[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]




 
                    SMALL BUSINESSES AND TAX REFORM

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

                                HEARING

                               before the

                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 3, 2011

                               __________

                          Serial No. 112-SRM1

                               __________

         Printed for the use of the Committee on Ways and Means




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                      COMMITTEE ON WAYS AND MEANS

                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                       PAT TIBERI, Ohio, Chairman

DEAN HELLER, Nevada                  RICHARD E. NEAL, Massachusetts, 
PETER ROSKAM, Illinois               Ranking Member
ERIK PAULSEN, Minnesota              MIKE THOMPSON, California
CHRISTOPHER LEE, New York            JOHN B. LARSON, Connecticut
RICK BERG, North Dakota              SHELLEY BERKLEY, Nevada
CHARLES BOUSTANY, Louisiana

                       Jon Traub, Staff Director

                  Janice Mays, Minority Staff Director


                            C O N T E N T S

                               __________
                                                                   Page

Advisory of March 3, 2011, announcing the hearing................     2

                               WITNESSES

Dr. Robert Carroll, Principal, Qualitative Economics and 
  Statistics, Ernst & Young LLP, Washington, D.C.................     5
Ms. Patricia A. Thompson, Chair, Tax Executive Committee, 
  American Institute of Certified Public Accountants, Piccerelli, 
  Gilstein & Co. LLP, Providence, Rhode Island...................    18
Mr. Dennis Tarnay, Chief Financial Officer, Lake Erie Electric, 
  Inc., Cleveland, Ohio..........................................    29
Dr. Donald B. Marron, Director, Tax Policy Center, The Urban 
  Institute, Washington, D.C.....................................    34

                       SUBMISSIONS FOR THE RECORD

Alvin S. Brown...................................................    67
National Association of Small Business Investment Companies......    75
Small Business Legislative Council...............................    79
The National Association of Home Builders........................    81
U.S. Chamber of Commerce.........................................    86


                    SMALL BUSINESSES AND TAX REFORM

                              ----------                              


                        THURSDAY, MARCH 3, 2011

             U.S. House of Representatives,
                       Committee on Ways and Means,
                   Subcommittee on Select Revenue Measures,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 9:05 a.m., in 
Room 1100, Longworth House Office Building, the Honorable Pat 
Tiberi [chairman of the subcommittee] presiding.
    [The advisory of the hearing follows:]
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    Chairman TIBERI. Now that we have finished our 
organizational meeting, I would like to call today's meeting to 
order. I want to welcome our witnesses to the hearing to 
discuss the taxation of small businesses and passthrough 
entities as part of a broader discussion on comprehensive tax 
reform.
    I believe there is a window of opportunity to enact 
comprehensive tax reform, and we must take advantage of it. 
Last November, the American people sent a strong message to 
Washington. They told Washington to stop putting off tough 
decisions, start making the decisions that will ensure future 
generations of Americans will prosper.
    Whether it will be reducing the national debt, ensuring 
entitlements will remain solvent, or reforming our Tax Code to 
encourage economic growth, saying it is too difficult isn't an 
excuse anymore. Our current system of taxation was written for 
an economy that was very different from the competitive global 
economy of today. It is time to enact a Tax Code that is 
competitive with the rest of the world, that is fairer, and 
that is simpler.
    Small businesses must be included in comprehensive tax 
reform. Reforming corporate taxes means only reforming roughly 
10 percent of Federal revenues. That is not comprehensive. Many 
small businesses pay taxes under the individual income tax 
rates as passthrough entities, which we will hear more about 
today.
    The last thing we want to do as part of tax reform is 
create a situation where we are putting small businesses at a 
competitive disadvantage. I fear leaving them out of tax reform 
will do just that. Small businesses are the engine of economic 
growth in our economy. As we move forward with tax reform, the 
question we must ask ourselves is how we reform the code in a 
manner that empowers small businesses to grow and create jobs.
    I look forward to hearing from our witnesses on those 
issues today.
    With that, I will yield to the ranking member, Mr. Neal.
    Mr. NEAL. Thank you, Mr. Chairman.
    And I want to thank you for calling this hearing this 
morning. I hope that it will be the first of many on the topic 
of tax reform.
    Earlier, I commented on how this subcommittee always hears 
diverse points of view, and certainly this morning is no 
exception. We have one witness who is complaining that there 
are too many special provisions for small businesses and that 
the clutter is overwhelming. We have another saying that these 
special provisions make for a code that favors small businesses 
over large, and yet another tells us that we need to lower 
income taxes on the upper-income to save small businesses.
    But one thing that we can agree on is that the U.S. offers 
some of the most flexible rules on structuring your business in 
the developed world, offering limited liability without the 
requirement of a corporate-level tax. As one witness tells us 
today, we are second only to Mexico in the size of the 
unincorporated businesses as a total share of business, and 
that this self-help integration is a step toward reform.
    While this hearing is intended to explore special tax 
issues on passthrough entities, much of the discussion will 
involve small-business incentives. We should note that the two 
are not necessarily the same. As one witness tells us, less 
than 1 percent of all passthroughs are large businesses with 
more than $10 million in receipts but they accounted for almost 
60 percent of the total revenues of all passthroughs.
    Confucius noted that a journey of a thousand miles begins 
with a single step. I want to thank you, Mr. Tiberi, for taking 
that first step this morning on the road to tax reform. And we 
hope the journey does not take a thousand hearings.
    Thank you.
    Chairman TIBERI. Thank you, Mr. Neal.
    I ask unanimous consent that all Members' written 
statements will be included in the record.
    Without objection, so ordered.
    Chairman TIBERI. We will now turn to our panel of 
witnesses, whose bios are in your packages. I will introduce 
them, and then we will begin after I have introduced them all.
    Dr. Robert Carroll is from Ernst & Young. Ms. Patricia 
Thompson is a tax partner at Piccerelli, Gilstein & Company and 
chair of the AICPA Tax Executive Committee. Mr. Dennis Tarnay 
is the CFO of Lake Erie Electric and a former board member of 
the Ohio Society of CPAs and from the great Buckeye State. And 
Dr. Donald Marron is director of the Urban-Brookings Tax Policy 
Center.
    Thank you all for joining us this morning.
    Dr. Carroll, you may begin your testimony.

 STATEMENT OF ROBERT CARROLL, PRINCIPAL, QUALITATIVE ECONOMICS 
      AND STATISTICS, ERNST & YOUNG LLP, WASHINGTON, D.C.

    Mr. CARROLL. Thank you, Chairman.
    Chairman Tiberi, Ranking Member Neal, and distinguished 
Members of the Subcommittee, I thank you for the opportunity to 
testify today regarding the taxation of flow-through businesses 
and tax reform.
    I have had the opportunity to consider the taxation of 
flow-through businesses from a number of different perspectives 
inside and outside of government in the context of broad reform 
of the code and narrow reform of the business tax system. More 
recently, I have been analyzing the flow-through sector in the 
course of preparing a report on behalf of the S Corporation 
Association. Today I would like to share my perspectives and 
provide some preliminary results from the study on the flow-
through sector we are preparing for release in the near future.
    Flow-through businesses, S corporations, partnerships, 
limited liability companies, and sole proprietorships play an 
important role in the U.S. economy. The vast majority of 
businesses in the United States have chosen to organize as 
flow-through businesses.
    Today, flow-through businesses comprise more than 90 
percent of all business entities, employ more than 50 percent 
of the workforce, and report more than one-third of all 
business receipts. Individual owners of flow-through businesses 
report 40 percent of all business net income. These individual 
owners also pay 43 percent of business taxes when filing their 
individual tax returns.
    The flow-through sector in the United States differs 
markedly from other developed nations. The business forms 
available in many other countries tend to push businesses 
toward the corporate form in pursuit of limited liability, 
whereas in the United States such limited liability is 
attainable through various organizational forms outside of the 
corporate sector.
    This has resulted in a flow-through sector with 
considerable flexibility in how they organize and how they 
structure their operations. Businesses can choose between 
several different organizational forms which may provide a 
better match to their management needs and capital 
requirements.
    The unincorporated business sector in the United States is 
also larger than in most other developed nations. Of the 
countries responding to a 2007 OECD survey, the unincorporated 
business sector was larger as a share of the total number of 
businesses in the U.S. in all but one country.
    With the increasing prominence of flow-through businesses, 
it is important to carefully consider how the flow-through form 
fits into the U.S. tax system and how any particular reform 
might affect flow-through businesses.
    Flow-through businesses are subject to a single level of 
tax on the income earned and allocated to their owners. Thus, 
it is the tax rates faced primarily by individual owners of 
flow-through businesses that affect decision-making and the 
economic health of these businesses.
    In contrast, the income of C corporations is subject to two 
levels of tax: first when income is earned at the corporate 
level and again when the income is paid out to shareholders in 
the form of dividends or retained earnings and later realized 
by shareholders as capital gains, hence the phrase, ``the 
double tax on corporate profits.''
    The double tax affects a number of important economic 
decisions: First, by increasing the cost of capital, it 
discourages investment and, thus, economic growth and job 
creation. Second, it leads to a bias in firms' financing 
decisions between the use of debt and equity. And, third, it 
distorts the allocation of capital within the economy. The 
flow-through form provides an important benefit to the economy 
by reducing these economically harmful effects of the double 
tax.
    Recent focus on the need to lower the corporate income tax 
has also drawn attention to how flow-through businesses might 
be affected by tax reform. With substantial evidence that the 
U.S. corporate tax rate is out of step internationally, 
corporate tax reform is an important component of an overall 
approach to improving the current tax system.
    As with any such endeavor, however, it is important to keep 
in mind the potential for undesirable side effects. Corporate 
reform that eliminates business tax expenditures would have the 
unintended impact of raising the taxes of businesses organized 
using the flow-through form without offering the benefit of the 
lower corporate tax rate. Flow-through businesses would lose 
the benefit of widely used and longstanding provisions such as 
accelerated depreciation and the charitable-giving deduction. 
In total, flow-through businesses use about 22 percent of the 
roughly $100 billion in annual business tax expenditures.
    Flow-through businesses are a large part of the U.S. 
business sector and important contributors to the economic 
vitality of the U.S. As reform progresses, it is important to 
understand and consider all of these issues with an eye toward 
bringing about the tax reform that is most conducive to 
increased growth and job creation.
    The path toward tax reform will need to take into account 
many features of our tax system and strike a balance between a 
number of sometimes conflicting and competing objectives. This 
committee should be commended for holding this hearing to 
better understand the role that the flow-through sector plays 
in the U.S. economy.
    I thank you, and I would be pleased to address any 
questions the subcommittee might have.
    [The prepared statement of Mr. Carroll follows:]

