[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]




 
                       FULL COMMITTEE HEARING ON
                      BUSINESS ACTIVITY TAXES AND
                         THEIR IMPACT ON SMALL
                               BUSINESSES

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

                      COMMITTEE ON SMALL BUSINESS
                 UNITED STATES HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 14, 2008

                               __________

                          Serial Number 110-71

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
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                   HOUSE COMMITTEE ON SMALL BUSINESS

                NYDIA M. VELAZQUEZ, New York, Chairwoman


HEATH SHULER, North Carolina         STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas              ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington              SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona               TODD AKIN, Missouri
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois               MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas                 STEVE KING, Iowa
DAN LIPINSKI, Illinois               JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin                LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania          LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa                   DEAN HELLER, Nevada
YVETTE CLARKE, New York              DAVID DAVIS, Tennessee
BRAD ELLSWORTH, Indiana              MARY FALLIN, Oklahoma
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio
BRIAN HIGGINS, New York
MAZIE HIRONO, Hawaii

                  Michael Day, Majority Staff Director

                 Adam Minehardt, Deputy Staff Director

                      Tim Slattery, Chief Counsel

               Kevin Fitzpatrick, Minority Staff Director

                                 ______

                         STANDING SUBCOMMITTEES

                    Subcommittee on Finance and Tax

                   MELISSA BEAN, Illinois, Chairwoman


RAUL GRIJALVA, Arizona               DEAN HELLER, Nevada, Ranking
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana              STEVE KING, Iowa
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio

                                 ______

               Subcommittee on Contracting and Technology

                      BRUCE BRALEY, IOWA, Chairman


HENRY CUELLAR, Texas                 DAVID DAVIS, Tennessee, Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              SAM GRAVES, Missouri
JOE SESTAK, Pennsylvania             TODD AKIN, Missouri
                                     MARY FALLIN, Oklahoma

        .........................................................

                                  (ii)

  
?

           Subcommittee on Regulations, Health Care and Trade

                   CHARLES GONZALEZ, Texas, Chairman


RICK LARSEN, Washington              LYNN WESTMORELAND, Georgia, 
DAN LIPINSKI, Illinois               Ranking
MELISSA BEAN, Illinois               BILL SHUSTER, Pennsylvania
GWEN MOORE, Wisconsin                STEVE KING, Iowa
JASON ALTMIRE, Pennsylvania          MARILYN MUSGRAVE, Colorado
JOE SESTAK, Pennsylvania             MARY FALLIN, Oklahoma
                                     VERN BUCHANAN, Florida
                                     JIM JORDAN, Ohio

                                 ______

            Subcommittee on Urban and Rural Entrepreneurship

                 HEATH SHULER, North Carolina, Chairman


RICK LARSEN, Washington              JEFF FORTENBERRY, Nebraska, 
MICHAEL MICHAUD, Maine               Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              MARILYN MUSGRAVE, Colorado
BRAD ELLSWORTH, Indiana              DEAN HELLER, Nevada
HANK JOHNSON, Georgia                DAVID DAVIS, Tennessee

                                 ______

              Subcommittee on Investigations and Oversight

                 JASON ALTMIRE, PENNSYLVANIA, Chairman


CHARLIE GONZALEZ, Texas              VACANT, Ranking
RAUL GRIJALVA, Arizona               LYNN WESTMORELAND, Georgia

                                 (iii)

  
?

                            C O N T E N T S

                              ----------                              

                           OPENING STATEMENTS

                                                                   Page

Velazquez, Hon. Nydia M..........................................     1
Chabot, Hon. Steve...............................................     2

                               WITNESSES

Rolston, David, Hatco............................................     4
Godwin, J. Barry, Stingray Boat Company..........................     6
Joost, Steven, Firehouse Subs....................................     8
Petricone, Michael, Consumer Electronics Association.............    11
Johnson, Peter, Direct Marketing Association.....................    13

                                APPENDIX


Prepared Statements:
Velazquez, Hon. Nydia M..........................................    25
Chabot, Hon. Steve...............................................    27
Altmire, Hon. Jason..............................................    29
Rolston, David, Hatco............................................    30
Godwin, J. Barry, Stingray Boat Company..........................    32
Joost, Steven, Firehouse Subs....................................    42
Petricone, Michael, Consumer Electronics Association.............    46
Johnson, Peter, Direct Marketing Association.....................    50

Statements for the Record:
American Bankers Association.....................................    66
Federation of Tax Administrators.................................    69
National Association of Manufacturers............................    89
The American Homeowners Grassroots Alliance......................    93
American Federation of State, County, and Municipal Employees....    98
Hope Trucking, Inc...............................................   100

                                  (v)

  


                       FULL COMMITTEE HEARING ON
                      BUSINESS ACTIVITY TAXES AND
                         THEIR IMPACT IN SMALL
                               BUSINESSES

                              ----------                              


                      Thursday, February 14, 2008

                     U.S. House of Representatives,
                               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 11:30 a.m., in Room 
2360 Rayburn House Office Building, Hon. Nydia Velazquez 
[chairwoman of the Committee] presiding.
    Present: Representatives Velazquez, Cuellar, Moore, Clarke, 
Higgins, Chabot, Akin, Davis, and Buchanan.

           OPENING STATEMENT OF CHAIRWOMAN VELAZQUEZ

    Chairwoman Velazquez. I now call this hearing to order on 
the business activity taxes and their impact on small 
businesses. In recent years, the American economy has changed 
dramatically, shifting away from the manufacture of goods to 
the delivery of services and intangibles. As a result, many 
states have sought to strengthen their eroding tax base by 
levying taxes on businesses that are not located within their 
jurisdiction. Today's hearing will focus on the potential 
problems many small businesses face when engaging in interstate 
commerce and the impact business activity taxes have on their 
firms.
    As the name implies, business activity taxes, are just 
that: taxes imposed by a state for merely conducting business, 
rather than being physically located within a state's borders. 
While there are clearly circumstances when this is reasonable, 
the question becomes whether states are going too far.
    This is not the first time this issue has come before 
Congress. In 1959, Congress enacted the federal interstate 
income tax law to address the matter of a state's ability to 
effect interstate commerce through taxation. Still in effect 
today, this law prohibits states from taxing the income of 
businesses whose only activities are the solicitation of orders 
for the sale of tangible personal property within that state. 
There is concern that this law needs to be clarified to prevent 
small firms from being unfairly burdened.
    Typically business activity taxes are levied on corporate 
income generated within the taxing jurisdiction. However, some 
states have imposed a business and occupation tax based on 
gross sales. And others have imposed taxes in the form of fees 
or licenses for products sold within their borders. This means 
that a small business software developer may be subject to 
licensing and use fees in states just for making sales via mail 
order.
    If each state charged a $400 licensing fee to that small 
business owner, it is not hard to imagine the chilling effect 
this would have on a small company. Having to pay unpredictable 
taxes inhibits the growth potential for small businesses and 
our economy at large.
    Congress is currently considering whether to provide 
clarity in this area by setting standards about when a state 
may invoke its taxing power. And for many small businesses, tax 
certainty is a primary concern.
    Today's hearing will help provide perspective on the scope 
of the problem. The issue of the BAT is something that has gone 
under the radar but has an enormous effect on our economy.
    The hearing will also provide insight on how any changes to 
federal law would affect a states' ability to tax legitimate 
economic activity. Limiting the ability of states is something 
that must be considered carefully.
    Many of these revenues are used to provide vital services 
such as police, fire, and education, to their citizens. The 
witnesses here today will discuss how the BAT affects their 
industries.
    As with most taxes, it impacts small and mid-sized 
companies to a greater extent than larger entities. Many small 
firms are completely unaware that they are even subject to 
these taxes until they receive a bill from a state taxing 
authority.
    Smaller businesses also often lack the resources or 
capability to comply with the multitude of state and local tax 
laws that are triggered by business activity taxes. Further, 
the prospect of challenging an incorrect assessment is costly 
and time-consuming.
    The issue becomes, how do we ensure clarity for these 
businesses while also ensuring that states are not going too 
far? While the issue is a complex one, it is important for 
thousands of businesses across this country.
    I look forward to today's discussion. And I appreciate the 
witnesses coming here to discuss this important matter. I now 
will yield to the ranking member, Mr. Chabot, for his opening 
statement.

