[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
SUBCOMMITTEE ON
CONTRACTING AND TECHNOLOGY
HEARING ON HELPING SMALL BUSINESS
INNOVATORS THROUGH THE RESEARCH
AND EXPERIMENTATION TAX CREDIT
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
July 9, 2009
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 111-035
Available via the GPO Website: http://www.access.gpo.gov/congress/house
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HOUSE COMMITTEE ON SMALL BUSINESS
NYDIA M. VELAZQUEZ, New York, Chairwoman
DENNIS MOORE, Kansas
HEATH SHULER, North Carolina
KATHY DAHLKEMPER, Pennsylvania
KURT SCHRADER, Oregon
ANN KIRKPATRICK, Arizona
GLENN NYE, Virginia
MICHAEL MICHAUD, Maine
MELISSA BEAN, Illinois
DAN LIPINSKI, Illinois
JASON ALTMIRE, Pennsylvania
YVETTE CLARKE, New York
BRAD ELLSWORTH, Indiana
JOE SESTAK, Pennsylvania
BOBBY BRIGHT, Alabama
PARKER GRIFFITH, Alabama
DEBORAH HALVORSON, Illinois
SAM GRAVES, Missouri, Ranking Member
ROSCOE G. BARTLETT, Maryland
W. TODD AKIN, Missouri
STEVE KING, Iowa
LYNN A. WESTMORELAND, Georgia
LOUIE GOHMERT, Texas
MARY FALLIN, Oklahoma
VERN BUCHANAN, Florida
BLAINE LUETKEMEYER, Missouri
AARON SCHOCK, Illinois
GLENN THOMPSON, Pennsylvania
MIKE COFFMAN, Colorado
Michael Day, Majority Staff Director
Adam Minehardt, Deputy Staff Director
Tim Slattery, Chief Counsel
Karen Haas, Minority Staff Director
.........................................................
(ii)
STANDING SUBCOMMITTEE
______
Subcommittee on Contracting and Technology
GLENN NYE, Virginia, Chairman
YVETTE CLARKE, New York AARON SCHOCK, Illinois, Ranking
BRAD ELLSWORTH, Indiana ROSCOE BARTLETT, Maryland
KURT SCHRADER, Oregon TODD AKIN, Missouri
DEBORAH HALVORSON, Illinois MARY FALLIN, Oklahoma
MELISSA BEAN, Illinois GLENN THOMPSON, Pennsylvania
JOE SESTAK, Pennsylvania
PARKER GRIFFITH, Alabama
(iii)
C O N T E N T S
__________
OPENING STATEMENTS
Page
Nye, Hon. Glenn.................................................. 1
Schock, Hon. Aaron............................................... 3
WITNESSES
Heenan, Mr. Bart, Chief Executive Officer, Morphix Technologies,
Virginia Beach, VA............................................. 4
Ferros, Mr. Scott, Chief Financial Officer, Blackhawk!, Norfolk,
VA............................................................. 6
Wilson, Mr. Doug, Executive Vice President, LifeNet Health,
Virginia Beach, VA............................................. 8
Schoenbach, Dr. Karl, Frank Reidy Research Center for
Bioelectrics, Old Dominion University, Norfolk, VA............. 9
Barrett, Mr. Ned, President, Direct Logic Solutions, Peoria, IL.. 11
Bendis, Mr. Richard, President & Chief Executive Officer,
Innovation America, Philadelphia, PA........................... 13
APPENDIX
Prepared Statements:
Nye, Hon. Glenn.................................................. 20
Schock, Hon. Aaron............................................... 22
Heenan, Mr. Bart, Chief Executive Officer, Morphix Technologies,
Virginia Beach, VA............................................. 24
Ferros, Mr. Scott, Chief Financial Officer, Blackhawk!, Norfolk,
VA............................................................. 29
Wilson, Mr. Doug, Executive Vice President, LifeNet Health,
Virginia Beach, VA............................................. 36
Schoenbach, Dr. Karl, Frank Reidy Research Center for
Bioelectrics, Old Dominion University, Norfolk, VA............. 39
Barrett, Mr. Ned, President, Direct Logic Solutions, Peoria, IL.. 41
Bendis, Mr. Richard, President & Chief Executive Officer,
Innovation America, Philadelphia, PA........................... 44
(v)
SUBCOMMITTEE ON
CONTRACTING AND TECHNOLOGY HEARING
ON HELPING SMALL BUSINESS
INNOVATORS THROUGH THE RESEARCH
AND EXPERIMENTATION TAX CREDIT
----------
Thursday, July 9, 2009
U.S. House of Representatives,
Committee on Small Business,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:10 a.m., in
Room 2360, Rayburn House Office Building, Hon. Glenn Nye
[chairman of the Subcommittee] presiding.
Present: Representatives Nye and Schock.
Chairman Nye. Good morning. Let me just go ahead and open
this hearing. I am going to start with an apology. We are going
to have votes relatively soon and so we are going to be
interrupted. We are going to get as far as we can through the
opening statements and then we will have to go vote, and then I
will get us back and start us right as soon as we get through
the first cycle of votes. Again, so apologies ahead of time. I
am going to ask for a little bit of patience today, but we will
get everybody a chance to say what they need to say.
I want to go ahead by just starting with an opening
statement. And again, welcome to all our panelists today.
Yesterday afternoon, the House voted on legislation to
strengthen the SBA's small business innovation programs. And in
debating that bill, the same two themes kept coming up over and
over again, job creation and economic growth. Those are areas
in which our country has traditionally excelled, thanks largely
to an emphasis on research and development. And today, even as
our economy moves towards recovery, we need to be focused on
the kind of innovation that can unlock new markets and create
new jobs. The Research and Experimentation Tax Credit, commonly
known as the R&D tax credit is a tested means for doing just
that.
Targeted tax relief is an important tool for encouraging
small business growth and also an effective catalyst for
innovation. In the past, the R&D tax credit has encouraged
countless entrepreneurs to test the waters of innovation. And
today we are going to look at that incentive and evaluate its
role in strengthening small firms.
Any investment in small business R&D goes a long way. That
is because entrepreneurs are already more inventive than their
larger competitors. Small firms produce 13 times as many
patents as big businesses, and have a history of pioneering new
markets. We can remember the tech boom in the 1990s wasn't a
corporate success story as much as a small business revolution,
one that saw the rise of lucrative new industries, such as on-
line advertising. But we must also remember that innovation
isn't just about developing the latest technology, it is about
creating jobs.