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    Chairman TIBERI. Five seconds to spare. Impressive.
    Ms. Thompson.

    STATEMENT OF PATRICIA A. THOMPSON, CHAIR, TAX EXECUTIVE 
COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, 
TAX PARTNER, PICCERELLI, GILSTEIN & CO. LLP, PROVIDENCE, RHODE 
                             ISLAND

    Ms. THOMPSON. Good morning, Chairman Tiberi, Ranking Member 
Neal, and Members of the Subcommittee. My name is Patricia 
Thompson. I am a CPA and chair of the AICPA Tax Executive 
Committee. My testimony today is based on my experiences with 
working with many small business clients. I am tax partner at 
Piccerelli, Gilstein & Company LLP, a CPA firm in Providence, 
Rhode Island, and have been with the firm for over 32 years. I 
would like to thank this subcommittee for the opportunity to 
appear today.
    Chairman Tiberi, I would like to start by thanking you for 
your work in trying to repeal the two 1099 provisions. As noted 
in our written testimony, these are significant burdens on 
small businesses.
    Today's hearing focuses on the special burdens that the tax 
law imposes on small businesses. Business tax reform cannot 
merely change the corporate tax rates or other corporate 
provisions if the desired impact is to help small businesses, 
since many of them are not organized as corporations. I 
understand the challenges inherent in drafting tax legislation 
and appreciate your diligence in trying to do the right thing 
for taxpayers.
    My full written testimony discusses several burdens and 
complexities facing small businesses. In my brief time with you 
today, I would like to highlight just a few.
    The first is tax simplification--depreciation is the best 
example. Methods to compute depreciation are different for tax 
and financial accounting purposes. Depreciation rates can vary 
depending on the method. There are special types of 
depreciation, such as bonus, special straight line, and Section 
179. Plus, there is a different method for AMT. So businesses 
have to maintain several different books of depreciation and 
update them annually for each individual asset.
    Let's say a client places several pieces of equipment in 
service throughout the year. To determine the best depreciation 
method, they need to run a complex analysis: When was it 
purchased? Was it new? Was it used? What was the total amount 
purchased? Depending on the purchase date, they may be entitled 
to 50 percent depreciation; maybe it is 100 percent. If they 
purchase too much equipment, Section 179 isn't available. If 
they don't earn enough money, Section 179 is limited. The best 
depreciation method may not be clear without extensive 
analysis.
    My second point is uncertainty in the tax law. Many of the 
changes passed last year were designed to help employ more 
workers, help small businesses improve cash flow, and improve 
the economy. For example, the HIRE Act that passed last March 
provided an incentive to hire unemployed workers. This 
legislation was time-sensitive. If taxpayers did not know of 
the new incentive, the tax-saving opportunity was permanently 
lost.
    The increased use of temporary provisions has also created 
some uncertainty. While some measures may be appropriate for 
the short term, temporary tax provisions and incentives have 
become far too common. Often they are allowed to expire, then 
they are revived after much debate, but only for another 
temporary period. It is inefficient and ineffective to make 
longstanding tax policy utilizing temporary provisions.
    Additionally, when changes occur late in the year, small-
business owners have little time to evaluate the impact of 
those changes on their businesses. It is even harder to plan 
when the new tax law takes effect in the same year that it is 
issued. In that case, a small-business owner can't do long-term 
planning for growth, business development, or new hiring. It 
can be difficult to change course in response to a new, short-
term expiring tax provision.
    The third issue I would like to highlight is the need to 
consider expansion of corporate provisions to help noncorporate 
entities.
    The Small Business Jobs Act passed last September expanded 
an existing provision to allow 100 percent gain exclusion on 
the sale of small-business stock if certain conditions were 
met. There are several requirements to qualify for this 
exclusion. It must be a C corporation of a qualifying business. 
The stock cannot exceed a certain value and must be held for 
more than 5 years.
    The key here is that this provision only benefits C 
corporations, so it excludes many small businesses that are 
conducted as sole proprietors or passthrough entities. This is 
an excellent example of a provision that was intended to help 
small business that will likely not have the desired impact.
    One final note: I would encourage you to review two of our 
recent publications, one on alternatives for tax reform, and 
the other is our report on penalty reform. Both are available 
online, and links are provided in our written testimony.
    Thank you again for the opportunity to testify, and I will 
be happy to answer any of your questions.
    [The prepared statement of Ms. Thompson follows:]

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    Chairman TIBERI. Thank you. Thank you, Ms. Thompson. And 
you came in under time, as well.
    Mr. Tarnay, welcome.