                OPENING STATEMENT OF MR. CHABOT

    Mr. Chabot. Thank you. Good morning, Madam Chairwoman. 
Thank you for holding this hearing examining one of the many 
tax burdens faced by small businesses. I'm looking forward to 
hearing from our distinguished panel of witnesses this morning. 
I know we all are.
    There is no doubt that technological advancements have 
fundamentally changed the landscape for America's small 
businesses. No longer are small businesses confined to a 
regional customer base or disadvantaged by their inability to 
compete with larger companies because they lack the 
technological sophistication. In fact, advancements in 
technology have allowed small businesses to thrive in a global 
economy, now largely depend on global communications, just-in-
time deliveries, and streamlined operations, all of which 
enable companies to decrease costs, increase capital 
investments, and provide new job opportunities.
    Despite these efficiencies, technology has also brought 
uncertainty, particularly as it relates to the excessive tax 
burdens faced by our nation's small businesses. Benjamin 
Franklin once said that nothing in this world is certain but 
death and taxes. Well, as usual, Ben was right. And in this 
case, state revenue collectors are taxing America's small 
businesses to death through the business activity tax.
    In 1959, Congress passed and President Eisenhower signed 
into law the Interstate Income Tax Act, which remains in effect 
today. This legislation prohibits states from imposing a tax on 
businesses whose only contact with a state involves 
solicitation of orders for tangible goods. Yet, nearly 50 years 
later, e-commerce and the Internet have greatly expanded the 
breadth of goods and services available to increasingly 
sophisticated consumers.
    Unfortunately, these new avenues of commerce have also 
become favorite targets of overly eager tax assessors, who from 
state to state spin a tangled web of rules, regulations, and 
guidelines, guaranteeing countless headaches for American small 
business owners.
    For example, some states believe that trucks nearly passing 
through the state only a couple of times a year without picking 
up or delivering goods even have sufficient connections with a 
state to justify imposing business activity taxes. Horror 
stories have surfaced describing state tax collectors' actually 
impounding trucks at weigh stations and demanding that 
companies pay unwarranted business activity taxes on the spot--
simply for passing through the state.
    While they're at it, perhaps the state tax collectors' 
offices should tax themselves for wasting taxpayers' money. It 
makes just about as much sense.
    These accounts demonstrate the need for legislation that 
will lower the tax burden and provide greater clarity to small 
businesses trying to compete in an increasingly global 
marketplace.
    Last week Congressman Boucher and Congressman Goodlatte 
introduced H.R. 5267, the Business Activity Tax Simplification 
Act of 2008. This legislation will go a long way toward 
accomplishing these objectives by establishing a physical 
presence nexus standard. It would eliminate the guesswork for 
small businesses in determining their tax liabilities by 
setting specific guidelines for states as they seek to tax 
businesses that actually conduct business within the state.
    My home state of Ohio has the regrettable honor of being 
consistently ranked as one of the worst climates for small 
business in the entire country. This climate is largely 
determined by the state's propensity to tax: individual income 
taxes, sales taxes, unemployment insurance taxes, property 
taxes, goes on and on. Ohio has even begun to impose a gross 
receipts tax on businesses.
    These excessive taxes are not the answer to turning the 
economy around in Ohio or anywhere else. Instead, we should be 
supporting legislation like the Business Activity Tax 
Simplification Act, which tells entrepreneurs and small 
business owners that it's okay to invest in our state or in 
other states around the country.
    I thank Mr. Boucher and Mr. Goodlatte for introducing this 
important legislation. And, Madam Chairwoman, I commend you for 
holding this important hearing today. And I look forward to 
hearing from our witnesses.
    I yield back the balance of my time.
    Chairwoman Velazquez. Thank you. And now I yield to Ms. 
Moore for the purpose of introducing our first witness.
    Mr. Moore. Thank you so much, Madam Chair Velazquez and 
Ranking Member Chabot.
    I am so very pleased today to introduce Mr. David Rolston, 
our first witness. Mr. Rolston is the President and CEO of 
Hatco Corporation, an employee-owned manufacturer of food 
equipment headquartered in Milwaukee, Wisconsin.
    For the past 58 years, Hatco has been a company dedicated 
to exceptional customer service and quality engineered 
equipment. Hatco has consistently been a leader of innovative 
ideas for the food service industry, such as being the first to 
recognize the need to sanitize dish wear at 180 degrees 
Fahrenheit, food warmers for food security and food safety, 
while at the same time with their flavor saver devices so that 
it still tastes good after it has been sitting around. And, in 
fact, our own Longworth cafeteria uses Hatco equipment.
    I am so proud to have Mr. Rolston here today representing 
my district. Mr. Rolston is here to testify on behalf of the 
North American Association of Food Equipment Manufacturers, of 
which Hatco is a member.
    The North American Association of Food Equipment 
Manufacturers represents more than 600 firms which manufacture 
the equipment used for food preparation and service in the 
nation's restaurants, cafeterias, and other food service 
establishments. Most members of the Association are small 
businesses. Sixty-six percent, or two-thirds, of their members 
have fewer than 100 employees.
    I so appreciate Mr. Rolston being here today to discuss the 
important issue of the business activity tax on small 
businesses. And, with that, Madam Chair, I yield back.
    Chairwoman Velazquez. Thank you.
    Mr. Rolston and all the witnesses, welcome. You have five 
minutes. In front of you, there is a timer with a green light. 
You start. And then the red light means that your time has 
expired.

STATEMENT OF DAVID ROLSTON, PRESIDENT, HATCO, ON BEHALF OF THE 
   NORTH AMERICAN ASSOCIATION OF FOOD EQUIPMENT MANUFACTURERS

    Mr. Rolston. Thank you for a very glowing introduction.
    Mr. Rolston. Madam Chairman, Committee members, I am Dave 
Rolston, President and CEO of Hatco Corporation, a manufacturer 
of commercial food-warming, toasters, and water-heating 
equipment in Milwaukee, Wisconsin. We have 375 employees, all 
in Wisconsin. And the company is 100 percent employee-owned, or 
an ESOP.
    I am also Chair of the Government Relations Committee of 
the North American Association of Food Equipment Manufacturers, 
for which I speak today. NAFEM represents more than 600 U.S. 
manufacturers, all in manufacturing commercial food 
preparation, cooking, storage, table service equipment, and 
supplies used in restaurants, cafeteria, institutional 
kitchens, and other commercial food service establishments.
     Typical products are freezers, refrigerators, stoves, 
ovens, broilers, food warmers, table displays, and serving 
equipment, cutlery, virtually everything you would find in a 
commercial food service establishment. And I am proud to say 
that much of this equipment is still manufactured in the U.S.
    This is a surprisingly large industry. Total domestic sales 
were over $8 billion. And it is an industry composed 
predominantly of small businesses. Sixty-six percent of our 
members have less than $10 million in sales per year and fewer 
than 100 employees.
    We have members from 46 states of the union. Most, like 
Hatco, are single-state companies with no physical presence 
outside of their home states.
    Efficiency and predictability are essential to a small 
business. The growing practice of states to assess business 
activity taxes on firms that have no physical presence in the 
taxiing jurisdiction has come as an unpleasant and shocking 
surprise. If left unchecked, these taxes will become a 
nightmare for small businesses, increasing our administrative 
costs, adding an unnecessary layer of inefficiency, and 
limiting our ability to grow.
    Let me give you our example. Hatco, like most NAFEM 
members, sells through independent manufacturer's 
representatives who represent 10 to 15 different companies. 
Hatco also uses independent service agents to complete warranty 
repairs on our equipment. Again, these independent companies 
service the equipment of many different manufacturers.
    Neither of these companies causes Hatco to have any 
physical presence in any state outside of Wisconsin. 
Nonetheless, we are now being forced to pay business activity 
taxes in four states where we have customers but no physical 
presence.
    Justification given by these states for these taxes is the 
existence of the representatives and/or the state service 
agents. Of course, our manufacturer's representatives and 
service agents in these states do pay income taxes on their own 
business profits. This is as it should be. We should be paying 
taxes in states where we have presence and receive government 
services. For us, that is Wisconsin. We should not be paying 
business activity taxes, which are a form of income tax, where 
we have no physical presence.
    We don't know what other states will come at us next. These 
tax bills catch us by surprise. When states first contact us, 
they sometimes come on hard. One state originally demanded that 
we pay eight years of back taxes. This would have been 
significant. Others have threatened penalties.
    Litigation, of course, is impractical for a small firm. We 
try to negotiate, and then we pay up. We can't pass the costs 
on. So both the tax payments and, even worse, the 
administrative costs come off our bottom line.
    What are the consequences? Think about where this is going. 
Facing business activity taxes assessed by four states where we 
have no presence is bad enough, but consider 20, 30, or even 
all states assessing these taxes. We would have to add 
significant staff in an attempt to keep track of all of these 
unforeseeable obligations, file the returns, and stay clear of 
all penalties and demands for back taxes. These would, of 
course, be unproductive employees, a hit to our efficiency.
     Bear in mind that we are a 100 percent employee-owned 
company. So any additional costs affect our employees directly. 
And what about the overall impact to the economy? The taxes we 
pay to states where we have no physical presence comes off our 
net profits. So do the administrative costs, which are an even 
larger burden.
    As our net income after expenses is reduced, the taxes we 
owe to Wisconsin are reduced. After you factor in both the 
added taxes and the added administrative costs, both to us and 
the states, I doubt that anyone is coming out ahead on what the 
economists would call a macroeconomic level. Certainly if other 
states jump on this bandwagon, we will just be spreading the 
taxes around with little or any net benefit to anyone.
    As a small manufacturer in the U.S., we face many threats 
from competitors outside our borders. We continue to be 
successful by staying lean and smart. Adding unnecessary head 
counts to administer programs like activity taxes makes us less 
competitive, not only here but overseas.
    For many years, it has been the presumption that businesses 
pay taxes only in the states where they have physical presence 
and receive government services. We believe that Congress 
should act to preserve this standard.
    Thank you.
    [The prepared statement of Mr. Rolston may be found in the 
Appendix on page 30.]