70 percent of R&D credit dollars go to high wage positions
for researchers, scientists and engineers. Because small firms
employ nearly 40 percent of these professionals, it is safe to
say that R&D job growth is small business job growth. And with
unemployment now hovering at 9-1/2 percent, we need every job
we can get. Incentives for innovation are an important means
for keeping current workers on payroll and putting unemployed
Americans back to work. They also make good economic sense.
According to one study, every dollar in R&D tax credits yields
another $2 in research.
Clearly, this credit is doing a great deal of good for our
economy. And yet, despite its obvious benefits, there is
concern that it is not accomplishing as much as it could for
entrepreneurs. That is a real issues because roughly 40 percent
of the businesses that claim this credit are small firms.
Perhaps the greatest shortcoming in the R&D credit is its
lack of permanence. In the nearly three decades since its
inception, the incentive has never been cemented. Instead, it
has been reauthorized 1 year at a time, often at the last
minute, retroactively, and after the credit has expired. Now,
if that sounds convoluted, it is because it is. And needless to
say, these actions have added an element of uncertainty to an
already risky R&D process. Making the tax credit permanent
could mitigate that risk, giving entrepreneurs the stability
they need to plan budgets and attract investment. Meanwhile, a
move to unravel some of the credits complexity could also be a
big help. By simplifying the process, we could cut down on
paperwork and ease compliance costs. Doing so would likely
encourage more small firms to participate in R&D, helping them
to develop more new products and create more new jobs.
Kitco Fiber Optics, a business based in my district, who
unfortunately could not make it here today, is just one example
of a small business which qualifies for the R&D tax credit, yet
does not receive the credit. The president and CEO of KITCO,
Geoff Clark, has told me that due to the uncertain nature of
the current legislation, his business has not made the initial
investment to hire accountant who specializes in R&D tax credit
dealings to go through their accounting books in order to
determine what would qualify for this credit. And my hope is
that taking action to both simplify and make permanent the R&D
tax credit would encourage KITCO and other small businesses to
use the incentive to increase their growth and productivity.
The strength of our economy has always been driven by the
innovation and hard work of our small entrepreneurs, and as we
work to create jobs and get our economy moving again, we must
once again look to small business to lead the way.
By strengthening the R&D tax credit, and cutting taxes for
small businesses, we can give our most inventive firms the
tools they need to innovate and grow. And most importantly, as
we face increased competition from abroad, continued investment
in R&D will help us retain our standing as home to the world's
greatest technological advances.
I would now like to thank today's witnesses in advance for
their testimony. I know that we are all looking forward to
hearing from them.
And with that, I would like to go ahead and recognize our
committee ranking member, Mr. Schock, for any opening statement
that he might have. And again, apologies for the fact that we
will have to break to go vote relatively soon. But we will see
how much we can get done before that. Mr. Schock.
[The statement of Mr. Nye is included in the appendix.]
Mr. Schock. Well, thank you Mr. Chairman. I apologize for
my tardiness. We have had, as you know, a very busy morning
already and we will have a busy morning.
So thank you to the witnesses who are here this morning and
for Mr. Chairman, for holding this meeting to further study the
impact of the research experiment or the, what we call the R&D
tax credit, and what effect it is having on our Nation's small
businesses.
I would also like to thank each one of our witnesses for
having taken the time to provide this committee with their
testimony and travel all the way to Washington here today.
The R&D tax credit has been available for businesses large
and small for over 20 years. And during that period, tens of
thousands of companies have used this important provision of
the Tax Code to help reinvest and grow their businesses,
encouraging more American ingenuity and domestic jobs.
Now, more than ever, we must be focused on providing
appropriate incentives to those companies, which will help grow
our economy and make a sustained commitment to conducting long
term, high cost research right here in the United States.
The R&D tax credit is positive motivation for U.S.
investment, innovation and something which will help to
contribute to a stronger economy and a higher standard of
living for American workers. Simply put, the R&D tax credit
stimulates immediate business investment decisions with long
term benefits to the U.S. economy.
Since the R&D credit is only available for research
performed in the United States, it remains a job creator that
cannot be exported. As such, the credit is certainly needed,
especially as foreign governments continue to actively recruit
American companies to base research operations at a low cost
option abroad.
Regrettably, Congress has repeatedly failed to provide long
term insight to extend this credit beyond just a few short
years. The fact that the R&D credit has proven itself popular
enough to be extended 13 times is all the evidence this
Congress needs to know that we should stop playing games and
make the credit permanent.
Again, the R&D tax credit is scheduled to expire at the end
of this year, and, again, small businesses are being pushed
into a scenario where saving proves wiser than investing for
growth due to the lack of certainty of the continued extension
of this credit. With such confusion, businesses are unable to
factor the full benefits of the R&D credit into their research
budgets, long term commitments and their capital needs.
The bottom line is that either a longer extension or
permanency of the R&D tax credit would create and help high
paying U.S. jobs and allow for better planning by our Nation's
business. I am optimistic that today we will hear from those
small businesses that are directly affected by this tax credit.
I look forward to hearing all of you regarding the necessity of
R&D tax credit, as well as specific changes so that we can
continue to incentivize the risk-taking entrepreneurship and
investment necessary to grow our economy and create good paying
American jobs.
I yield back, Mr. Chairman.
Chairman Nye. Thank you, Mr. Schock. I am going to go ahead
and introduce the panel members one by one. We are going to ask
you to try to get your remarks into the 5-minute window, if you
can. And you will notice in front of you a set of lights which
will be green for 4 minutes, yellow for the final minute, and
then will turn red when 5 minutes is up. If we get to the end,
we would ask you to try to go ahead and conclude as quickly as
you can.
I want to start by introducing Mr. Heenan, CEO of Morphix
Technologies, based in Virginia Beach, Virginia. As the CEO,
Mr. Heenan leads the strategic direction and day-to-day
operations of the company.
Morphix Technologies provides innovative gas detection
products to military, first response, and industrial users
throughout the world. And again, thank you for being with us
today. Mr. Heenan, you are recognized.
STATEMENT OF BART HEENAN
Mr. Heenan. Thank you, Chairman Nye and Ranking Member
Schock.