STATEMENT OF DENNIS TARNAY, CHIEF FINANCIAL OFFICER, LAKE ERIE 
                ELECTRIC, INC., CLEVELAND, OHIO

    Mr. TARNAY. Chairman Tiberi, Ranking Member Neal, and 
Members of the Subcommittee, thank you for inviting me to 
appear before you today to discuss the issue of fundamental tax 
reform, particularly as it relates to small businesses.
    I am the chief financial officer and a minority owner of 
Lake Erie Electric, a position I have held since 1987, and a 
former board member of the Ohio Society of Certified Public 
Accountants. I am speaking today on behalf of both Lake Erie 
Electric and the OSCPA.
    Lake Erie Electric, based in Cleveland, Ohio, is an 
electrical contracting company that was first formed as a C 
corporation in the 1950s to primarily serve industrial 
customers in the automotive and steel sectors of the Midwest.
    My company has seen many changes since its inception, both 
in terms of its corporate structure and business strategies. In 
1987, we modified the corporate structure of the company to a 
passthrough Subchapter S corporation through the Federal tax 
law changes that occurred at that time and because it was a 
better fit for us. When Cleveland's industrial base contracted, 
we transitioned our customer base to be more heavily weighted 
to commercial businesses and the health-care sector.
    The main message I want to deliver to you today, gentlemen, 
is that simplifying the Tax Code for small businesses means 
creating jobs in places like Cleveland, Ohio. Predictability 
and stability within the Tax Code provides businesses, 
particularly small businesses, which typically have tighter 
profit margins, the necessary lens with which to make decisions 
regarding growth, investment or reinvestment of capital, and 
expanding new employee job opportunities.
    Further, a simpler Tax Code means small-business owners can 
spend less time on costly and burdensome compliance activities 
and invest more of their time on innovation and growing their 
businesses. Simplicity also helps to minimize taxpayer 
confusion over exactly what liability is owed and helps with 
financial planning for the future.
    Tax reform for small business is about one thing in 
America: jobs for all business sectors.
    Subchapter S corporations are structured so that net income 
or losses to the business are distributed to the shareholders 
of the company and are reflected on the individual's Federal, 
State, and even local income tax returns. The tax is assessed 
at their individual income tax rates, meaning legislators 
should be conscious that discussions of assessing higher tax 
rates on individuals at the $200,000 level and families at the 
$250,000 level will have a direct impact on the ability of many 
small-business owners to reinvest in their businesses and keep 
or grow their workforce.
    In addition to Subchapter S corporations, other forms of 
passthrough entities that will be similarly impacted are 
limited-liability companies, partnerships, limited-liability 
partnerships, and sole proprietorships. Roughly 75 percent of 
small businesses are passthrough entities. As we know, the 
primary reason there are so many passthrough entities is 
because double taxation is eliminated, first at the entity 
level as earnings and then again at the individual level as 
dividend payments to shareholders.
    This data leaves little doubt that, in order for a 
significant economic recovery to take place, there must be a 
tax structure in place that will give small businesses the 
incentive to hire and thrive.
    Tax law does matter to small-business passthrough entities 
because they modify business practices to adjust for law 
changes. In recent years, tax-law changes have become a 
political tool, with revisions occurring far too often, 
sometimes more than once a year and sometimes so late in the 
year that it is retroactive in impact, causing business owners 
to be confused and uncertain on how to proceed.
    The frequency of tax-law changes affects small businesses 
in particular because the unpredictability often slows or 
discourages the hiring or rehiring of employees or investing in 
new capital or other products and services. While certainly 
businesses of all sizes are impacted by the frequency of tax-
law changes, they have a far greater impact on small-business 
decisions because so many of them operate on very tight profit 
margins.
    Predictability helps to keep costs down, as fewer changes 
equate to fewer compliance costs associated with changing 
practices and procedures that, in many cases, are longstanding 
and successful from a cost-benefit standpoint. Lower cost 
equals greater ability to reinvest in company and future 
growth.
    The current structure of passthrough entities, such as 
Subchapter S corporations, provides flexibility and control to 
small-business owners and should be maintained in any tax 
reform proposal. Going forward, tax reform should help small 
business by reforming issues such as: simplifying compliance 
rules regarding E-Filing and E-Verify; shifting the burden away 
from being the watchdog for various government entities on its 
employees; reforming the timing requirements for S-corporation 
formations; increasing the amount a small businesses may 
expense on the Federal tax returns; reasonable independent 
contractor rules.
    Gentlemen, the alternative minimum tax should be 
eliminated. If it can't be eliminated, enact a more reasonable 
and consistent threshold for the alternative minimum tax.
    In a related matter, I do applaud your efforts to address 
the expanded 1099 requirements currently on schedule to become 
effective January in 2012. From a small-business perspective, 
this is the classic example of a compliance cost on both 
businesses and the Internal Revenue Service outweighing the 
benefits derived.
    Chairman TIBERI. Mr. Tarnay, if you can wrap up----
    Mr. TARNAY. I am right now.
    Chairman TIBERI. Thank you.
    Mr. TARNAY. Meaningful tax reform that focuses on 
simplicity, predictability, and fairness that includes an 
emphasis on the related cost and compliance burden to small 
businesses is critically important so that we, as small-
business owners, do our part to grow the economy.
    On behalf of both Lake Erie and the Ohio Society of CPAs, I 
appreciate the opportunity to share my concerns and would 
welcome any questions you have.
    [The prepared statement of Mr. Tarnay follows:]

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    Chairman TIBERI. Thank you.
    Mr. Marron.

 STATEMENT OF DONALD B. MARRON, DIRECTOR, URBAN-BROOKINGS TAX 
                POLICY CENTER, WASHINGTON, D.C.

    Mr. MARRON. Chairman Tiberi, Ranking Member Neal, Members 
of the Subcommittee, thank you for inviting me to appear today 
to discuss the tax system and small business.
    America's tax system is needlessly complex, economically 
harmful, and often unfair. Because of a plethora of temporary 
tax cuts, it is increasingly unpredictable. And it fails at its 
most basic task, which is raising enough money to pay our 
government's bills. For all those reasons, the time has come 
for fundamental tax reform.
    Such reform could have far-reaching effects on every 
participant in the economy, including small businesses. To 
provide a foundation for thinking about these effects, my 
testimony discusses basic facts about the relationships between 
tax policy and small business.
    I make six main points.
    First, today's Tax Code generally favors small businesses 
over larger ones. Provisions such as Section 179 expensing, 
graduated corporate tax rates, and special low capital gains 
taxes benefit businesses that are small in terms of investment, 
income, or assets.
    Second, many small businesses also benefit from the 
opportunity to organize as passthrough entities. S 
corporations, limited-liability companies, partnerships, and 
sole proprietorships all avoid the double taxation that applies 
to income earned by C corporations.
    Third, the benefits of organizing as a passthrough are not 
limited to small businesses. Some large businesses adopt these 
forms, as well. Although these large firms account for a tiny 
share of passthrough entities, they represent a substantial 
fraction of passthrough economic activity. For example, only 
0.3 percent of S corporations had revenues above $50 million in 
2005, but they accounted for more than a quarter of S-
corporation income. The situation is even more extreme with 
partnerships. Only 0.2 percent of partnerships had revenues 
above $50 million, but they accounted for 57 percent of 
partnership income. Lawmakers should therefore take care not to 
assume that all passthroughs are small businesses.
    Fourth, small businesses face disproportionately high costs 
in complying with the Tax Code. They are also more likely to 
understate their income and underpay their taxes. High 
compliance costs thus disadvantage responsible small 
businesses, while the greater opportunity to evade taxes can 
advantage less responsible ones.
    Fifth, an ideal tax system would collect enough revenue to 
pay for government services while minimizing distortions to 
economic activity. To the extent possible, economic 
fundamentals, not tax considerations, should drive business 
decisions about organizational structure. By treating 
passthroughs and C corporations differently, our current tax 
system deviates from that ideal.
    Sixth, and finally, in discussing reform proposals, it is 
important to distinguish between businesses--a broad category 
that includes passthroughs--and corporations, which generally 
means C corporations. Many tax reform proposals would reduce 
business tax preferences and use the resulting revenue to cut 
corporate income tax rates. Such revenue-neutral reforms could 
lessen the disparity in tax treatment between passthroughs and 
C corporations. Passthroughs would see their tax burden 
increase since they would lose some tax preferences but not 
benefit from the rate reduction, while C corporations would, on 
average, see their taxes decline.
    Thank you. I look forward to any questions.
    [The prepared statement of Mr. Marron follows:]