    Chairwoman Velazquez. Thank you, Mr. Rolston.
    Our next witness is Mr. Barry Godwin, who is the Controller 
of Stingray Boat Company. Stingray Boat Company is located in 
Hartsville, South Carolina and has been in business since 1979 
and employs 240 people.
    Mr. Godwin is testifying on behalf of the National Marine 
Manufacturers Association. The association represents 1,400 
companies that produce products used by recreational boaters.
    Thank you for being here and welcome.

    STATEMENT OF J. BARRY GODWIN, CONTROLLER, STINGRAY BOAT 
    COMPANY, ON BEHALF OF THE NATIONAL MARINE MANUFACTURERS 
                          ASSOCIATION

    Mr. Godwin. Madam Chairman and members of the Committee, 
thank you for inviting me to express my views concerning the 
business activities tax, the tax burdens felt by small 
businesses engaged in interstate commerce, and the issues it 
addresses.
    I am the Controller at Stingray Boat Company. Like most 
small business managers, I have multiple responsibilities and 
perform various tasks.
    Stingray Boat Company was founded by Al Fink in 1979, where 
Al remains the president of the company. Al Fink remains keenly 
involved in the company, from its roots to the top. Stingray 
Boats, located in Hartsville, South Carolina, employs 240 
individuals full-time.
    We are, by all standards, the epitome of the American dream 
and a small business proudly dedicated to our employees and 
their families. Stingray builds fiberglass boats from 18 to 25 
feet in length. We ship to almost every state within the U.S., 
Canada, Europe, and Australia.
    In my testimony, I will relate three differing experiences 
that I had with three different states. I am seeking 
clarification of P.L. 86-272, as each state is interpreting how 
tax nexus has occurred between us and them.
    The burden placed upon Stingray is to incur legal fees, 
accounting fees and time to address each state as they seek to 
attach an economic nexus to Stingray'S business activities. 
This is another tax in addition to the sales tax incurred by 
the independent dealer in the jurisdiction of that state.
    Until three years ago, we were unaware of nexus 
implications as it relates to taxes. In 2005, we began to hear 
more about nexus. We became aware of a situation in which the 
State of New Jersey had stopped another boat manufacturer's 
boat load due to nexus issues. We researched what nexus meant 
to us. Our activities within all states are the same.
    We operate according to P.L. 86-272. Our boats are sold to 
independent dealers. All orders are taken within the State of 
South Carolina via the telephone or Internet. Boats are paid 
for before their delivery is taken by the dealer.
    Sales representatives from Stingray may travel to see a 
dealer from time to time but do not operate a Stingray office 
within that state. Dealers visit Stingray each year to review 
new products and test drive the boats. The boats may be 
delivered to the dealer on our trucks or by a contract carrier. 
We reimburse the dealer for warranty work performed by them on 
our boats. We believe we are operating within the law.
    The State of Maine versus Stingray, in 2006, a revenue 
agent from the State of Maine sent a letter to us regarding our 
actions with that state. I responded to Mr. Flynn, representing 
the State of Maine, that we believed that we were operating 
within the confines of the law. After I had completed a nexus 
questionnaire, Mr. Flynn told us that we had created a nexus by 
paying the independent dealer for warranty work performed on 
one of our boats.
    I assume that the dealer paid tax to Maine on the amounts 
received from us as payment for the work done in Maine. 
Stingray did not perform the work, but because we had paid the 
dealer, Maine claimed that our action created a nexus.
    I objected to the revenue agent, but we decided it would be 
less costly to pay the retroactive taxes and fines than to 
pursue the matter in the courts. The State of Maine agreed to 
require us to file tax returns and payments covering the years 
2003 through 2005 and to abate any penalties during this 
period.
    The State of New Jersey versus Stingray, on July the 23rd, 
2007, I received a call transferred over from our truck fleet 
dispatcher at 10:15. The person on the other end was Ms. 
Kostak, a revenue agent from the State of New Jersey. I was 
immediately told that our truck had been pulled over at the 
weigh station on the interstate highway and could not move 
until we paid New Jersey for jeopardy assessment taxes.
    I asked Ms. Kostak why they were doing this. I was told 
that we had a dealer in the State of New Jersey. This incident 
was becoming unbelievable. So I asked her to fax me proof that 
she was who she said she was.
    I asked what I could do to let the driver go, and I was 
told to pay the New Jersey Division of Revenue money. I asked 
how much, and I was told it depended upon our sales into the 
State of New Jersey.
    I looked up the sales for the past seven years as 
requested, and Ms. Kostak quoted me a price of $46,200 to 
release the truck. I then told her I would need to discuss the 
issue with our company president.
    Ms. Kostak told me I had until 1:00 p.m. that day to get 
them the money or the truck would be impounded and we would 
need to make arrangements to retrieve the driver. I asked her, 
``Can I not send you a check or work something out to let the 
truck pass through New Jersey?'' I was told to wire them the 
money.
    I first talked to the truck driver and asked him what had 
happened. Our driver was passing through the State of New 
Jersey carrying a load of boats for delivery into 
Massachusetts. Our driver told me that the agent pulled his rig 
over at the weigh station and asked him if we had a boat dealer 
in New Jersey. The driver had never delivered into New Jersey 
and told the agent, Ms. Kostak, that he did not know.
    Because he did not know whether we have a New Jersey 
dealer, he gave Ms. Kostak our home office number and the 
dispatcher's name. Ms. Kostak called our dispatcher and found 
out we had a dealer in New Jersey, and more probing questions 
were asked and then passed over to me.
    After talking to Ms. Kostak, I discussed the situation with 
our company president. He decided to call another boat 
manufacturer that this had happened to. In summing this up, 
Madam Chairman, I felt that we were the victim of extortion by 
the State of New Jersey. And the only way that we could let our 
boats pass through to Massachusetts was to pay the fees before 
they were turned free.
    And I ask that the Committee please consider clarification 
of 86-272. It is very important to us, a small business. And I 
appreciate your time.
    [The prepared statement of Mr. Godwin may be found in the 
Appendix on page 32.]