Good morning. It is my pleasure to be here. And I
appreciate your leadership on this important issue to small
technology businesses.
Morphix Technologies was formed in 1995. We make chemical
detection products that have the potential to save lives for
military, for first responders and for industrial workers. Our
niche is providing low cost, rugged, easy to use chemical
detection devices that your average cop, your average 18-year
old who goes and volunteers to serve in our military can use
with minimal training. We now employ 35 people, 15 of whom are
scientists and engineers, five of them have Ph.Ds.
As a business person, I am really not in a position to
recommend policy. However, I would like to share with you some
of my thoughts of the practical implications and practical
issues I see with the R&D tax credit. Clearly, as you have
already stated, the R&D tax credit has a big impact on
America's competitiveness, can have a big impact on job
creation.
At Morphix, 85 percent of our R&D is labor cost. And those
are good paying jobs. A well functioning R&D tax credit, I
think, can help small businesses maybe increase their science
staff by five to 10 percent. However, the companies need to
believe in the R&D tax credit.
Frankly, at Morphix, we don't have that confidence in the
R&D tax credit on a regular basis, so we haven't gone out and
hired that additional scientist or additional engineer that we
might otherwise hire from the R&D tax credit, and there are
three main reasons for that that I would like to share with
you.
The first both of you have already addressed and that is
the permanence issue. That impacts all companies participating
in the R&D tax credit, so I am not going to discuss that any
further. You have already discussed that very well.
The second and third issue are both, I think, very specific
to small companies. And the first of those is that there is a
significant administrative burden for small companies to be
able to take advantage of the R&D tax credit. That
administrative burden is not just going out and hiring a tax
accountant, but it is having the accounting systems in place
that allow you to do what you need do to comply to the IRS
regulations. Most large companies have those accounting systems
in place.
In my experience, most small companies do not. So it is not
just an investment once a year in a tax accountant. It is
actually a big investment of changing the infrastructure of the
company, and that is a very, very difficult issue for many
small companies.
The next and last issue I would like to highlight is
probably the one that is most important to me personally, and
that is the impact of the alternative minimum tax or AMT
relative to the R&D tax credit. This issue is really, I think,
pretty simple, and that is that many small businesses,
including mine, are taxed through the individuals' income tax,
not through a corporate income tax. Large companies are often
taxed through corporate income tax, small companies more
through individual tax.
If the individual owners, the business owners, who are
being taxed through their individual tax return are subject to
the AMT, they are not allowed to take the R&D tax credit. As a
result, I think many business owners feel that it is not worth
the effort to go after the R&D tax credit because they are not
really going to get the result.
Let me give you an example, my personal example. At
Morphix, we have spent well over a million dollars in R&D over
the last 3 to 4 years. My share of the taxes we have paid for
income and employment taxes has been in the hundreds of
thousands of dollars, and I have personally been able to take
$138 in R&D tax credit over that time period. That is really
not much of an incentive to go and do something that is going
to employ the people and do the things that the R&D tax credit
is intended to do.
In summary, I fully support the R&D tax credit. I think it
is a powerful engine for employment growth, a powerful engine
for competitiveness of the country. For the reasons I outlined
above, I believe that small technology businesses are generally
not fully utilizing the tax benefit to their full advantage.
And of course, if companies aren't taking the R&D tax credit,
then it is not achieving its economic and social benefits that
it is intended to take.
I would ask the committee to consider three things: One,
make it permanent, two, simplify the administrative burden for
small businesses, and three, try to address the AMT issue
relative to the R&D tax credit.
Thank you for your time.
Chairman Nye. Thank you, Mr. Heenan.
[The statement of Mr. Heenan is included in the appendix.]
Chairman Nye. I would now like to introduce Mr. Ferros. Mr.
Scott Ferros, Chief Financial Officer for Blackhawk, located in
Norfolk, Virginia.
Blackhawk was founded in 1995 by a former U.S. Navy SEAL,
Mike Knoll. The company is recognized as a world leader in
supplying tactical equipment to the military and law
enforcement markets.
Mr. Ferros.
STATEMENT OF SCOTT FERROS
Mr. Ferros. Chairman Nye, Ranking Member Schock, and the
distinguished members of the Contracting and Technology
Subcommittee of the House Small Business Committee, happy to be
here today.
Again, my name is Scott Ferros. I am the Vice President and
Chief Financial Officer for Blackhawk in Norfolk, Virginia,
based veteran owned small business. Thank you again for
allowing me the opportunity to share my views on the merits of
the research and experimentation tax credit.
As a certified public accountant with over 30 years of
varied public accounting and industry experience and the chief
financial officer of a highly innovative small business, I feel
somewhat uniquely qualified to convey to you some of my
observations on the R&D credit.
As I am sure you already know, which I have experienced
time and time again, tax policy does significantly influence
taxpayer behavior. With respect to the R&D credit, I believe
the economics of the credit stimulate product innovation
related spending. However, the ongoing temporary nature of the
legislation, along with administrative complexities of the
program, do create an uncertainty for all users; and there is a
punitive cost to compliance issue that will limit the use for
very small businesses.
As we meet here today, I would like you to consider a
couple of simple recommendations. First, recognize the economic
benefits most companies do derive from the program; second,
make the R&D credit permanent law; and third, work to simplify
the compliance process.
Blackhawk is a 16-year old company with a history of
developing new and innovative product solutions which we
believe enhance the effectiveness and safety of our primary end
users, the warfighter and the law enforcement officer. It is
our collective opinion at Blackhawk that the economic benefits
of the R&D credit allowed under the Internal Revenue code have
helped enable our company to grow from a very small
entrepreneurial run business to a product development driven
organization that now employs over 300 people throughout the
United States and sells thousands of products to military and
law enforcement professionals on a global basis.
Blackhawk has utilized the R&E credit since 1999. During
this 10-year period, the company has successfully developed
several hundred new products and increased payroll related
research and experimentation expense from approximately
$200,000 in 1999 to over $5 million in 2008. During that time,
while credits increased from roughly 15 to over $300,000 last
year, the gross revenue, subject to Federal and State tax, grew
ten-fold. Much of this increase that we have experienced has
been driven by new products introduced as a result of the R&D
process, which leads us to believe that the payback to the
government far surpasses the cost of the program.
While the benefits of the program appear clear, the
temporary nature of the credit has caused uncertainty, and the
compliance complexities have created barriers of entry in a
cottage industry supporting the compliance.