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    Chairman TIBERI. Thank you.
    Mr. Tarnay, in your written testimony and briefly in your 
verbal testimony, you mentioned a couple of things I would like 
you to expand on, if you could. You mentioned simplifying 
compliance rules regarding E-Filing and E-Verify. And you also 
mentioned shifting the burden away from small businesses to be 
the watchdog for government on their employees.
    Can you expand on both of those issues?
    Mr. TARNAY. E-Verify--in our business sector, since our 
labor force comes from the unions, we have employees that come 
and go during the course of the year. And every time they come 
on, we have to E-Verify.
    So you can have an employee, an electrician, for example, 
that comes on the payroll for, let's say, 3 weeks, 4 weeks, 3 
months, and then goes back to the labor force because we don't 
need that employee anymore. Well, the next time he comes on, we 
once again have to go through the E-Verify process, and we have 
to do that within 3 days of him being on the payroll. But when 
we do that, and since we have roughly 400 or 500 electricians 
and they rotate, we could have that same employee being E-
Verified 3 or 4 times a year.
    It is time-consuming, and it takes away from other 
opportunities.
    Chairman TIBERI. And the other issue?
    Mr. TARNAY. E-Filing? We haven't had much to do with E-
Filing. But I know for small businesses it can be very 
difficult, simply because many of the small businesses are not 
that, I am going to call it, technologically--have those 
technological abilities.
    Chairman TIBERI. And your point about being a watchdog, 
small businesses being a----
    Mr. TARNAY. Well, that isn't just at the Federal level. 
That is at all levels of government. Garnishments, 
withholdings----
    Chairman TIBERI. 1099s.
    Mr. TARNAY [continuing]. Child support. It goes throughout. 
It is a tremendous burden.
    Chairman TIBERI. Thank you.
    Dr. Carroll, if Congress decides to reduce business tax 
expenditures and cut the corporate tax rate, what are some ways 
that we could mimic a corporate tax rate cut for noncorporate 
businesses?
    I would note, and I know you are aware, for example, that 
the House Republican Pledge to America proposes a 20 percent 
deduction for small-business income, which would, I believe, be 
a similar rate cut from 35 percent to 28 percent for small 
businesses.
    Can you give us some thoughts on that?
    Mr. CARROLL. Yeah, sure. I think there are a couple of ways 
that that could be accommodated in our current tax system. One 
approach would be to put in place a separate rate schedule, 
similar to dividends and capital gains. Another approach would 
be to put in a deduction for a certain fraction of flow-through 
income.
    One of the complexities in extending a deduction or a lower 
rate to flow-through income might be trying to split up the 
return to labor and return to capital associated with that 
income.
    For S corporations, it is fairly--it is more 
straightforward, I would say. S corporations are required to 
pay the owners a reasonable level of compensation. But for 
other organizational forms, such as, you know--one would have 
to address that issue. Some of the Nordic countries have tried 
to split up the return to labor and return to capital, but they 
have come up with very, very complicated approaches for that.
    Chairman TIBERI. Last question, if you could all just 
comment on this. Some have said that if we can lower the rate 
and broaden the base and get rid of some of the other stuff 
within the Tax Code to simplify it--Ms. Thompson, starting with 
you--what would be a ballpark figure that you think you could 
lower rates for passthrough entities and get rid of some of the 
things that might benefit some passthrough entities but not 
all?
    Ms. THOMPSON. The AICPA actually doesn't take a position on 
the best alternative to come up with. But what they have is the 
report talks about reform alternatives for the 21st century.
    And what they think about when evaluating the tax reform 
proposals, they would want to look for simplicity within the 
measure; whether it is fair; whether it has economic growth and 
efficiency; its neutrality; whether it is transparent to 
everybody; whether or not it is minimizing the noncompliance, 
because we all know that that is a significant issue, and the 
easier you make something, the more compliant people will be; 
whether it has the ability to have cost-effective collection 
and the impact on the government revenues; whether there is 
certainty in it; and whether there is payment convenience.
    So the AICPA really, at this point, doesn't have a 
position, to answer your question, on it. But as proposals come 
up, we could take a look at them and see what----
    Chairman TIBERI. We could probably move your bill right 
now, actually. I think everyone agrees with what you have said.
    Mr. Tarnay.
    Mr. TARNAY. Simplicity and predictability for a small 
business is essential so that they know what to do, moving 
forward. As we all know, in small businesses, it is usually the 
owner that leads it, and he is not necessarily the key in 
financial decision-making. That is why, many times, the CFO is 
known as an ``OFO,'' the ``only financial officer.''
    If you make it simple and predictable, a small-business 
owner begins to understand it, and he can make decisions in his 
structure, in his decision-making, so that he can expand his 
business. It is as simple as that.
    Chairman TIBERI. Mr. Marron.
    Mr. MARRON. I was quite impressed with where the 
President's fiscal commission came out. I served on the 
parallel Domenici-Rivlin commission.
    Both of those did full-scale tax reform, individual and 
corporate at the same time. And in both of those, they came out 
in roughly the same place, saying that we should aspire to a 
system where both the top corporate rate and the top individual 
rate are the same and begin with a ``2,'' and it is 27, 28, 
somewhere in there.
    Chairman TIBERI. Thank you.
    And, finally, Dr. Carroll?
    Mr. CARROLL. Just following on Mr. Marron's comments, both 
the fiscal commission and the Rivlin commission got down to 
about a 27, 28 percent. They would eliminate most, if not all, 
business tax expenditures, depending on the plan. They kept a 
few things.
    If you go back to the 2007 Treasury competitiveness report, 
we were able to get the rate, at that time, down to about the 
same. If you eliminated all business tax expenditures, you 
could get the rate down to about 27, 28 percent. And that 
includes getting rid of provisions like accelerated 
depreciation, and so some provisions that are longstanding and, 
certainly, widely used.
    And one of the things I think you need to also consider is, 
when you add in the State rates, even if you got the business 
rate down to 28 percent for corporations and for flow-throughs, 
when you add in State rates you would still have a rate on the 
order of about 33 percent, combined rate, for the U.S., which 
would still place us at a rate above the OECD and the G-7.
    Chairman TIBERI. Thank you. Thank you all.
    I will yield for questioning to the ranking member, Mr. 
Neal.
    Mr. NEAL. Thank you, Mr. Chairman.
    Dr. Marron, both you and Dr. Carroll discussed the problem 
with eliminating business tax preferences as part of an effort 
to lower the corporate rate. In fact, Dr. Carroll's testimony 
highlights the annual cost of these preferences and which ones 
are used equally by both corporations and passthroughs.
    Since base-broadening, though, seems to be the best way to 
accomplish reform, how do you think that Congress should 
address this real concern?
    Mr. MARRON. I would start with broad principles. And from 
the security of being a think-tank economist kind of guy, the 
number-one principle I start with is a leveling the playing 
field. That the first order, the goal of our tax system should 
be not to play favorites among different types of activities, 
different organizational forms. And that when you have business 
tax preferences that are clearly skewing the field in one 
direction or another, that those are ones that ought to get 
close attention.
    A second one--and this one I want to highlight just because 
it doesn't come up as much. We often talk about a strategy of 
rolling back tax preferences, and lowering rates as a strategy 
for doing corporate reform and business reform. There is 
another strategy, which is to keep favorable depreciation 
policies, possibly even move toward expensing, but then pay for 
that by walking back the deductibility of interest.
    And an attraction--I would recommend that as a strategy to 
keep in mind, because the attraction of that is that it would 
eliminate some of the distortions in our current system that 
favor leverage and favor debt. And, in principle, it could be a 
way that it would have favorable business incentives but in a 
paid-for way.
    Mr. NEAL. Uh-huh.
    Dr. Carroll.
    Mr. CARROLL. Yeah, I think the challenge is--there has been 
some discussion of corporate reform focused on trying to bring 
the corporate rate down, primarily due to the pressures from 
abroad, with the corporate rates coming down quite a lot over 
the last couple of decades among our major trading partners. 
And I think, you know, tax reform--I think business tax reform 
needs to be somewhat more broadly considered.
    I think it is very hard to lower the corporate rate and pay 
for that by repealing all business tax expenditures or some set 
of business tax expenditures for both flow-throughs as well as 
C corporations. I think one needs to pursue not just reform of 
the corporate income tax but, more broadly, reform of the 
business tax system and look at that in a more holistic 
fashion.
    And the tax system is very intertwined. There are a lot of 
interrelationships between, as I have discussed in my written 
testimony, between C corporations and the flow-through sector, 
but also in the taxation of investor-level income, in the form 
of capital gains and dividends. You have the part of the double 
tax on corporate profits.
    These things are very interrelated, and I think it is very 
difficult to take a small piece of the Tax Code and try to 
reform that in isolation. I think pursuing it in a much broader 
way is more constructive.
    Mr. NEAL. Uh-huh.
    Off-script for a moment: But a few moments ago in your 
comments, you spoke to depreciation allowance. While I think, 
in my own instance, having rejected the idea, the theology that 
tax cuts pay for themselves, I do subscribe to the notion, as 
Chairman Tiberi offered at the outset, that the use of the NOL 
last year was very important, further suggesting that, at 
certain times, some tax cuts are better than others.