    Chairwoman Velazquez. Thank you, Mr. Godwin.
    Our next witness, Mr. Steven Joost, is the Chief Financial 
Officer for Firehouse Subs, headquartered in Jacksonville, 
Florida. Firehouse Subs has been in business for 13 years and 
operates over 300 restaurants across 14 states.
    Mr. Joost is testifying on behalf of the International 
Franchise Association. IFA represents franchisors, franchisees, 
and suppliers throughout the world.
    Welcome, sir. You have five minutes.

  STATEMENT OF STEVEN JOOST, FIREHOUSE SUBS, ON BEHALF OF THE 
              INTERNATIONAL FRANCHISE ASSOCIATION

    Mr. Joost. Thank you.
    Mr. Joost. Thank you, members of Congress, ladies and 
gentlemen, for allowing me to testify before your Committee 
today. Again, my name is Steven Joost. I am the Chief Financial 
Officer and principal in Firehouse Subs. I am also a Florida 
C.P.A. and a member of the city council in Jacksonville, 
Florida.
    We have 312 restaurants operating from Las Vegas, Nevada to 
right here in Washington, D.C. We started in Jacksonville, 
Florida 13 years ago. Through our franchising efforts we employ 
over 5,000 people and have achieved the national sales level of 
over $200 million. Firehouse has helped numerous employees, 
franchisees, and area representatives achieve their American 
dream. And yes, some have become very wealthy.
    On the national level, franchising also has made a 
tremendous impact on the economy and the entrepreneurial spirit 
of Americans. According to a 2008 International Franchise 
Association Educational Foundation study conducted by 
PricewaterhouseCoopers, there are over 900,000 franchised 
businesses currently operating in the United States, employing 
over 21 million workers. This is responsible for $2.3 trillion 
in annual economic output.
    During that time, over the last 13 years, we have come 
across various impediments to our growth. There are the usual 
ones: products, competing for real estate, competing for 
employees. These are all natural impediments that every 
business competes for. And we work very hard to outwork our 
competitors.
    However, there have been many artificial barriers, 
complexities, and tax traps that have been created by 
government that have hurt my business over the years that have 
led to unwarranted expenses and wasted money. I am here today 
to help explain what myself and my company have been through 
and to add suggestions as to how you may be able to help.
    One of the more perplexing problems facing a growing 
business is that of interstate commerce. Of course, as you are 
well-aware, with our federal system of government, each state 
is allowed to make its own laws. This has led to the 
implementation of many different laws with many different 
standards.
    Examples are differing disclosure requirements for our 
disclosure documents, differing sales tax methods and rates, 
differing income tax laws and application thereof, just to name 
just a few. These differing laws and standards upon which they 
are applied have necessitated my company to hire a plethora of 
tax accountants and lawyers to help us comply with the 
regulations, file the various tax returns and documents that 
each state requires. We have to employ various strategies to 
help limit our liabilities. And sometimes, quite frankly, I 
wonder what business I am in.
    One of the more disturbing problems created by governments 
is that of state income taxes and franchise taxes. As economic 
growth has slowed, so has state revenue growth. According to 
Allison Grinnell of the Rockefeller Institute, when adjusted 
for inflation, state revenue actually dropped .6 of a percent. 
So, therefore, the squeeze is on for the states to find more 
money to help them fund their budgets.
    One of the ways they do this is through nexus. Very simply, 
nexus is a connection. It means connection. Certain activities, 
as insignificant as they may seem, may establish a nexus.
    A company may have unknowingly had nexus with a state for 
many years. It might even be responsible for back sales tax, 
franchise tax and/or income taxes, penalty and interest for 
past years.
    Examples of creating nexus that an ordinary person would 
never think of are having a sales representative just solicit 
business, traveling for a meeting within a state, traveling to 
inspect a store, or even the mere just asking for somebody for 
their business in a state can trigger nexus. It depends which 
state you're in and which 50 rule is being applied to you.
    And then, worse yet, the nexus standards between states 
vary widely and wildly. Furthermore, the nexus standards within 
a state within different years can change depending on who the 
latest administration comes in and who is interpreting the law.
    For example the nexus standards for franchise taxes are 
much broader than they are for income taxes. This means a 
company that could be exempt from paying income taxes in a 
certain state and think they're home free, all of a sudden, 
gets a bill for paying a franchise tax liability if they do 
business in that state depending on how nexus is defined.
    Each state has its own department of revenue and 
interpretations on how the laws are applied change. Once a 
nexus is established, then the states get into the game of 
apportionment. Apportionment is the formula to figure out how 
much income is attributable to a specific state's income tax. 
Apportionment rules are often changed by the individual states 
to help them garner advantage over other states.
    Currently, my view on the subject matter is the way states 
are imposing burdensome rules and changing them every year is 
an unfair tax on intellectual property rights. And, secondly, 
it has created a subsidy for lawyers and accountants.
    I believe the fact that the whole Firehouse concept was 
created in Jacksonville, Florida--okay? And in its very 
essence, royalty is paid for our trademarks and the fact that 
our property is in Jacksonville. I helped create it. I spent 13 
years creating it. You know, our business model, our 
trademarks, our marketing all is created in Jacksonville. And, 
in essence, a royalty is rent for these trademarks.
    So if I own a piece of property in Jacksonville, Florida, 
why, in essence, am I paying property taxes in all of these 
other states? It's beyond me.
    So I believe these rules have created an unintended attack 
on the franchise business. While I am not and my company is not 
opposed to paying taxes, what we are opposed to is spending 
hundreds of thousands of dollars to figure out how to do it 
because we have to hire an army of accountants and lawyers to 
do so.
    What is needed and what I would recommend is either to get 
rid of nexus or at least apply a single set of rules defining 
what constitutes nexus and how it will be applied in a uniform 
manner in all 50 states so when I go into a mine field I at 
least know where the mines are.
    Chairwoman Velazquez. Mr. Joost, your time is up.
    Mr. Joost. Okay.
    Chairwoman Velazquez. Okay? So during the question and 
answer period, you will be able to expand on how you feel we 
can--
    Mr. Joost. Thank you for hearing me out today. I appreciate 
it.
    [The prepared statement of Mr. Joost may be found in the 
Appendix on page 42.]

    Chairwoman Velazquez. --clarify this issue. And thank you 
very much for your testimony.
    Our next witness is Mr. Michael Petricone. He is the Senior 
Vice President of Government Affairs at the Consumer 
Electronics Association. Mr. Petricone is responsible for 
developing and implementing the public policy priorities.
    CEA is a frequent public speaker on issues impacting the 
consumer electronics industry. CEA represents more than 1,000 
U.S. manufacturers of audio, video accessories, mobile 
electronics, communication information, and multimedia products 
that are sold through consumer channels.
    Welcome, sir.

