sent out to the President.

New Image Industries, Inc.
Odetics
Jones & Askew
Racom Systems, Inc.