    And I think there is some evidence over the years that 
acceleration of depreciation allowance has worked, in terms of 
changing behavior in an economic downturn. Are you prepared to 
suggest that that ought to be eliminated as a possibility?
    Mr. CARROLL. Yeah, I am not really here to suggest what 
should be eliminated or kept.
    With respect to accelerated depreciation and expensing, I 
think it is a pretty common view among economists that 
expensing and accelerated depreciation are constructive 
provisions that help encourage investment. Both in times of 
economic downturns--the bonus depreciation and 100 percent 
expensing enacted in late December can be very constructive to 
help stimulate business investment during periods of economic 
weakness--but it is also, I think, very helpful in terms of 
longer-term tax policy. Accelerated depreciation and expensing 
help to reduce the tax on capital income in the economy, which 
can help encourage capital formation and promote growth in the 
longer term.
    Mr. NEAL. And, Ms. Thompson, it was dizzying just to read 
your client scenarios with all the complex depreciation 
options, but I am sure you understand that Congress was trying 
to help small business, even though the result was a patchwork 
of generous rates and confusing expiration dates.
    And I share the argument that the four of you seem to be 
unified around, with respect to the need for predictability, in 
our tax rules. That is a given.
    But since you mentioned how tax accounting here differs 
from financial accounting, is conformity a recommendation that 
you would make?
    Ms. THOMPSON. We are not really saying that the tax rules 
need to be the same as the financial accounting rules. But what 
we are thinking is that it is just one area that could be 
analyzed to see if it can be made easier and it can be more 
predictable. Because, as we had said, during 2010 there were 
quite a few tax provisions that came in and actually were 
changing depreciation. So it just adds to the complexity of it.
    I don't think that anybody is opposed to accelerated 
depreciation; my small-business clients aren't. But they would 
like to know ahead of time so that they could have time to plan 
for it. So that is really what they are asking for.
    Mr. NEAL. Just lastly, Rep. Phil English and I, at one 
time, worked on that, as you know. And there was substantial 
evidence that it was an effective approach. And, certainly, tax 
receipts were up, based upon that initiative.
    Chairman TIBERI. Thank you, Mr. Neal.
    Mr. Heller is recognized.
    Mr. HELLER. Thank you, Mr. Chairman. And I appreciate your 
comments and holding this hearing.
    I appreciate all of you being here.
    I am from Nevada. So when you think of Nevada, a lot of 
times you think of gaming properties, and I can understand 
that. But I think the fact remains that small businesses make 
up almost 96 percent of the employers in Nevada.
    And just some other statistics, only because I think Nevada 
is a microcosm of what is going on economically in the country 
as a whole. In 2004-2005, it created nearly 68,000 new small-
business jobs. In 2005 to 2006, we created 77,000, so an 
increase of nearly 10,000. But in 2006-2007, going from 77,000, 
it was reduced to 40,000 new small-business jobs. And, clearly, 
economic factors have everything to do with it.
    In 2009, Nevada averaged 3,300 new small-business startups 
each quarter. The down side is that we averaged 3,700 small 
businesses being closed each quarter. So, clearly, those that 
are closing are unfortunately outpacing those new jobs that are 
being created.
    In the Obama fiscal year 2012 budget, he raises taxes on 
small businesses. He does it in three ways: He raises the top 2 
individual income tax rates from 33 percent to 36 percent and 
then from 35 percent to 39.6 percent. He reinstates the 
personal exemption phaseout and the Pease limitations on 
itemized deductions. And, finally, he raises taxes on dividends 
and long-term capital gains, hoping to raise in his budget $709 
billion.
    Now, the theme--and I appreciate Mr. Tarnay's comments 
about what businesses need--and I think it has been a theme for 
all of you, and that is predictability, stability, and 
simplicity.
    I guess my question, Ms. Thompson, since you alluded to 
these issues and the importance of planning, long-term 
planning, as you know, last year we extended the 2001-2003 tax 
cuts for only 2 years. And you were talking about the ability 
of a small business to be able to plan long-term, a 5-year 
plan, a 10-year plan.
    With these potential increased taxes of $709 billion and 
the extension for only 2 years, the 2001-2003 tax extension, 
how does a small business today put together a 5-year plan or 
put together a 10-year plan?
    Ms. THOMPSON. They don't. Or, they can't. Because you are 
absolutely right, it was very helpful that the 2001 tax rates 
were extended for a 2-year period. But what we would like to 
see is to know either this year or as soon as we can what the 
rates are going to be beyond 2012 so it will help that small-
business owner know what his tax liability is going to be in 
the future. Because if he knows that his taxes are going to 
increase, it is going to have an impact on his cash flow. If it 
has an impact on his cash flow, there are going to be 
potentially cuts in other areas, and, unfortunately, that might 
be workers. It is hard to say.
    But they will definitely need to know what their tax 
liability is going in the future to make business decisions 
now.
    Mr. HELLER. Mr. Tarnay, since those were your words, 
``predictability, simplicity, and stability,'' how does a 
business today plan under the current tax rates that we have?
    Mr. TARNAY. I would agree it is very difficult, because for 
years, for decades, it used to be we understood what the tax 
rates were, what the law was moving forward, accelerated 
depreciation, the whole nine yards. Then I would say, in the 
past 10 to 15 years, laws changed annually, sometimes retro. It 
is very, very difficult for small businesses to do that. They 
have to bring in their experts, their tax advisors, and that is 
costly.
    If small-business owners understood what it is going to be 
for a 5-year period, a 10-year period, they can plan. That is 
what they are good at. That is what we need.
    Mr. HELLER. The President's deficit-reduction commission, 
is there anything that you disagreed with? There were a lot of 
tax structural changes talking about deductions and removing--
Dr. Marron, you are talking about moving forward with a 
different type of tax structure.
    What in the President's deficit-reduction commission--were 
there any principles in there that you agreed or disagreed 
with? You said you sat on a similar commission yourself.
    Mr. MARRON. Yes. So, in terms of things agreed with, I very 
much endorse the idea that, if you are going to do reform, A, 
it makes sense to do the whole tax system at once, if you 
possibly can politically, to take into account all of the 
interactions. That there are a lot of tax preferences out there 
that really look a lot like spending programs; they have just 
been dressed up to appear as tax cuts. And that, as a result, 
if someone is interested in making the government smaller, 
there are actually some things you can do that will be recorded 
as tax increases that actually are functionally the reduction 
of spending, from any sort of economic or budget point of view. 
And that, as a result, there are ways, basically, to increase 
revenues that, you know, are not that troubling, frankly.
    I am very much encouraged by the idea of bringing down 
rates, kind of broaden the base, lower the rates. As Dr. 
Carroll mentioned, a little bit of concern that the plans do 
raise dividend rates and capital gains rates. And so there is 
an issue that, while for the corporate form you are reducing 
rates with one hand, on the other hand you are raising rates, 
and you are not getting as much of a net incentive for 
investment as you might get with a slightly different form.
    Mr. HELLER. Thank you.
    I have run out of time. Thank you, Mr. Chairman.
    Chairman TIBERI. Thank you.
    Mr. Roskam is recognized for 5 minutes.
    Mr. ROSKAM. Thank you, Mr. Chairman.
    Well, the good news is we all agree on something, and we 
all agree that the status quo has to change. There is no voice 
here on this panel and there is no voice among the witnesses 
that says, let's stick with the status quo. And that is, 
actually, good news. I mean, there is this shared premise that 
we can move forward from.
    What I am interested--you know, we are all products of our 
environment, and we are all reflecting our districts today. Mr. 
Heller talked about Nevada. I am from suburban Chicago, and my 
district has an extraordinary number of manufacturers, small 
manufacturers, tool-and-die types that are selling into foreign 
markets and are selling around the world, selling to the 
Caterpillars of the world and so forth.
    Illinois has a unique dynamic that I am concerned about. It 
is nothing that we are going to do anything about today. It was 
a bad decision, I think, that was made. But it is having an 
impact on this larger conversation about passthroughs.
    Let me just give you a couple of quick facts on Illinois. 
Illinois just raised its taxes, right? So the individual rate 
went from 3 to 5 percent, a 67 percent increase. The corporate 
income tax rate went from 7.3 to 9.5, a 30 percent tax 
increase. Illinois now has the fourth-highest combined 
national-local corporate income tax rate. And according to The 
Tax Foundation, we have dropped from 23 to 36 in the country 
among States.
    Now, that is not your problem; that is my problem, because 
I am an Illinois resident. But it is also the problem of a lot 
of companies and businesses that I represent.
    So if we are making changes at a macro level, in terms of 
U.S. tax policy, that have an impact on driving more businesses 
into a corporate structure, you see what that does to the 
employers that I represent. They are jammed, right? They have 
to go into this position. And what we don't want to do is move 
them so that they have to go that route.
    Dr. Carroll, I am interested in your perspective. A lot of 
times, when we talk about corporate tax rates and, sort of, 
corporate tax conversations or general tax reform, we tend to 
shun passthroughs as a little bit of a sideshow.
    You mentioned three key points, and I just want to yield 
you some time. Could you go through those key factors on the 
distortions within the marketplace, the debt equity distortions 
and so forth? Because I think that is an important part of the 
calibration that this subcommittee needs to take into 
consideration as we move forward.