    STATEMENT OF MICHAEL PETRICONE, SENIOR VICE PRESIDENT, 
      GOVERNMENT AFFAIRS, CONSUMER ELECTRONICS ASSOCIATION

    Mr. Petricone. Good morning, Madam Chairman and Committee 
members. Many of you know the Consumer Electronics Association 
as the representative of America's most innovative companies, 
but the fact is 80 percent of our members are small businesses. 
In reality, CEA is a small business association.
    Also, I grew up in a small business family. So I am 
delighted to be here talking about this issue.
    No taxation without representation is America's first 
governing principle. Having established our nation under that 
cry, our founders went further. They created a single national 
economy and imposed constitutional safeguards to ensure that 
the states cannot impede interstate commerce.
    Unfortunately, the system our founders put in place is 
eroding. As you heard today, about a dozen state and local 
governments are imposing income taxes on businesses with no 
physical presence in the taxing state. The states have adopted 
a variety of ill-defined so-called economic nexus theories to 
justify these levies.
    The problems caused by this growing patchwork of taxation 
are obvious. And they fall disproportionately on our members. 
This Committee knows that small businesses run close to the 
bone. To thrive, they need reasonable taxation and a settled, 
predictable business climate, but increasingly they face 
significant costs of determining their state tax liabilities. 
They must meet multiple filing requirements, keep multiple 
records, and deal with multiple sets of regulators. And it is 
becoming difficult for them to make any reasonable estimate of 
their projected tax burden. You can imagine the challenges of 
long-term business planning in such an environment.
    Of course, small firms also have few resources that 
challenge questionable assessments in faraway states. As a 
practical matter, when faced with these levies, many of our 
members have little choice but to bite the bullet and write the 
check. As a technology association, we are especially concerned 
with the burdens the situation places on electronic commerce.
    At the very moment that the Internet grants every small 
business access to a national marketplace, a crazy quilt of 
local tax obligations throws a roadblock across the electronic 
highway. Small businesses will avoid sales to the various 
states. And consumers, especially those in remote areas, will 
be unable to go online and get the goods they need, This 
situation will not resolve itself. In fact, it will likely get 
worse.
    Our-of-state businesses present tempting targets to 
legislators trying to raise revenue. Naturally states have 
every political incentive to export their tax burdens as 
aggressively as possible.
    Meanwhile, state courts have made conflicting decisions. 
And the Supreme Court has declined to address this issue. The 
Supreme Court recently refused to hear two cases challenging 
the constitutionality of the economic nexus approach. States 
see the Supreme Court decision or of non-decision as a green 
light to press forward with more economic nexus legislation.
    Pursuant to your authority under the commerce clause, it is 
time for you to act. There is ample precedent here. A few 
examples. You have moved to prevent multiple state taxes on 
electronic commerce. You have ensured that states cannot impose 
fly-over taxes on airlines. And you have restricted taxation of 
mobile communication services by the state where the service is 
primarily used.
    Specifically, we urge you to support H.R. 5267, the 
Business Activity Tax Simplification Act. This bill provides 
that pursuant to the commerce clause, a state may not impose 
business activity taxes on a business that has no physical 
presence in the state. It contains protections to ensure that 
businesses cannot restructure their activities to avoid paying 
legitimate taxes.
    This bill's physical presence will instantly clarify as the 
state taxation landscape. It is easy to understand. It is easy 
to enforce. Its bright line standard ensures that small 
businesses know with certainty when and where they will be 
taxed. For an owner, this means fewer resources spent on tax 
compliance litigation and more invested in building her 
business.
    Such an approach would also ensure compliance with our 
international treaty obligations. In every tax treaty to which 
the U.S. is a party, the universal requirement for imposing 
income taxes on non-residents is a physical presence in the 
taxing jurisdiction.
    Our members are good corporate citizens. We do not object 
to paying our fair share of taxes. We simply believe that the 
states that provide meaningful benefits to a business, water, 
roads, fire, police protection, should properly receive a 
state's business taxes, rather than a distant state that 
provides no benefit.
    The Constitution is clear. The right to regulate beyond 
individual states' borders lies not with the states but with 
Congress. A bright line physical presence eliminates ambiguity, 
stimulates investment, and promotes interstate commerce. It is 
good for small business. It is good for the economy.
    We urge Congress to support H.R. 5267, the Business 
Activity Tax Simplification Act. Madam Chairman and members of 
the Committee, I commend you for holding this hearing, and I 
look forward to answering your questions.
    [The prepared statement of Mr. Petricone may be found in 
the Appendix on page 46.]

    Chairwoman Velazquez. Thank you, Mr. Petricone.
    Our next witness, Dr. Peter A. Johnson, is a senior 
economist and Vice President for Research Strategy and 
Platforms with the Direct Marketing Association. At the DMA, 
Dr. Johnson's research focuses on economic and policy issues 
pertaining to direct and interactive marketing.
    The Direct Marketing Association is the leading global 
trade association of businesses and nonprofit organizations 
using and supporting multi-channel direct marketing tools and 
techniques.
    Welcome, sir.
    Mr. Johnson. Thank you, Madam Chairman. Thank you, ranking 
member. And thank you, other members of the Committee.

  STATEMENT OF PETER A. JOHNSON, Ph.D., VICE PRESIDENT/SENIOR 
            ECONOMIST, DIRECT MARKETING ASSOCIATION

    Mr. Johnson. On behalf of the Direct Marketing Association, 
it is my pleasure to be here and making my inaugural appearance 
before any congressional committee.
    It is and has been the longstanding position of the Direct 
Marketing Association and its members that a clear physical 
presence test, such as found in the current legislation and its 
predecessors, is consistent with the Constitution and the 
overall stricture of our federal system.
    My colleagues George Isaacson and Mark Micali, who is with 
me here today, have spoken before this House Committee, these 
various House committees, to this effect emphasizing the legal 
perspective.
    What I hope to do is to bring the economist newspaper 
because in a sense, my association represents everybody along 
this table. Direct marketing is not any one particular 
industry. Direct marketing is basically a way of bringing end-
users and primary sellers together.
    There have always been two kinds of marketing across the 
states. In fact, anybody who checks their pantry in their 
kitchen knows that almost everything in the household or on a 
business today at some point crosses state boundaries. The 
question is how.
    What I want to propose to you today, members of the 
Committee, is an essentially economic framework within which I 
believe you should understand not only the current version of 
the bill but what happens as it goes through your various 
future deliberations because I think that the route here is 
fundamental misunderstanding of what is involved in the latest 
form of interstate commerce.
    Essentially what is going on here is that there have always 
been two kinds of interstate commerce, one that's focused on 
mass marketing. And you all know mostly what it looks like. 
It's big physical structures, like, you know, the big box 
retailers or your local branch or store.
    Mass marketing worked across interstate boundaries because 
there were efficiencies of scale that allowed bringing bulk 
products to big, bulky markets and concentrated areas.
    But although it wasn't often seen during the heyday of 
broadcast television and radio, there was always another kind 
of marketing that crossed state boundaries. And that was direct 
marketing or what is now often called interactive marketing. It 
was originally the post office set up by Ben Franklin.
    And what is different about this is that it uses economies 
of scope to bring not the product to the customer but 
fundamentally to bring the customer to the seller or the 
product.
    Now, it may not be apparent that this is what is going on. 
But for anyone who has really thought about what is at stake at 
the Internet, that is really what is occurring is that in 
investing in information, whether it was direct mail 
solicitations and the statistics that underlie that--and I 
explain this in probably lugubrious detail in my written 
testimony--or it's now the Internet and investment in search 
ads.
    The basic logic is, bring the customer to the seller or the 
product, as opposed to bringing the sell or the product to the 
end customer. Why does this matter for business activity? For 
all of the different industries and different kinds of products 
and services available through my members and so on and 
everybody here.
    Essentially there are much lower start-up costs and much 
lower overhead investments that make this kind of marketing 
unusually attractive to small businesses. And business activity 
taxes discriminate against this way of bringing the end 
customer to the primary seller in a way that I don't think the 
states really fully understand the underlying logic.
    To put it most simply, at the end of the day--and this is 
going to sound like a paradox. I would be happy to offer a 
pedantic statistics tutorial to explain why this is. In direct 
or interactive marketing, the smaller the business, the more 
likely it is that their end customers will be disbursed across 
multiple jurisdictions. In mass marketing, the more likely it 
is, the smaller the business or the more concentrated or, in 
other words, the fewer the jurisdictions to which they will be 
exposed.
    Now, our state/federal tax system was set up on the 
assumption that almost all interstate commerce fell along the 
lines of mass marketing. Now, because of the increased 
efficiencies of statistical analysis and the Internet itself, 
transacting across boundaries by bringing the customer to the 
primary seller is making, a, the small business opportunity 
increasingly valuable to the small business so that we see in 
retail, non-store retail, for example, the number of small 
firms has increased far faster than the number of large firms.
    In fact, the number of large traditional store retailers 
has been decreasing over the Internet decade while the number 
of non-store retailers has been increasing dramatically, the 
efficiency has been increasing dramatically. The bottom line 
is--and that is just retail--it's similar. Is it manufacturing, 
finance, insurance?
    This way of bringing customers to the primary seller, using 
interstate carriers and interstate communications media, which 
are not directly owned by the customer or the seller, offer 
unusually low barriers to entry and increased inefficiencies in 
terms of promoting overall growth.
    Thus, given the fact that for statistical and financial 
investment reasons the smaller the company the more 
jurisdictions, the business activity tax levied potentially 
across all 50 states and all of the thousands of sub-state 
jurisdictions to which a small business who is marketing 
directly is exposed, obviously inherently the more exposed they 
are to this tax and the resulting burdens.
    The bottom line, as I said, is, unlike other forms of 
marketing, the basic fundamental logic requires small 
businesses to run this risk to incur more exposure to more 
state and sub-state jurisdictions.
    We looked at what is currently being lost as a result--
    Chairwoman Velazquez. Dr. Johnson, the time is up.
    Mr. Johnson. All right.
    Chairwoman Velazquez. We will continue having this 
conversation--
    Mr. Johnson. Thank you, Madam Chairman.
    [prepared statement of Mr. Johnson may be found in the 
Appendix on page 50.]