The R&E credit was originally enacted as part of the 1981
Economic Recovery Tax Act, and has been revised and amended in
the years since through many updated tax acts, but remains
still temporary. The continuance of the credit is a frequent
topic of discussion and speculation between businesses, tax
advisers, Members of Congress, and the Department of Treasury,
creating an air of uncertainty for all parties involved.
We believe that making the credit permanent would encourage
more companies to use this credit and, therefore, stimulate
research.
Finally, the tax credit and the expenses are addressed in
Internal Revenue Code sections 41 and 174, as well as the
corresponding regulations. The source of the law is well over
100 pages in length, which does not include the thousands of
court cases and other rulings pertaining to the same topic. An
editorial discussion by the Bureau of National Affairs is
nearly 300 pages in length, as evidenced by the massive volume
of law compliance and access to the credit is extremely
difficult. The complexity has given rise to a cottage industry
of tax advisers who specialize exclusively in quantifying and
reporting the credit.
In our case, we justify the compliance and consulting costs
to report the credit. However, quite, frankly the professional
services associated with this credit are expensive and, I
believe, prevent smaller entrepreneurs from benefiting.
At Blackhawk, we have a well organized and disciplined R&D
division with remarkable employees and distinct financial
reporting. Even with this unique organization, we are required
to produce contemporaneous documentation to support our
activities for the sole purpose of qualifying for the credit.
And while we have sufficient size to benefit from the credit,
it is not always the case, and it was very difficult when we
were a small company.
We believe there are many barriers that prevent smaller and
younger companies from claiming this credit, not the least of
which are the complexities, the compliance costs, the
Alternative Minimum Tax and the net operating loss limitations.
So, Mr. Chairman, and members of the committee, we strongly
recommend that easing these barriers will permit more and
smaller companies to claim the credit and drive the innovation
within the United States.
This concludes my prepared statement. And again, thank you
for the opportunity to testify to the committee today. And I
look forward to answering any of your questions.
Chairman Nye. Thank you Mr. Ferros.
[The statement of Mr. Ferros is included in the appendix.]
Chairman Nye. Mr. Schock, if you don't have any opposition,
I am going to go ahead and invite Mr. Wilson. I think we have
time to get one more person's opening statement before we will
have to go take some votes.
So Mr. Wilson, thank you for joining us today.
Mr. Doug Wilson is the Executive Vice President of LifeNet
Health in Virginia Beach, Virginia. LifeNet Health is a no
profit organ procurement organization providing donation
systems for heart, liver, kidney and other organs for
transplant.
And Mr. Wilson, thank you for joining us today. Please.
STATEMENT OF DOUG WILSON
Mr. Wilson. Good morning, Congressman Nye, and Congressman
Schock. Thank you for having us.
Research has played a significant role in LifeNet Health's
past, and it will play a significant role in our future.
Today LifeNet Health is the largest nonprofit full service
tissue provider in the United States. And since our formation
in 1982, LifeNet Health has pioneered technologies through a
strong and unwavering commitment to research designed to ensure
safety in allograft screening, recovery, cleaning and delivery.
Allograft tissue is tissue donated from the gift of tissue
donation at the time of one's death. LifeNet Health processes
this tissue into implants for surgeons to use in their patients
who are suffering from a disease or a specific injury.
Our innovative processes have been benchmarks in the
industry. Allograft tissues are actually transplanted in nearly
every hospital, every day, specifically, in orthopedics, trauma
care, neurosurgery, cardiac surgery and vascular surgery.
Key to today's hearing is the following: LifeNet Health
works closely with many for profit companies, both in research
as well as in the distribution phases of our product life
cycles. In some cases we rely on them, and we will continue to
rely on them for their capital investments through contractual
programs and joint ventures for research into new bioimplant
technologies leading to new and improved clinical products. In
many cases, these companies provide LifeNet Health, a
nonprofit, with the necessary capital to enhance our research
and our production efforts, carry the products through the
regulatory process, and the product development cycle.
The research tax credit in its many forms can be a factor
in the investment decision by our for profit partners. Most of
our new products, particularly those emanating from
regenerative medicine, are very long time horizon projects and
they have high fixed costs. Thus, permanence of the tax credits
could reduce the risk for the investment and distribution
partner that we may solicit.
Equally important, permanence provides an environment in
which our for profit partners can plan and forecast with more
confidence long term. The use of the tax credits allows
LifeNet, through our partners, to have flexibility in the
selection of projects and products to fund, especially those
who have high social value and long term impact on our society.
Future R&D will ensure better patient care and, more
importantly, optimized economic options for hospitals which
they need. LifeNet Health's commitment to safety and quality
and patient outcome is evident in everything we do, including
ongoing research and development efforts. We have more than 45
patents that include cleaning technology which is the industry
standard in tissue banking.
As a result of our R&D work, LifeNet Health has distributed
nearly 2 million allografts with no incidence of disease
transmission linked to tissue screened and processed by
LifeNet.
As part of our ongoing commitment to bio-implants, LifeNet
Health recently announced the LifeNet Health Regenerative
Medicine Institute. The focus of the new institute will be to
utilize our current technologies, coupled with the latest in
stem cell and growth factor development, to yield new
generations of more clinically effective implants. For these
lofty projects going forward, LifeNet Health will surely
establish alliances with for profit organizations for co-
development. The use of the permanent tax credit for research
and development purposes by our potential alliance partners
will, no doubt, allow us to move ahead in developing better
therapies for patients in need and furthering our mission of
saving lives.
Thank you very much.
Chairman Nye. Thank you, Mr. Wilson.
[The statement of Mr. Wilson is included in the appendix.]
Chairman Nye. I just want to check the clock here. All
right. What I am going to do is I am going to adjourn the
session until we have time to go take this vote. And I
understand we have a series of votes to take that is going to
eat up a little bit of time. I am not sure exactly how long it
is going to take. I am hoping it will be less than an hour, but
it will be a significant bit of time. So we are going to
adjourn until we finish this round of votes. We will come right
back as soon as it is over, and we will have the staff kind of
keep you up to date on where we are and how long we think it
will take. And again, apologize. But this is one thing that we
as Members of Congress have to do when they tell us and
personally. So again, thank you for being here. And we will
adjourn temporarily, and then we will reconvene as soon as
possible.