RPTS MERCHANT
DCMN MAGMER
[10:00 a.m.]

    Mr. CARROLL. Yeah. As I mentioned in my oral statement and 
explained in some detail in the written testimony, one of the 
major differences between the taxation as a C corporation and 
as a flow-through is the double tax on corporate profits, the 
notion that a dollar investment in the corporate sector, the 
return to that investment is first subject to the corporate 
income tax and then taxed again at the individual level, either 
when it is paid out as a dividend or if the return is retained 
then it would be taxed as a capital gain eventually when the 
shareholder disposes of the stock. So when you combine those 
two levels of tax you wind up with a double tax, and that 
distorts economic decision-making in a couple of ways.
    Dr. Marron had mentioned that economic fundamentals should 
drive decision-making, not tax considerations. One of the 
things that the corporate tax does, because it is tax on equity 
financed investment, interest expenses are deductible but 
dividends are not, and so it is tax on equity finance 
investment which creates a bias or adds to the bias for debt 
finance investment, increases the overall leverage within the 
economy to the extent that firms are more highly leveraged. 
Because of this tax bias, they are going to be more susceptible 
to financial distress during times of economic weakness. So 
that is one of the distortions. The tax bias for debt finance, 
the tax bias for greater leverage, that is an issue.
    Another issue is you have a different treatment of 
investment in the corporate sector versus elsewhere in the 
economy, in the noncorporate, in housing, other sectors in the 
economy, and that causes a misallocation of capital within the 
economy. Again, you have investment decisions throughout the 
economy being made for tax considerations, not economic 
fundamentals. When you have that misallocation of capital, the 
capital stock will not be allocated to its best and highest 
use, and that is going to reduce economic growth.
    And then, third, it raises the cost of capital. The double 
tax and corporate profits, you know, it is another layer of tax 
on capital formation, that that higher cost of capital 
discourages capital formation and investment and, again, would 
reduce the overall growth rate of the economy.
    Mr. ROSKAM. Thanks, Dr. Carroll.
    Thanks, Mr. Chairman.
    Chairman TIBERI. Thank you.
    Mr. Thompson, you are recognized for 5 minutes.
    Mr. THOMPSON OF CALIFORNIA. Thank you, Mr. Chairman. Thanks 
for holding this hearing and thanks to all the witnesses for 
being here. I concur with everyone else who said that this is 
an issue that we all agree on. We just need to figure out how 
to get there.
    Just a real quick question, Ms. Thompson. On the 1099 issue 
that you raised, do you have any suggestions on how this 
Congress should deal with the underlying issues that brought 
the 1099 matter to the forefront? And that is, the $30 billion 
or $25 billion worth of tax evasion that is going on, how do 
you address that?
    Ms. THOMPSON. I think that would probably be on enforcement 
side, which the IRS does have the ability to----
    Mr. THOMPSON OF CALIFORNIA. But they don't have the data. 
You can't put an IRS person at every point of purchase.
    Ms. THOMPSON. I think that the existing rules that are in 
place cover services, and I don't think that everybody is even 
in compliance with that one. So we might start working on that 
area first.
    I think the way the legislation is written right now it is 
covering goods and it is covering corporations, and that is not 
realistic on how you are going to solve the problems. The 
example that everybody is talking about is if a small business 
owner goes into Staples and purchases their office supplies and 
they happen to spend more than $600 in a year, they are going 
to be required to send a 1099 to Wal-Mart and Staples, and it 
just doesn't seem like it is the right target that you are 
looking for.
    Mr. THOMPSON OF CALIFORNIA. A couple of you have raised the 
whole issue of complexity, and for those of us who were in the 
meeting that we had in the full committee when we got a 
briefing on the U.S. tax structure it is pretty hard to argue 
that the system isn't just overwhelmingly complex.
    In another life, I chaired a tax committee in the State 
legislature in California, and I had business people tell me 
just, you know, lower the heck out of our taxes. We understand 
things need to be revenue neutral, and that you need money to 
do all the things that government does. But the lower our tax 
rate is, the more people we will hire, the higher wages we will 
pay, the better off everybody will be. Get it at the employee. 
We are paying them well. They should pay taxes. Do you think 
that is a pretty accurate approach?
    To any of you, do we have too many tax options for 
business? I think Mr. Neal said it earlier, that everything 
that is there that makes it complex was there to address a 
certain issue or, in most cases, to help business. Do 
businesses have too many tax options on the table?
    Mr. TARNAY. The answer is yes. Also, the answer is, if it 
can be done so that the law is something that people can 
understand for a significant period of time, as opposed to 
things changing year-to-year or less than 5 years, people can 
plan that. I can plan it. My company can plan that. We 
understand that. We can move forward. Okay? That is the 
difficulty that we have.
    And the other thing is, simply law changes that are 
retroactive. When you hear that, you don't do things because 
you don't know when that retroactive application is. If we knew 
that, we can plan. That is what we need.
    Mr. THOMPSON OF CALIFORNIA. So if there were fewer options, 
if you didn't have the LLC, didn't have the corporate election, 
and you had just a business tax?
    Mr. TARNAY. Well, I am not saying the type of entity. I am 
saying within that type of entity that you understand what the 
law is. It is simple. It is fair.
    Mr. THOMPSON OF CALIFORNIA. I get that part.
    Mr. TARNAY. That is it.
    Mr. CARROLL. I guess I would say that I think one of the 
distinguishing features of the U.S. business tax system is we 
do afford businesses with different choices on how to organize 
themselves, and I have always thought of that as a virtue. It 
allows companies to make the choice that best fits and suits 
their capital requirements and their management needs. It is 
probably one of the many distinguishing features of the U.S. 
economy in comparison to our major trading partners. That 
flexibility probably adds to the dynamism of the U.S. economy.
    Mr. THOMPSON OF CALIFORNIA. To follow up on that, Dr. 
Carroll, are there certain anti-avoidance measures that would 
have to be put in place if you were to devise a system that 
pushed the rate down and lessened the options?
    Mr. CARROLL. Yeah, that is a very, very interesting 
question, and it is kind of an extension of your earlier 
question in some sense in terms of how tax rates affect 
decision-making.
    Typically, from an avoidance or a compliance perspective, 
one would think higher tax rates would encourage greater 
avoidance and noncompliance activity. Because the benefit of 
avoiding and the benefit of not complying to the taxpayer is 
greater with the higher rates. So one of the benefits of 
lowering rates generally would be that you would help mitigate 
and reduce avoidance behavior.
    Chairman TIBERI. The gentleman's time has expired.
    Mr. Thompson, just a side note we tried to find Grandma 
Thompson to come testify. When we couldn't, we had Ms. Thompson 
instead.
    Mr. THOMPSON OF CALIFORNIA. That is why I cautioned you, 
you better lay off the Grandma Thompson jokes today.
    Chairman TIBERI. Mr. Paulsen is recognized for 5 minutes.
    Mr. PAULSEN. Thank you, Mr. Chairman. It is nice to be 
having a hearing that is focused on small business entities, 
and I appreciate your testimony here today.
    Knowing that we are in a very globally competitive economy, 
absolutely, and, you know, today we have to have a Tax Code 
that has not only the predictability in the long-term thinking, 
but, I mean, I really do believe it also has to spur 
innovation, spur the whole idea of entrepreneurship, and also 
capital formation and investment. I think there are a lot of 
staff people in the administration or even Members of Congress 
that don't understand the allocation of capital, and that is 
really what this is about, how you allocate capital in the 
global environment.
    One of my concerns with the administration's proposal on 
tax reform is that it is centered more on the corporate tax 
side, at least in the President's State of the Union proposal, 
and he talks about having a revenue-neutral basis for corporate 
tax reform. I want to make sure that is not going to be an 
expensive trap for small business entities and pass-through 
entities such as S corps, LLCs, sole proprietorships, 
partnerships, et cetera.
    If that is the track that is ultimately pursued and a lot 
of our Nation's employers are going to see tax increases 
because we eliminated certain tax business, the expenditure 
side like deductions for depreciation, et cetera, which you 
talked about, you know, what would be some of the ramifications 
of that from the standpoint of--while there might be not be any 
offsetting benefit, in essence, for small employers--and, on 
top of this, we also heard Secretary Geithner actually, just 
last week I think, float the idea of having some pass-throughs 
be pushed more into the C corporation model, actually, ensuring 
they would also be hit with this inefficient double tax.
    So let me ask Mr. Carroll first maybe, if the purpose of 
tax reform is to actually make the U.S. government more 
competitive or our economy more competitive, I should say, and 
encourage job creation, does it make sense to push more people 
into the C corporation tax model?
    Mr. CARROLL. My view is that that is problematic. As I 
already discussed, we have a double tax on corporate profits. 
It distorts decision-making in some fairly fundamental ways. It 
is kind of widely recognized among economists in the policy 
community that the double tax on corporate profits is a 
significant problem. It contributes to the leverage among 
businesses. It misallocates capital, and it raises the overall 
cost of capital for the economy.
    Most other developed nations have provided some relief from 
the double tax on corporate profits in some way. They have 
shifted a little bit in the last 10 years in how they do that, 
whether they do it at the shareholder level, whether they do it 
at the corporate level, the mechanism in which they deliver it. 
But the U.S. tends to have fairly--even after the lower rates 
on dividends and capital gains were enacted in 2003, we still 
have a fairly high double tax on corporate profits such that a 