    Chairwoman Velazquez. --in the question and answer period. 
Thank you.
    Mr. Joost, I would like to address my first question to 
you.
    Mr. Joost. Sure.
    Chairwoman Velazquez. You mentioned that certain states 
have been especially aggressive in attempting to collect 
business activity taxes from your firm. Have you scaled back 
operations in these states? And how has this affected the 
economics of your business?
    Mr. Joost. To answer your first question, yes. Specifically 
I'm not trying to point fingers, but the State of South 
Carolina comes to mind. Just the fact that we have stepped foot 
in that state creates what they call a nexus. And now they want 
part of our income tax, state income tax.
    While it has not scaled back our activity per se, it does 
cost us money and, therefore, lowers our profit margins. At the 
end of the day, you just look at it. And it's the cost of doing 
business.
    And what happens, what we have done in our company since we 
started our company 13 years ago, we did not take a dividend 
for ten years. We put every dollar and dime we made back into 
our business.
    So theoretically answering your question because now we 
don't have as much money to put back into our business and grow 
it, that effect, yes, has stopped/slowed growth.
    Chairwoman Velazquez. Do you believe it is possible to 
establish a clear standard that would allow businesses to know 
that if they do X, Y, or Z in a state, that that will be 
subject to that state's taxing regime?
    Mr. Joost. Absolutely. And I think the Committee right here 
is going to do it.
    Chairwoman Velazquez. Thank you.
    Mr. Petricone, those in favor of business activity taxes 
argue that these taxes broaden the tax base and allow for lower 
taxes for locally owned businesses. What is your reaction to 
the criticism that a clear jurisdictional standard will limit 
the tax base to only those in state companies? How would you 
respond to those who argued that this could lead to higher 
taxes for local small businesses?
    Mr. Petricone. Thank you, Madam Chairman.
    First of all, I would take issue with any notion that this 
approach would lead to an aggregate lowering of taxes on 
businesses because the businesses will still be paying the 
taxes in the state where they are domiciled.
    Beyond that, I think certainly there in any way range of 
factors that affects any given state's tax revenues at any 
given time. But I do keep coming back to what I believe is a 
basic principle of fairness that if a company is not domiciled 
in a state and does not have a presence in that state, that 
state should not be subject to the state's taxes.
    And some of the stories you hear from Mr. Godwin, for 
example, of trucks being seized as they go across state borders 
I think are exactly the sorts of situations envisioned by the 
founders when they drafted the commerce clause.
    Chairwoman Velazquez. Mr. Godwin, you mentioned that you 
canceled your membership with the Northwest Marine Trade 
Association to prevent any potential nexus with the State of 
Washington. And you also stated that Maine asserted a nexus was 
established due to the fact that you paid an independent 
service dealer to perform warranty work on one of your boats.
    Is it possible for you to take the same approach you did 
with the State of Washington to prevent any nexus or does your 
business model require this type of relationship with local 
service dealers?
    Mr. Godwin. Madam Chairman, every independent dealer we do 
ask them to service the boats if there is a problem that needs 
to be corrected and a consumer brings it in. And we reimburse 
them for their work that they do.
    So we operate the same way in every state. And our business 
model does require that we do that. It's basically the way the 
industry works.
    Chairwoman Velazquez. Mr. Rolston, you stated that one of 
the greatest challenges for small businesses is that they are 
completely unaware that they are even subject to these taxes. 
Many only find out after they receive a tax bill from a state. 
Can you discuss your experience when you receive a notice or 
notices about potential business activity, tax liability? And 
was there any documentation as to what type of activity on your 
part triggered taxation?
    Mr. Rolston. Yes. We are currently paying taxes in 
Michigan, Washington State, Iowa, and Ohio. And in every case, 
they cited either the presence of an independent manufacturer's 
rep, who represents our equipment and those of many other 
companies--so they are independent business people--and/or the 
independent service agents. Much as the boat dealer situation 
we have service agents that are separate from our dealers, but 
they are service agents who service the equipment on our 
behalf. They service many other people's equipment also. So 
yes, in both cases, it was the presence of an independent 
businessman.
    Chairwoman Velazquez. Okay. Thank you.
    Dr. Johnson, in the past, the issue of business activity 
taxes has mostly been a concern for large corporations doing 
businesses across the country. However, we have seen some 
dramatic changes to our economy shifting away from one focused 
on manufacturing to a more service-based economy.
    Given that dynamic, why are business activity taxes now 
more of a problem or issue for small businesses than in the 
past?
    Mr. Johnson. Well, thank you.
    You are absolutely right about why are they more, because 
essentially on both the end seller side and the middle men; 
that is to say, the firms that create economic passageway 
connections between end sellers and markets, both of those are 
affected by business activity taxes. And, unfortunately, both 
the end sellers and the intermediaries, whether it be the 
common carriers or the communication networks, have 
particularly low barriers to entries for small firms.
    And so given that interactive marketing, direct marketing, 
is drawing more and more business activity, business overall is 
growing faster in this area and the firms are getting smaller, 
the net balance now as states introduce more business activity 
taxes is falling increasingly on the small firms who are 
wanting to use these indirect connections to bring customers to 
them.
    Chairwoman Velazquez. Thank you.
    Now I recognize Mr. Chabot.
    Mr. Chabot. Thank you very much, Madam Chair.
    I think you described the onslaught that you faced in many 
of these examples that you had when the states were coming 
after you.
    I think, Mr. Rolston, you said you negotiated but then 
ultimately paid up. Mr. Godwin, I think you referred to it as 
extortion, which was the word that I had floating around in my 
head when you were describing your situation.
    It was either you, Mr. Joost, or Mr. Petricone. I'm not 
sure. One of you said you ultimately bit the bullet and cut the 
check. I guess that was you.
    The three of you, could you describe what sort of thought 
process went on, the conclusion that you ultimately reached 
when you came to the decision that you had to surrender and 
pay, even though I think to your core you felt this was not a 
fair situation that you were facing? And maybe I'll begin with 
you, Mr. Rolston, if that's okay.
    Mr. Rolston. Well, it is like a lot of situations where you 
are faced with a potential litigation. You choose which is more 
or least expensive. In this case, specifically they wanted the 
eight years' payment in the past. We were able to negotiate 
that down to a more reasonable number, something that we 
considered acceptable. And then we paid it, as opposed to 
litigating, because litigating would have been much more 
expensive and, from what I understand, not very successful.
    So in each case, that was our situation. It came down to a 
strictly economic decision.
    Mr. Chabot. Mr. Godwin?
    Mr. Godwin. For us, New Jersey, we didn't have a choice. 
Our boats were stranded on the interstate. And the only way 
they could get to the dealership in Massachusetts was for us to 
wire the money to the State of New Jersey within this time 
frame they specified. And if we didn't do that, our boats were 
being impounded and we were told that it was left up to us to 
take care of our driver. So I didn't have a choice. I mean, it 
was ``Show me the money, and we'll let you go or you're 
stuck.''
    But, then, during that time frame, we also talked to a 
fellow boat-builder who had been through a similar situation. 
They had incurred over $100,000 in legal fees. And so we 
decided that we would rather go ahead, pay this, and deal with 
the New Jersey tax courts possibly at a later time and file the 
tax returns as they requested so that we could in the future 
also continue to ship boats through their state because we were 
told that if we didn't do what they were asking, the next time 
we showed up through the state, that we would be going through 
the same situation.
    Mr. Chabot. I will yield.
    Chairwoman Velazquez. Will you yield?
    Mr. Chabot. Yes.
    Chairwoman Velazquez. Mr. Godwin, have you been forced to 
curtail operations?
    Mr. Godwin. We haven't yet. We are basically taking this as 
each state comes at us and dealing with that situation. It's 
just this particular situation, we didn't have a lot of time to 