[recess.]
Chairman Nye. I am going to go ahead and bring this hearing
back to order. Thank you. And apologizes for holding you here
for so long. But I am glad you stayed. I think it is important
that everyone here who spent the time to get here have a chance
to be heard today on this important topic. So what I would like
to go ahead and do is introduce our next panelist for his
opening statement. Dr. Karl Schoenbach, a professor and eminent
scholar from the Frank Reidy Research Center for Bioelectrics
in Old Dominion University located in Norfolk, Virginia. The
Frank Reidy Research Center works to develop medical
diagnostics, therapeutics and environmental decontamination.
Dr. Schoenbach, thank you for joining us.
STATEMENT OF KARL SCHOENBACH
Mr. Schoenbach. Chairman Nye, thank you for inviting me. I
am representing the Frank Reidy Research Center for
Bioelectrics today. It is an interdisciplinary research center,
and we have about 40 faculty, graduate students and technical
staff. We focus on the study of biological effects of
electrical pulses and try to develop new therapies based on
these bioelectric effects. One of our major application is
treatment of cancer. We are doing very well in basic research
as shown by the funding which we get mainly from NIH and the
Department of Defense, by a large number of publications, and
by invited talks all over the world. We are less successful in
transferring, however, our research to industry. Two examples.
Already in 2002, we have shown that we can, with very short
electrical pulses, kill cancer cells very effectively. And in
2006 in animal experiments, we could demonstrate that we can
eliminate melanoma tumors completely with these short pulses.
We have tried since then, since 2006 and actually before that,
to find companies who work with us to bring this technology to
market. And we were only successful now, this year, to find a
company who is willing to work with us.
Another example is based again on research developed for
the treatment of melanoma. In this case, we have developed an
efficient method using electrical pulses to deliver genes
directly into the tumors which then stimulate the immune system
and destroy tumor cells. We could show that this therapeutic
approach is not only effective in treating tumors locally, but
it also prevents new tumor growth and it eliminates metastatic
tumors.
So even with these exciting results we were not able to get
support from companies immediately. It took us 2 years to get
support from a small business which helped us to get the
equipment in place and financial support from a cancer center
to do a phase one trial. And again, this gave us fantastic
results. But we are still searching for companies to help us
support a phase two trial.
Again, because of limited availability of research dollars
we have not been successful yet. In both cases, we lost
valuable time which could have been used to bring our therapies
to cancer patients. The problem is that the university research
is still focused on basic research. It will only demonstrate
feasibility in preclinical studies or early phase clinical
studies and will seldom go towards for full development of
therapies. This is considered to be the task of companies.
Small companies, on the other hand, would understandably like
to minimize risk when taking on new projects and would like to
only take on "mature projects," projects which are only in a
certain stage such that the risk is relatively small.
So there is a gap between university research and research
and development at small companies. Any incentive which helps
to bridge this gap to lower this barrier is extremely important
for university research, and tax incentives could be one of
them. It would definitely help to get our research at the
universities better to the market and faster to the market if
this barrier would lower. Thank you.
Chairman Nye. All right. Thank you very much, Dr.
Schoenbach.
[The statement of Mr. Schoenbach is included in the
appendix.]
Chairman Nye. I am going to--we are going to go on. I am
going to actually invite our ranking member, Mr. Schock, to do
the next introduction, as I believe our next panelist is
someone who is from his area. So I will turn things over to Mr.
Schock.
Mr. Schock. Thank you, Mr. Chairman. Our next witness is
Mr. Barrett, is that correct?
Mr. Barrett. That is.
Mr. Schock. All right. Mr. Ned Barrett is the President and
chief operating officer of Direct Logic Solutions located in my
home town of Peoria, Illinois. Direct Logic was founded in 1998
and has grown substantially since then helping their clients
with direct to consumer marketing. Direct Logic has a number of
customers located in central Illinois and also around the
country. They focus on marketing consultation, search engine
optimization, marketing database construction, as well as sales
forecasting. Ned has been with Direct Logic from the start, but
before that ran a variety of other different business. I
appreciate you making the trip here today and look forward to
hearing the testimony before our committee. Welcome.
STATEMENT OF NED BARRETT
Mr. Barrett. Ranking Member Schock, thank you, Chairman
Nye, I appreciate it. I appreciate the opportunity to testify
to the committee today. I am here to tell you that we support
the continuation of an expansion of the R&D tax credit. Direct
Logic employs 25 people and we specialize in interactive
marketing which includes Web site development, as you
mentioned, database construction, e-mail marketing, on-line
promotions, social marketing to Facebook and Twitter and other
advanced database marketing technologies. We are a small
company, but we count many top firms as clients including
Hasbro Toys, The Breeders Cup, Thoroughbred Horse Racing, TV
Guide, Maui Jim Sunglasses, FTD Florists, BASF, the German
chemical company and many others. I mention these clients
because people are sometimes surprised that a firm from Peoria
can compete with large agencies in New York, Los Angeles and
Chicago to win such accounts.
The reason we have the securities accounts is due to our
superior products and services that are a result of our
intensive research and development and our proprietary
technologies. Our success is due in large part to our people.
It used to be the top technology talent only migrated to large
cities and technology hubs. Now that there is such a great
ability for people to collaborate on line in real-time with
colleagues and peers around the U.S. and around the world a
person's physical location is much less important. Our program
has worked with people around the world who have access to the
most recent technical developments at their fingerprints.
What they are seeking is a quality of life and creative
environment where they can make the most of their lives. The
people that we attract to our firm are attracted to Peoria for
the low cost of living and the higher quality of life that they
can enjoy with their families. Our real challenge in recruiting
these employees is to be able to offer them a position where
they are free to exercise their intellectual talents to the
fullest. Our strong commitment to research and development
creates the kind of work environment these people are looking
for.
As a result, central Illinois employment base is
strengthened by the jobs that we and other small businesses are
creating. As a percentage of our business we have poured huge
amounts of money into R&D over the past several years. Since
venture capital firms like ours is much scarcer than is
generally understood and that we have limited access to credit
markets we have used money from ongoing operations to fund most
of our R&D. Many small firms do this and the R&D tax credit can
be an incredibly important offset to this utilization of scarce
capital. It is a very important point that the committee needs
to consider. Small firms are the innovators of tomorrow and
represent critical sources of new tax revenue for both the
state and Federal governments.