dollar of investment in the corporate sector that is paid out 
as dividends is taxed pretty highly relative to most other 
things.
    I think that is a problem. It kind of complicates--and I 
think it really complicates if you try to redraw the line 
between the flow-through sector and the C corporation sector. 
To raise more revenue to lower the corporate rate, I think it 
would make the double tax problem larger, not smaller.
    Mr. PAULSEN. And, Ms. Thompson, I am just curious, what 
would happen to your clients if they got pushed into a C corp 
model?
    Ms. THOMPSON. I think it is really too early to say what 
would happen if they moved into the corporate form because it 
hasn't been worked out on what all the details of that are. Are 
there going to be changes to the expenses? Is there going to be 
a double tax? So it is really too early to answer that 
question.
    Mr. PAULSEN. Mr. Chairman, I follow up in a different angle 
to what Mr. Carroll--I know that you looked at the economic 
issues that are associated with S corporations and with the 
subset of S corporations, namely, employee owned or ESOP S 
corporations, in particular. These are companies essentially 
that are employee owned and they fared much better in tough 
economic times in terms of actually growing their companies 
during these trying times and also putting people back to work, 
providing retirement security, actually, for their employees. 
If the administration's proposal to move and eliminate some of 
those pass-throughs on S corps became a reality, for instance, 
what would this mean for privately employee-owned companies 
potentially? Who would be affected by such changes within those 
organizations?
    Mr. CARROLL. Yeah, I think the S corp ESOP structure is 
very interesting. The employee ownership aspect is very 
interesting, and the performance of those companies based on 
some work that I have done suggest that those companies 
performed better during the economic downturn than the rest of 
the economy in the sense--although it is not a huge segment of 
the economy, they did in effect provide, in some sense, a 
backstop during the economic downturn. They tend to pay their 
workers higher average wages, and they tend to provide a fairly 
high level of retirement security. So the ESOP provides that 
benefit as well.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    Chairman TIBERI. Thank you.
    Mr. Berg is recognized for 5 minutes.
    Mr. BERG. Thank you, Mr. Chairman. I appreciate you being 
here.
    As a small businessman, it is kind of over the years going 
through the 1986 tax reform and everything else, small business 
tends to make decisions, first of all, on the economics, but 
they are really influenced by the taxation. And it seems to 
me--I enjoyed the OFO, only financial officer. I think that is 
what a lot of these small businesses are.
    And when there is laws that are passed, they are either 
convoluted or complicated. They are trying to look at that and 
figure that out. And the point of having a third party analyze 
this for the business, I mean, those are things that, again, 
specifically help at little moments in time but I think overall 
really cause a lack of focus in what maybe a small business 
should be focused on.
    So one of the things that I heard you saying that 
potentially when you eliminate some of the accelerated 
depreciation and other things that you could probably bring the 
rate down to 28, 27 percent. I wonder if you ever looked at 
just the silo of pass-through entities. If you said just 
looking at this group of pass-through entities, if we 
eliminated, again, or changed this to simplify it, what could 
that overall rate be brought down to? Would that be the 28 
percent? Whoever would like to----
    Mr. CARROLL. I think if you were looking at just the flow-
through sector by itself, I haven't done the calculations in 
terms of how low the rate could be brought down. As I 
mentioned, flow-through entities use about 22 percent of the 
business tax expenditures, and they report about 40 percent of 
the net income and pay about 43 percent of the business taxes. 
So, in that sense, the C corporations kind of make somewhat 
greater use of business tax expenditures. So that might give 
you some sense of kind of the relative reduction of the rates.
    But I would point out that if one tried to just do 
corporate reform and tried to draw a line in the various 
business tax expenditures or business tax provisions so that 
they would only be reduced or eliminated for C corporations or 
did the same for pass-throughs, I think that would be a very, 
very complex, complicated system. Trying to make those 
distinctions on something like accelerated depreciation that is 
probably available to all business forms in trying to have one 
system for C corporations and another system for flow-throughs 
I think would be an extraordinarily complex system.
    Mr. BERG. Ms. Thompson, you had mentioned the 100 percent 
gain exemption, and that was a little bit new to me. Could you 
explain that briefly and how that could benefit if it were 
implemented for pass-through entities?
    Ms. THOMPSON. The provision is that if you have a gain on 
the sale of a small business stock you can exclude 100 percent 
as long as you purchased the stock between September, 2010, and 
December, 2011; and starting in January, 2012, it is going to 
drop down to 50 percent gain exclusion.
    But what happens with that provision right now is it is 
only available to C corporations; and, as we had talked about, 
most of the small businesses are running as pass-through 
entities. And so if that is a C corporation provision, it 
automatically excludes everybody who has been running this 
small business as a pass-through entity. The value has to be 
less than $50 million, and it has to be in certain types of 
businesses, and it can't be any type of personal services. It 
can't be restaurants, hotels, motels, those types of things. So 
it is really very narrow, and it is even more narrow because it 
is only C corporations, which most of the small businesses 
aren't.
    Mr. BERG. Thank you.
    The other issue that has come up time and time again is the 
uncertainty and unpredictability. I mean, I think whatever our 
tax rates were, whatever our deductions were, if they were set 
in stone for 15 years, that would be a good thing for small 
business and probably all business, as long as it is 
competitive. And so I guess looking at that--and I am asking 
myself--what are the taxes out there that are on like a short-
term trigger that need to be renewed that create this 
uncertainty out there? In our current Tax Code, as it relates 
to the pass-through entities, what are those either deductions 
or what are those things that you are aware of that creates 
that uncertainty that could be addressed in this Congress?
    Again, I am not, I guess----
    Ms. THOMPSON. The first one could absolutely be the tax 
rate. Because we do know that they are set until the end of the 
next 2 years, through 2012. But then once you get beyond that 
depreciation we do know that this is a business incentive that 
you put in place more when the economy isn't really good. But 
having that come in and out as frequently as it does, that is 
causing quite some challenges.
    Mr. BERG. Thank you.
    So tax rates and depreciation. Is there anything else?
    Ms. THOMPSON. From the small business perspective, I think 
those are the major ones that we come across.
    Mr. BERG. Dr. Carroll.
    Mr. CARROLL. I think if you look broadly at the tax system, 
you have a large fraction of the Tax Code that is really in 
flux from year to year. You have the sunset of the Bush tax 
cuts at the end of 2012 which raises a considerable 
uncertainty, and you also have the various expiring provisions, 
including the R&D credit that is used by small businesses as 
well as large businesses, and that expires periodically. There 
is a long list of expiring provisions. All of these things 
create a lot of uncertainty and instability in the Tax Code and 
make it very, very difficult for both individual and business 
taxpayers to make decisions.
    Mr. BERG. Thank you.
    Chairman TIBERI. Thank you. Thank you, Mr. Berg.
    Dr. Boustany is recognized for 5 minutes.
    Mr. BOUSTANY. Thank you, Mr. Chairman, and thank you for 
holding this hearing. This is a very important hearing.
    Some time ago, I was back home doing a town hall meeting 
and I was talking about American competitiveness and the need 
to lower the corporate tax rates so we could compete in the 
global economy. And after some lengthy discussion about all of 
that, I had a small business owner who I had happened to know, 
a gentleman by the name of Paul Fontana, who owns an 
occupational therapy business, and he stood up and he said, 
what about me? What does this get me? And it got me to thinking 
and I said, well, you know, you are right, because you have a 
pass-through entity.
    And as we go through this discussion it becomes apparently 
clear to me that we really have to focus on our small 
businesses and pass-through entities as we do tax reform. 
Otherwise, I think we will be negligent in the approach.
    Dr. Carroll and Dr. Marron, the administration is talking 
about reducing the corporate tax rate, which I think we all 
agree we need to do, and we are looking at targeting it down 
into the 20s, you know, 20, 25 percent, if we can get it down 
that low, to be really competitive. But, at the same time, the 
administration is talking about raising the top level for pass-
through entities, the top rate for pass-through entities and 
individuals to almost 40 percent. So what is going to be the 
economic consequence if that is allowed to go through? Dr. 
Carroll.
    Mr. CARROLL. Yeah. I think our corporate tax system is very 
much out of step in the global economy. Most other developed 
nations within the OECD have lowered their corporate tax rates 
significantly over the last--certainly since the mid-1980s, and 
we now have the second highest corporate tax rate exceeded only 
by Japan. Japan is likely to reduce their corporate tax rate in 
April, in which case we will have the highest. So that kind of 
provides a backdrop for why there is an interest in corporate 
tax reform. You know, we want the U.S. to be able to compete in 
a global economy, and the world has really changed. It is very 
different now than it was.
    Mr. BOUSTANY. What is the economic consequence here in the 
U.S. with this disparity if we have a top rate of almost 40 
percent for our pass-throughs and for individuals as we lower 
the corporate tax rate?
    Mr. CARROLL. I think it is a very problematic. I think it 
is very problematic. The flow-through sector, as I said, is a 
very large segment of the economy, employs 54 percent of the 
private labor workforce, and to have a very different treatment 