react or deal with it in a business manner.
    Chairwoman Velazquez. Thank you.
    Mr. Chabot. Reclaiming my time, Mr. Petricone?
    Mr. Petricone. Thank you.
    In my position, I regularly get anguished calls from 
members who received a significant tax bill they didn't expect 
and don't understand. Often the state approach is very 
aggressive, involving threats of seizure of inventory, you 
know, back taxes going back multiple years.
    As far as the advice I give them, it is not very helpful. I 
ask them if they have the resources to devote to litigating and 
contesting the issue. For the vast majority of small 
businesses, the answer is clearly no, in which case I advise 
them to comply.
    What makes it worse is there is a Pandora's box effect, 
where if a big business complies in one case, they soon find 
other states coming after them. So, unfortunately, there are no 
good answers.
    Mr. Chabot. Thank you.
    Mr. Joost, obviously you are trying to grow your business 
to the extent you are able to. What impact does this have on a 
business owner like yourself who is trying to grow businesses 
and, most importantly, create jobs, which is obviously 
important to the overall economy?
    Mr. Joost. Thank you for asking that question.
    Going back to the Madam Chairwoman's question, while you 
can't say there is necessarily a direct correlation because you 
have incurred these higher costs, intuitively you know there is 
an opportunity cost.
    Like for my company, for example, going back to the fact 
that we did not pay dividends for the first ten years of our 
existence, we constantly put the money back in our company, 
growing company stores, hiring people to build the foundation 
so we could start our franchising operation.
    So, just intuitively, if you know the fact that you don't 
have as much money to reinvest in your company, you can't go 
out and hire more people. You can't go out and get more 
franchisees. And you can't go out and create more jobs. So 
there are opportunity costs there. Whenever you impose higher 
costs on these companies, the opportunity is gone to invest 
that money to create more jobs and create an economic 
multiplier.
    Mr. Chabot. Thank you.
    Dr. Johnson, those states that are most aggressive in 
pursuing these types of taxes, do you have an opinion as to 
whether the ultimate business activity in that state would, in 
all likelihood, be suppressed in some manner? In other words, 
those states that are taxing higher, do businesses take their 
business elsewhere or avoid those states, if possible? Any 
comments that you would have on that?
    Mr. Johnson. I do. I think that cumulatively--and I 
emphasize cumulatively--as one of my colleagues said, the 
Pandora's box effect is that, in fact, you get--to draw a 
different analogy, a kind of tragedy of the commons, similar to 
where in medieval England, there would be a town with a central 
pasture that all of the local farmers would graze their sheep 
on. Well, the first farmer to graze the sheep on that pasture, 
his sleep flourished. But by the time the 50th sheep farmer 
shows up with his sheep, the pasture is completely denuded.
    So yes, I believe that as more and more states become 
aggressive, the cumulative effect will be negative. And, in 
fact, let me tell you that I believe because the tax falls both 
on the small business intermediaries and the small business 
marketers who use those intermediaries, we did some preliminary 
calculations.
    Our estimate is that there are approximately $755 million, 
at least, of sales to these small businesses, who are the 
intermediaries that are being lost across the states that are 
doing this and that the opportunity cost, the lost revenue, 
amounts to about $8.9 billion, or 44,000 jobs, across the 
economy as a result of the states doing this.
    Mr. Chabot. Could you repeat that one more time, the 
numbers?
    Mr. Johnson. Sure. So assuming that the CBO is essentially 
correct in some earlier versions of this bill in adjusting 
downward for the new version of the bill that's currently 
before your Committee, we estimate that there are some $755 
million that are not currently being spent on the small 
business intermediaries who are helping to bring customers to 
original sellers and that the opportunity cost; in other words, 
the lost sales that marketers are not receiving from those 
customers as a result, amounts nationwide to $8.9 billion, 
which if that $8.9 billion could be restored in 2008 to the 
American economy through the passage of this, the physical 
presence test, de minimis provisions, would result 
incrementally in 44,000 jobs. That's 44,000 jobs that BAT taxes 
we believe are currently preventing the U.S. economy from 
producing.
    Mr. Chabot. Thank you very much. I yield back the balance 
of my time.
    Chairwoman Velazquez. Thank you.
    Mr. Petricone, the legislation being considered will 
clarify physical presence as the standard for establishing 
nexus as the basis for taxation. Using this nexus test, would 
it be possible for the company to have employees in a state and 
solicit sales from residents in the state yet not be subject to 
any business activity taxes?
    Mr. Petricone. Madam Chairwoman, we believe not. And we 
believe that the existing legislation, BATSA, is put together 
in such a way as to prevent companies from gaining system, in 
effect. It is a 14-day period. And after the 14 days, you are 
considered to have a nexus in the state. So we think that is a 
bright line and easy to understand and easy to enforce.
    Chairwoman Velazquez. Okay. Mr. Akin, let me ask just one 
more question. I didn't see you. I'm sorry.
    How would you respond to critics who suggest that this 
standard may deny states the right to tax businesses that are 
using the services of that state? Mr. Petricone?
    Mr. Petricone. Right. The state will still be able to tax 
the in-state. To the extent there is an in-state representative 
that is domiciled in that state, then they will still be 
susceptible to taxes. If there is somebody in state A who is 
manufacturing a machine and then that machine is sent to state 
B and sold by somebody in state B, then the seller in state B 
will be taxable by state B. And included in the tax will be the 
value of the machine made in state A.
    So, again, the aggregate pie remains the same. And then the 
state gets the benefit.
    Chairwoman Velazquez. Thank you.
    Mr. Akin?
    Mr. Akin. Thank you, Madam Chair.
    This is my eighth year of being here. And I have sat in 
some very, very interesting Committee hearings. But I have 
never sat in a Committee hearing on highway robbery before. And 
so I would really like to compliment you on your choice of a 
topic. I mean, this is really something new and innovative.
    I don't know if any of you are really trained in terms of 
monetary theory, but my sense is that we just passed a thing 
called an economic stimulus package. I don't know how much 
stimulating it is really going to do but maybe some small 
amount.
    If I were going to choose an economic stimulus package, I 
would think stamping this practice out would be at the head of 
my list just in terms of common sense because the place where 
we really get the economy going is small business because they 
can react rapidly and they can invest in different equipment or 
procedures, which allow companies to grow and create a lot of 
jobs.
    It seems like this is a tremendously destructive practice. 
And if one state starts it and it starts cascading--I don't 
know if anybody wants to comment on that.
    As I said, I haven't ever sat in a Committee on highway 
robbery. Thank you, Madam Chairwoman, for this wonderful and 
interesting twist of things, the dumb things that government 
can do.
    Mr. Rolston. Yes. I will comment. I mean, that is the 
primary reason I am here. Right now the four states that we're 
paying to are a burden, but it's not a huge burden. My fear is 
that when it gets to 50 states, that it will be a huge burden 
and we will have 5 or 6 people on our staff just to deal with 
the technicalities.
    Mr. Joost. I would also like to comment. I am not so much 
against the taxes. It is literally we have paid accountants and 
lawyers hundreds of thousands of dollars to figure out how to 
comply with the laws. I don't mind paying taxes. I just hate 
paying an army of people to figure out how to do it. If I could 
just simplify it even, it would save us a ton of money just 
from a compliance level.
    Mr. Akin. Thank you, Madam Chair.
    Chairwoman Velazquez. Mr. Chabot, do you have any 
questions.
    Mr. Chabot. No. Thank you.
    Chairwoman Velazquez. I have two questions. Dr. Johnson, 
one of the concerns related to a potential qualification of 
physical presences, that it would lead to tax avoidance or tax 
sheltering by corporations. For instance, a business located in 
one state could diversify its operation and have entities 
operating in another state, thus creating a tax shelter.
    Would enactment of a physical presence standard or any 
other standard lead to another round of tax planning and tax 
avoidance, causing states' revenue streams to erode further?
    Mr. Johnson. I don't believe so, no. In fact, on the 