In order to stay competitive and grow, we pour every
available tax dollar into R&D. The money freed up by the R&D
tax credit gets plowed back into businesses in the form of
additional salaries and investment in the future. Furthermore,
the R&D investment we are doing is helping in the
transformation of the work place. A significant percentage of
our employees are the sons and daughters of large manufacturing
companies. Although Peoria is blessed with a strong industrial
base through Caterpillar equipment, we and other small tech
firms like ours are contributing to the development of a
knowledge economy in central Illinois.
Although I am concerned about the impact the R&D tax credit
has on businesses like Direct Logics, I am also very concerned
about its impact on the international competitiveness of the
U.S. Industry in general. The world is truly becoming flat when
it comes to competitive advantage. As a technology executive, I
am being contacted daily by foreign outsourcing firms who would
like to subcontract work with us. We don't do any
subcontracting work with foreign firms. But what I am struck by
when I speak with these executives is the level of work they
are doing and the sophistication of the work that they are
doing.
During the past 150 years the competitive advantage that
nations and their commercial enterprises have enjoyed represent
significant barriers to entry for foreign competitors. In many
cases it took years or decades for foreign competitor to enter
commercial space and then supplant the domestic industry. Now,
in many industries that time line has shrunk from years to
months. Furthermore in the past, older industries that were
captured by foreign competition were typically replaced by new
domestic industries and services that provide a greater overall
GNP growth in the industries that it replaced.
Now, I still believe that the U.S. is an innovation leader
in many technology categories. Our dominance time though in
those categories is shrinking. I am not sure that there is any
way to slow down this progression since it seems to be a part
of the accelerating nature of global economics, but I do think
the government needs to provide industry with the tools to help
innovation occur in the first place. I believe that the U.S.
can continue to innovate and create new businesses well into
the future. I think this is a function of national creativity
of our society. However, it is critical that government support
this innovation any way it can.
And the R&D tax credit is an important tool that supports
this goal. Properly applied it not only encourages industry to
invest in R&D, but it acts to ensure that those dollars are
spent domestically. The R&D tax credit must be considered in
its global context. It is my understanding that the U.S. credit
has become much less competitive relative to the structures
offered by other governments. In this sense, the U.S.
Government needs to compete with foreign governments making our
R&D tax credit more attractive relative to foreign
alternatives. This will encourage larger firms to locate their
R&D projects in their U.S. operations rather than abroad where
the tax incentives might be relatively greater. Further it may
encourage foreign firms to relocate their R&D in the United
States. In evaluating this, I think that this committee needs
to question why other governments are much generous with this
type of credit.
Looking at it from a business person's point of view, I
must assume that those countries have made a rational
determination that it enhances their own competitive advantage
and it ultimately pays for itself through greater tax revenues.
There are many proposals for how to maximum the utility of this
tax. Although I do not have the expertise to tell you exactly
how to structure the tax I can offer the following general
opinions. First I think that the tax should become a permanent
fixture of our tax code. Second the rates should be made
competitive with the rates of other countries. And third, you
should consider allowing more rapid expensive equipment to
purchase and support R&D efforts. I believe that the R&D credit
is critical to the continued innovation and growth of the U.S.
economy. And I thank you for considering my testimony.
Chairman Nye. Thank you very much.
[The statement of Mr. Barrett is included in the appendix.]
Chairman Nye. Finally, I would like to introduce Mr.
Bendis, Mr. Richard Bendis, President and CEO of Innovation
America located in Philadelphia, Pennsylvania. Mr. Bendis is a
frequent consultant and speaker to international technology
based economic development organizations. Innovation America
works towards accelerating the growth of the entrepreneurial
innovation economy in America. We are happy to have you, Mr.
Bendis, and we are ready to hear your opening statement.
STATEMENT OF RICHARD BENDIS
Mr. Bendis. Thank you, Chairman Nye and Ranking Member
Schock. Good afternoon. My name is Rich Bendis, and I am the
President and CEO of Innovation America. I am also a long-time
member of the American Society of Mechanical Engineers, a
founding board member of both the National Association of Seed
and Venture Funds and the State Science and Technology
Institute and a former technology entrepreneur who has
benefited from R&D tax credits. I want to thank the
subcommittee for providing me the opportunity to comment on the
importance of extending and making permanent the research and
experimentation tax credit. Innovation America, ASME and NASVF
support this extension.
Innovation America also supports the R&D credit coalitions
recommendations of a permanent R&D tax credit at a commensurate
rate for all companies, a 20 percent simplified credit and a
longer extension of the traditional credit. Since 1981 when the
Federal R&D tax credit was enacted the U.S. Government sought
to encourage businesses to look to the future and invest in
long-term high risk high dollar investments that would create
high wage jobs. The R&D tax credit helps to lower the cost of
these high risk investments that are necessary to keep American
companies competitive and foster growth in the overall economy
especially during these challenging economic times.
The National Academies has cautioned that without high
quality knowledge-intensive jobs and the innovative enterprises
that lead to discovery and new technology, our economy will
suffer and our people will face a lower standard of living. Our
trading partners around the globe recognize the long-term value
of R&D and have moved aggressively to implement generous and
permanent tax policies that attract these vital investments to
their shores. In addition to the Federal R&D tax program, at
least 38 States utilize tax credit programs as economic
development incentives. A research paper published in Economic
Development Quarterly "in-state R&D tax credits and high
technology establishments" concluded that State R&D tax credit
programs have significant and positive effects on a number of
high tech establishments in the state.
R&D tax credit programs vary from State to State as some
offer refundable credits set up in a way that the amount
provided to a company utilizing the R&D tax credit may exceed
the company's actual State income tax liability. Some States
allow credits to carry forward to future years while others set
percentage caps on the tax liability that can be applied to
credits. And additionally some States allow for transferability
or sale of credits in the event the company has no tax
liability. That generates cash for these entrepreneurial firms
which is needed at those early stages of growth. I also believe
that while the R&D tax credit program extension is a critical
component of the U.S. innovation portfolio of programs it is
not the only area that this subcommittee should be concerned
with.
In the chairman's opening comments, he referred to job
creation as one of the highest priorities for this
administration and Congress. Especially those created by
innovative entrepreneurial companies. If recent history is any
indication for 3 years following both the 1990 and 2000
recessions, small businesses of less than 20 employees were
responsible for over 100 percent of the net new job creation in
America.