contrary, I believe that, as one of my colleagues to my right 
has said, a clear physical presence de minimis standard 
clarifies, establishes a bright line relationship.
    So that not only would tax avoidance be minimized, but all 
of the business activity by small businesses that is currently 
not occurring could now be adequately planned for and budgeted.
    So there is no question in my mind whatsoever that a clear 
boundary is to everyone's benefit, including, obviously, the 
states, who would then be able to tax properly the resulting 
revenue from increased activity by small businesses.
    Chairwoman Velazquez. Mr. Davis?
    Mr. Davis. No questions.
    Chairwoman Velazquez. No questions? Okay.
    Yes. I would like to ask this question. Anyone in the panel 
could answer. We have always talked about having a fair and 
balanced tax system. In terms of progressivity and 
regressivity, on a scale of one to ten, with one being very 
regressive and ten being progressive, where would business 
activity taxes fall on that scale? Dr. Johnson?
    Mr. Johnson. Madam Chairman, which end is which?
    [Laughter.]
    Mr. Johnson. Which was the progressive number? Which was 
the regressive number?
    Chairwoman Velazquez. One regressive.
    Mr. Johnson. One regressive?
    Chairwoman Velazquez. Yes.
    Mr. Johnson. I would say probably a three or a four.
    Chairwoman Velazquez. Three or four?
    Mr. Johnson. In terms of business activity tax--
    Chairwoman Velazquez. Yes.
    Mr. Johnson. --in terms of total regressivity?
    Chairwoman Velazquez. Yes.
    Mr. Johnson. I would say about a three.
    Chairwoman Velazquez. Any other person? Yes, Mr. Petricone?
    Mr. Petricone. Well, it's not outright confiscation. So I 
guess I can't give it a one. I guess I will go with two or 
three. Again, you know, as you are so aware, small businesses 
operate so close to the margin. And what they need is a fair 
tax environment and also some elements of predictability. And 
this is unfair, and it's entirely random. So it's very 
troublesome.
    Chairwoman Velazquez. Mr. Davis, do you have any?
    Mr. Davis. Thank you, Madam Chairman.
    Mr. Rolston, I understand you do business in more than one 
state. Can you tell me what effect this has on your business?
    Mr. Rolston. Well, we do business in almost every state. 
And at this point, I would say this is more of an annoyance 
than it is a hindrance. We have not stopped business in any 
state because of this. We have not minimized business in any 
state. But we have had to increase our effort to deal with 
these issues in the four states that we currently are 
addressing these issues with. So if it continues to grow, it 
will become a larger burden.
    We will deal with it. We are a reasonably large company. 
There are many companies in the North American Association of 
Food Equipment Manufacturers that are very small and will have 
to either use outside counsel at a very high price or hire 
people to deal with it. You know, adding three people to my 
payroll is not going to put me out of business, but a company 
that has ten people, adding three is a much more significant 
burden.
    Mr. Davis. So when you say increased efforts to deal with 
it, it actually is more people?
    Mr. Rolston. Oh, yes, without a doubt, because we have to 
deal with paying local taxes in all of these different states. 
So we need people just to administer that.
    Mr. Davis. And what effect does that have on your business, 
actually the business that you're really in? Would it be better 
to go out and hire three more people to sell more product or 
make more product?
    Mr. Rolston. Oh, absolutely. I would much rather hire three 
more salesmen than three more accountants.
    Mr. Davis. Thank you.
    Chairwoman Velazquez. Mr. Petricone, you would like to 
comment?
    Mr. Petricone. If I could just add? I guess the one thing 
that I would like to notice, this isn't a static issue. You 
know, right now we're dealing with a dozen states.
    But, you know, every state understandably has every 
incentive to export its tax burden. So if we end up in a 
situation we're talking about 20, 30, 50 states and thousands 
of local jurisdiction, you know, the current situation could 
get exponentially worse.
    Mr. Johnson. And, Madam Chair, if I could emphasize, again, 
from an economic modeling point of view, it may be true that on 
a case-by-case basis, no particular company will say, ``Oh, I'm 
not going to operate in state X because of the business 
activity tax.''
    What will happen, however, is that the intermediaries that 
make interactive direct marketing possible will have their 
costs grow imperceptively but enough across the entire economy 
as a result of these taxes such that businesses who at the 
margin might have used them will not.
    And that is in a sense the dog that doesn't bark, the old 
Sherlock Holmes principle. What should have happened? The dog 
should have barked. In this case, there should have been 
business activity.
    Why does it not happen? Because intermediaries are being 
inappropriately taxed, both in terms of the compliance costs 
and the direct burden. Costs go up. Businesses choose not to 
sue them to get to out-of-state markets.
    Chairwoman Velazquez. Sure.
    Mr. Davis. As those costs go up, they're doing business in 
more and more states. I've never really known a business that 
has control of paying the taxes. That is usually passed on to a 
consumer. And what effect does it have on the consumer in the 
economy as we go into this economic down turn that we're 
looking at right now?
    Mr. Johnson. Well, again, if I may be the first to speak to 
that, you know, that $8.9 billion that I mentioned before, that 
is $8.9 billion of incremental spending, spending that would 
not otherwise have existed, whether it is spent by the end 
customer as a consumer or end customer as a small business, it 
ultimately really does not matter.
    And you're right. At the DMA, we just did our quarterly 
survey of our members' projected economic performance. And, you 
know, essentially the number of firms in our association who 
are concerned about recession has essentially doubled just in 
the last quarter.
    I think $8.9 billion in these circumstances in additional 
sales and the 44,000 jobs, which would be necessary to support 
that additional demand, is something everybody should be taking 
very, very seriously in this period.
    Mr. Davis. Anyone else want to speak to that?
    Mr. Joost. In our business, in each city, we have seven 
pricing tiers. For example, in Orlando, which is more expensive 
to do business, say, than Jacksonville or some of our other 
cities because of economic factors and one of them is local 
taxation, the people in Orlando pay a dollar more for the same 
product than they do in Jacksonville because the cost of 
business is higher. Any time you make the cost of business 
higher, at some point you've got to pass it on to the consumer.
    So to break it down in my world, I can see directly because 
of all of the different pricing tiers we have to have, where it 
costs more to do business, people pay more.
    Mr. Davis. Anyone else? Mr. Godwin?
    Mr. Godwin. I would like to say that right now the boating 
industry in America is down. It is already soft. So we can't 
really pass along additional costs to our dealership network 
because boats are a luxury, a pleasure item. And so, you know, 
we can't pass that cost. The boating industry is down.
    In looking forward, you know, we want to keep people having 
the ability to come in and buy these boats. And if we continue 
to shift the cost down to them, they're not going to be able to 
get into boating.
    So thank you.
    Mr. Davis. Just to follow up on that, then, on the other 
side, if you can't increase the cost to the consumer, you're 
probably going to have to put it on your employees. And you 
potentially have a loss of jobs. Is that--
    Mr. Godwin. That is very true, very true.
    Mr. Joost. Or stop paying their health care.
    Mr. Rolston. Yes. We are in the same situation. We have a 
nationwide pricing. So we can't pass it on to the consumer in a 
particular market because that market is more expensive for us. 
So any abnormalities we have to eat. And then that affects our 
profitability and essentially our employment.
    Mr. Davis. Well, my time is up. I would just say I have 
always believed that you can't tax and regulate yourself into 
prosperity. And I think that is what I hear you saying.
    I yield back. Thank you.
    Chairwoman Velazquez. Thank you.
    I want to thank all of the witnesses. Clearly this is a 
complex and important issue for small businesses when it comes 
to interstate commerce and BAT. What I intend to do is to send 
a letter to the Judiciary Committee commenting on this issue so 
that they could keep the small business perspective of this 
issue when they consider the legislation that has been 
introduced.
    I ask unanimous consent that members will have five days to 
submit a statement and supporting materials for the record. 
Without objection, so ordered.
    This hearing is now adjourned.
    [Whereupon, at 12:50 p.m., the foregoing matter was 
concluded.]

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