Unfortunately, what worked after the last two recessions
might not work as well today due to the fragile nature of our
financial markets. The valley of death, which represents the
entrepreneurial funding gap between a half a million and $5
million, has gotten wider and deeper. Venture capitalist
average investment last year was $8.3 million per investment
and they had their lowest investment quarter in 13 years last
quarter. Angel investors last year invested 26 percent less
than the prior year due to their own personal financial crisis
and 47 out of 50 States have budget problems that will
negatively impact their entrepreneurial support programs. For
the first time in U.S. history, we now have a perfect storm
affecting our innovation economy.
In December of 2008, we met with the members of the Obama
transition team and presented a proposal for creating an
national innovation framework. The details of this proposal
have also been submitted to this subcommittee in a white paper
which was published by Science Progress. In summary, we
recommended that a national innovation seed capital jobs fund
to funds be created and we support the permanent
reauthorization of the SBIR and STTR programs. We also
recommend that an integrated national innovation strategy be
developed and that the administration prioritize innovation as
part of their national agenda.
Time does not permit a detailed discussion of this
innovation strategy, but it is complementary to the R&D tax
credit discussion that has occurred today in this subcommittee
hearing.
In closing I strongly support the permanent extension of
the R&D tax credit program as it is an extremely important
component of America's innovation program portfolio. And I
would like to thank you for the opportunity to present my view
to this subcommittee and request that my written statement as
well as other supporting documentation be submitted into the
record. Thank you very much.
Chairman Nye. We will do that. And again thank you for your
testimony.
[The statement of Mr. Bendis is included in the appendix.]
Chairman Nye. Thank you to everyone, not only for making
the effort to be in here today, but for bearing with us while
we were a little bit delayed. I am going to be mindful of the
time we have kept you here. I am going to ask a couple of
follow-up questions and then yield to Mr. Schock as much time
as he would like and then we will conclude. But I want to just
pick up on a couple of things that I think are important that I
have heard today. And one is starting with Mr. Heenan. You
mentioned the effect of the AMT and not being able to take
advantage of the R&D tax credit. I just want to get a poll. Has
anybody else experienced that problem or know folks in the
industry who have had the same issue by a raise of hand if that
is clearly an issue. Mr. Heenan do you have any suggestions how
we can solve that.
Mr. Heenan. I guess the simplest suggestion would be to
carve out the R&D tax credit from the AMT. If you could allow
that credit to be taken if someone is subject to AMT then it
would eliminate the problem.
Chairman Nye. Well, that sounds very direct and reasonable.
I want to follow up on also an issue that a number of people
have mentioned about the expense of compliance. And I believe,
Mr. Heenan, you and Mr. Ferros had also mentioned having some
trouble with that. And again, as I mentioned in my opening
statement I have talked to other business owners in the Hampton
Roads area in my district who have said they had some trouble
with that.
Mr. Ferros, can you comment on how you have handled that
and how big of an expense that has been for you at Blackhawk.
Mr. Ferros. Well, the way we typically handle it is we have
had to set up some sophisticated accounting and we do project
related accounting that is very specific to the R&D process. So
our engineers have to maintain time records, project specific
records. We have a lot of specific documentation that we have
to have available for the specialists as they come in to ensure
that we not only have sufficient documentation but we put it in
place for a potential IRS audit. What I have been told from our
tax professionals is that this is a tier one IRS topic.
Consequently every year we submit our tax filings. We feel that
the R&D tax credit will be subject to review. So we go through
the extra steps and consequently the extra cost to ensure that
we are in compliance. For the small business person, I think
they just typically avoid it because they don't want to deal
with the issues, nor do they have the available cash to go
through the process that is involved in ensuring that they are
compliant with the IRS regulations.
Chairman Nye. I would like to ask if any other panelists
have any other comments on the cost of compliance and the
complexity. Yes, Mr. Heenan.
Mr. Heenan. At my company, we do government contracting, so
we are required by the DOD and other agencies to have a pretty
robust accounting system. So it actually is not an issue for my
company today. However, I have had the pleasure of working at
three other small companies prior to this. None of them did
government contracting and none of them--all of them did a lot
of research, none of them went for the R&D tax credit. And the
reason was simple. We just didn't have the accounting systems
robust enough to meet the IRS standard for applying for the R&D
tax credit.
Chairman Nye. One more follow-up question for Mr. Ferros.
We are talking about complexity. Can you make any comments
about, and I understand, and I have heard I think pretty
consistently today that the permanence of the program would be
a big help in planning for future years, what about the
structure and the complexity of the way the tax credit is put
together and the difficulty in understanding how it is set up.
Do you have any comments on either ways to make it easier?
Would something like a flat credit for R&D be something that
would be more easy to manage.
Mr. Ferros. Certainly I am a proponent of a very simplistic
approach. Again, if you are a larger company, you can rely on
the expertise of professionals. They can depict the
interpretation of the law. I am a certified public accountant.
I don't understand the law. I rely on our professionals to come
in and help us be compliant. As a small business person,
somebody that is focusing on truly innovative and thought
provoking and hopefully very significant outcomes, the last
thing they want to think about is tax compliance. They are
focused on technology, they are focused on product innovation,
they are focused on growing their business. Consequently we
need to keep it simple, they need to understand what the net
business is for them at the end of the day and they should be
able to scratch it on a single piece of paper rather than call
up their CPA and go through a very time consuming and
sophisticated process. So I am all about simplification. Thank
you.
Chairman Nye. Dr. Schoenbach in your testimony you
suggested that one of the challenges you see from your
perspective is getting the universities and the businesses
together and bridging a gap between the two. Do you have any
specific suggestions of ways we could make that bridge easier?
Mr. Schoenbach. I think that it requires from our side,
from a university side, to be more open to the needs of the
industry. That we don't stay in an ivory tower but that we are
trying to reach out to industry and ask them what we need to do
rather than just offer them what we have. And I think what
happens to a large extent now in universities. For the other
side, for the industry, I think it would be important to reward
risk-taking more. Because it is always a risk, to take a new
project, but the payoff could be very high. If it is possible
to reward risk-taking in a certain way through incentives that
could be tax incentives, that would probably also encourage
small companies, small business to get closer to a university
and try to find out what is actually available there and cross
the bridge this way.
Chairman Nye. Thank you. And I have just one final question
for Mr. Bendis. You began to lay out, I think, kind of an
ambitious agenda of other ideas that could be very helpful to
us in terms of assisting innovative small businesses. I am just
wondering if you could give us any ideas about specific changes
to the R&D tax credit that might help us at least get halfway
there.
Mr. Bendis. Performance is number one. I think one of the
problems is that it is somewhat like the SBIR program, which I
know the House passed on it yesterday. I think there is a
little frustration amongst all of the practitioners in the
United States and small businesses that they really can't plan
long-term on a number of items based on the temporary nature of
some of these programs. Or they are always going back for
reauthorization. So there are a number of countries around the
world who basically look at what the United States creates.
Simplify it, improve upon it and then they build it into their
innovation strategy and make it permanent. So the question is
why should we continue to be the one that designs the programs,
other people benefit around the world and then we debate our
own programs which everybody agrees with are the best working
in the world and we come back and debate them every couple of
years here in Congress.
So permanence, I think for these kind of programs, as well
as other critical programs in the innovation portfolio is
extremely important. Simplification is another area. And that
has been talked about by some other panelists. Anything that
can be done to simplify the program to where a nonaccounting,
nonlegal person can understand the legislation and whether or
not they can qualify for it very quickly would be very
advantageous to entrepreneurial and innovative businesses.
Chairman Nye. Well, again, I want to thank all of you. You
have given us some really good ideas to take into account as we
look at reauthorization. And I would like now to yield to Mr.
Schock for as much time as he would like.
Mr. Schock. Well, thank you, Mr. Chairman. You have taken
some of my very thoughtful and creative questions already, so I
will be brief. Dr. Schoenbach, to follow up on Chairman Nye's
question about transferring that technology to businesses, part
of the bill yesterday was the STTR provision, the small
business technology transfer program. And I am just wondering
if your university is able to or if you target businesses who
may already participate in that program as potential customers
for your technology that you are developing at the university,
if there is a way for you to get that information of
recipients, in other words of those entrepreneurs who are
already involved with that that are interested in taking the
risk and developing the technology that a university like yours
would use. It would seem to me that that might be a good
program to look at for potential partners.
Mr. Schoenbach. I think definitely STTRs, and we have done
several of them, are a good vehicle, to bring certain projects
to fruition. And SBIRs, as well, with subcontracts to the
university. So this is a possibility and that can be used. It
doesn't work for all the projects. Preclinical studies, trials
and so on, require in my opinion much more funding than is
available through these STTRs. The other problem sometimes with
STTRs and SBIRs, especially at Department of Defense, is that
you have to see what is available. That means you have to find
a match first before you can start working on a project. And
very often there is no match. An innovation coming from a
university, might not have reached that stage where somebody at
DOD has made a decision this is worth funding. There is a
certain delay then in all these procedures. But definitely for
many projects this is an excellent program, and we have made
use of it several times.
Mr. Schock. So the limitations in the program aren't so
much in the way the rules are written, but it is much in the
grant award sizes don't allow for some of the research.
Mr. Schoenbach. That is what my opinion is. Some of the
projects require more funding. So this is one obstacle. And
particularly if you go into biomedical applications trials are
very expensive. The other one is the delay in bringing
innovations to industry. For example, I go into the Internet
and look at what is available in SBIR and STTR at DOD. I am an
engineer so this would be my first thing to do, go in the Web
site of DOD. And then I see the different topics which are
offered. And some of them might fit, but most of them will not
fit if I do something which is really innovative. So it
requires additional work to make people aware of this
innovation which takes time to do. So this is a matter of
involving the researcher more in the decision making about
topics which are worth funding. And I don't know how this could
be done; this is a matter of procedures.
Mr. Schock. Mr. Barrett, you mentioned in your testimony
that in addition to the R&D tax credit perhaps we could offer
some incentives for what I would interpret as like an
accelerated depreciation or some kind of incentive for the
capital required for the R&D. Is that what you are thinking of
as like an accelerated depreciation method for those
investments or do you have some specific ideas on what we could
do as a part of the R&D tax credit to help lessen the burden
required for some of the more capital intensive research.
Mr. Barrett. I think that more rapid depreciation would be
a very good thing because in our business the hardware becomes
obsolete much more rapidly. Five years, I think, is a typical
schedule. And it can become obsolete within a year or 2 years,
depending upon the technology uses. So yeah, looking at that I
think a little bit more carefully would be warranted.
Mr. Schock. And then, Mr. Bendis, you talked about
improving the R&D tax--or research and development tax credit.
I am wondering if there are specific States that are
exceptionally good at this or they have a better R&D than other
States that we can model our legislation at or at least look to
for ideas.
Mr. Bendis. As I mentioned, there are 38 States, and a
number of them have modeled their programs based on what the
earlier States have done and tried to improve them. I know that
New Jersey has done some modifications recently, Pennsylvania
has a very aggressive program. But I think it would be very
easy. And the State Science and Technology Institute, which is
a technology based economic development national association
working with these kind of organizations in all 50 States,
could very easily summarize for you and this committee what
some of the best practices are and what some of the
improvements have been made as well as the National Association
of Seed Venture Capital. We would be glad to work with the
committee to look at what some of the innovative things are
that are occurring in the States that may benefit this
legislation as you are trying to either extend or make it
permanent.
And I don't know if it is too late, but it is never too
late to look at constant improvements. And I think that the
platforms of innovation are really occurring at the State
level. So how do you take advantage of some of the things that
they have learned from best practices that can be incorporated
at a Federal level. And we would be glad to work with you on
that.
Mr. Schock. Well, I don't think it is too late. I mean,
that is why we are having the hearing, so we can get ideas and
feedback and ways to improve. So very good. Thank you all for
your traveling here and most importantly for putting up with
our very crazy schedule. Welcome to Congress.
Chairman Nye. Again, I want to add my word of thanks to
everyone for spending this time with us and for sharing your
expertise. You all are on the front lines here and see this in
execution every day, and it is our job to listen to you and
then to try to make policy which reflects the reality of what
is going on out in the economy. So we thank you again. I am
going to ask unanimous consent that members have 5 days to
submit statements and supporting materials for the record.
Without objection so ordered. This hearing is now adjourned.
[Whereupon, at 1:22 p.m., the subcommittee was adjourned.]
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