of pass-throughs relative to C corporations is a problem.
    Mr. BOUSTANY. Thank you.
    Dr. Marron.
    Mr. MARRON. Again, I would go back and reference what the 
fiscal commission came up with, the Domenici-Rivlin Commission 
came up with. There was a reason they chose in the end to try 
to have the top rates on the individual side and the corporate 
side be the same, and one of those key reasons is to avoid all 
the distortions that would arise. If you have one rate that is 
40 and you have another that is 25, you have created a gigantic 
incentive for creative people to think about how do I exploit 
this to best advantage, and that is thinking that would be 
better deployed doing something else in the economy.
    So if you can do fundamental reform of the entire system, 
that means touching all sorts of other tax preferences that are 
purely on the individual side and have nothing to do with 
business, much better to end up with rates being--you know, 
they don't literally have to be identical but close to each 
other.
    Mr. BOUSTANY. Close. Thank you.
    One of the common refrains I hear from small business 
owners is about the issue of accelerated depreciation, and we 
saw this after the hurricanes. It was probably the single most 
important thing Congress did to spur the Louisiana economy 
after hurricanes Katrina and Rita; and I appreciated your 
comments earlier, Dr. Carroll, about both the short-term and 
long-term consequences that are positive with this type of 
approach.
    And, Ms. Thompson, in your testimony you highlighted a 
number of the complexities, the varying in rules and everything 
else, which I read with great interest; and I am going to look 
at the report that you all have as well. But how could tax 
reform simplify some of these rules related to capital 
investment that would allow for small businesses to actually 
see capital formation?
    Ms. THOMPSON. I think the best thing you could do with the 
depreciation is have it for a longer period of time and put it 
in place prior to the time that you are thinking about it.
    For example, if you wanted it to be effective January 1, 
2011, put it in place, if you could, in 2010 and don't have it 
just for a 1-year period, have it for a much longer period of 
time. Then that gives the ability to the small business owner 
to plan their investments better, their purchases, and that 
would really add a lot to the simplification of the system 
because everybody does like the accelerated. It is just that it 
comes in too frequently at various times during the year. It is 
just challenging.
    Mr. BOUSTANY. Does anyone else want to comment on the issue 
of depreciation versus expensing and, you know, the concerns 
about debt financing before we conclude this?
    Mr. MARRON. If I could just second something I said before, 
is I am sympathetic to approaches that would move towards 
expensing if at the same time you think about walking back the 
deductibility of interest. Otherwise, you accidentally end up 
in a system where, if interest is deductible, you can have a 
situation in which we effectively have negative tax rates on 
capital investment, which I think is going too far. But if you, 
you know, keep accelerated depreciation and move towards 
expensing but then think about rolling back interest 
deductibility, you can have a system that reduces that debt 
equity distortion and provides incentives for investment.
    Chairman TIBERI. Anybody else care to answer?
    The gentleman's time has expired.
    Mr. BOUSTANY. Thank you.
    Chairman TIBERI. Ms. Berkeley, recognized for 5 minutes.
    Ms. BERKLEY. Thank you very much, Mr. Tiberi, and thank you 
for holding this hearing. I thank all the witnesses. I have 
learned a lot this morning, and I appreciate that.
    I agree with my colleagues that reforming the tax system is 
critical to the long-term health of our economy. I don't think 
you need to be a genius to figure out that the Tax Code is 
bloated and it is very complex. It adds unnecessary costs to 
business operations and distorts business investment decisions.
    That the Code is unnecessarily complex is a complaint that 
I hear often from my constituents in Las Vegas, and I worry 
that it poses an additional hurdle to my district getting back 
on its feet economically. We are in a world of hurt in Nevada, 
particularly in Las Vegas, which is the community that I 
represent. Half of the businesses--although I know everybody 
thinks of Las Vegas as the glitz and the glitter and the big 
hotels, and in fact that is part of our persona and has served 
us well until the latest economic crash--about half of the 
people that are employed in the State of Nevada are employed by 
small businesses. So what we are talking about today is very 
important. I know that this is the beginning of a very long 
process.
    In the State of Nevada, pass-through entities outnumber C 
corporations by almost three to one. So what we are talking 
about here today is very important to the people I represent.
    There are a number of questions that I have. The first one 
is just some musings. I know that we are all talking about 
budget neutrality and if we could bring down the corporate 
rates to 27, 28 percent across the board, get rid of all the 
tax extenders, the tax breaks, the tax credits, it would add to 
predictability and simplicity, which everybody believes would 
be better for small businesses. If you know what is happening, 
what you can plan for 10 years from now, 5 years from now, 
obviously, it impacts on your business decisions and gives you 
an opportunity to make better ones.
    But having been through the tax extender debate and having 
everybody that I knew that owned a business of some kind coming 
into my office and asking for an extension of their tax break, 
no matter what business they are in, if it is propane gas or 
speedways throughout the United States, I am wondering how 
willing businesses are going to be to give up these tax breaks 
that we have extended over the years?
    And I would imagine that if we lowered the tax rate--and I 
agree with you, when you look at our tax rate on paper in 
comparison to other industrialized countries, it seems very, 
very high. But when you factor in all the tax breaks, tax 
credits, tax extenders, I think it generally lowers our overall 
corporate tax rate dramatically.
    I can tell you in my congressional district, without naming 
names specifically, I have one gaming company that pays overall 
about 8 percent after they take advantage of all their tax 
breaks, and I have another that pays over 30, and they are both 
pretty big companies. Now, I wonder how the company that is now 
paying about 8 percent of their taxes is going to feel when we 
pass legislation that kind of stabilizes everybody at around 
27, 28 percent while eliminating the tax breaks. Can you 
comment on that?
    Mr. CARROLL. Yeah. A lot of points that you have raised 
there that are all I think very important. One point is, you 
know, how do we compare to other nations? And there are 
different ways of measuring that. We do have a high statutory 
corporate tax rate. We also have a high--what economists call a 
marginally effective tax rate relative to other nations. There 
is a recent study that was released by an academic in Canada, 
Jack Mintz, that makes that point.
    We also have a very high effective tax rate and measured on 
a financial statement basis based on some work by an academic, 
Doug Shackleford down in North Carolina.
    There are a number of ways of thinking about effective tax 
rates or tax rates generally, and which tax rate you look at 
really depends on which question you are asking. But by a 
number of different metrics the U.S. looks like it is pretty 
out of step relative to other countries. So that is I think one 
point to keep in mind.
    Ms. BERKLEY. Mr. Marron, you pointed out in your testimony 
the connection between the complexity of the Code and the 
tendency of small businesses to underpay their taxes. Can you 
share with us some areas of the Tax Code where simplification 
would have the highest effect on boosting compliance?
    Mr. MARRON. Well, in my remarks I was very careful to use--
what was the word I used--responsible and irresponsible just to 
distinguish small business as a whole, vast array of different 
kinds of firms, some of which face very high compliance burdens 
and try to pay the taxes they do; and then, unfortunately, 
there are other ones who are able to avoid.
    You know, unfortunately, I don't have any good 
recommendations for you. I mean, again, some of these things 
have to do with, you know, cash transactions which are hard to 
monitor. It is just sort of a fundamental nature of some of 
these transactions that they are going to be more difficult to 
reach to.
    There was the effort with the 1099 which has gotten a lot 
of understandable pushback, and that is that the burden it 
placed on folks seems to be disproportionate to the additional 
revenue it is going to raise.
    Maybe some of my colleagues have some suggestions for you, 
but I do not, sorry.
    Chairman TIBERI. The gentlelady's time has expired, but any 
of the other witnesses care to answer her question?
    Ms. BERKLEY. So no suggestions on how we can, in fact--what 
we can do with the Tax Code where simplification would have the 
highest effect on compliance? No help?
    Chairman TIBERI. The gentlelady's time has expired.
    We are going to one more round, if the witnesses would care 
to indulge us, for just one question from each of the members, 
if they wish. I will start out by asking all four of you--well, 
two of you--a question; and then I will follow up with the 
other two.
    Earlier this week, in a publication called Tax Notes, an 
article, a gentleman by the name of Marty Sullivan, who the 
minority actually invited as a witness a couple of weeks ago on 
tax reform, argued that double-taxing on corporate income is 
bad economic policy; and let me quote what he wrote in the 
article: We should recognize that the movement from double 
taxation to flow-through taxation is a step in the direction of 
sound policy. Tax reformers and professors will tell anyone who 
will listen that all business income should be taxed on a flow-
through basis.
    I would like to get opinions from Dr. Carroll and Dr. 
Marron on Dr. Sullivan's point that double taxation on business 
income is bad for jobs and the economy, and good policy means 
moving toward taxing business income once. Do you agree or 
disagree or and why?
    Mr. CARROLL. I do agree with that. As I have already 
alluded to or stated in my comments, the double tax on 
corporate profits distorts economic decision-making in a number 
of very important ways. It leads to a higher degree of leverage 
in the economy, which is problematic; it leads to a 
misallocation of capital throughout the economy, which is 
problematic; and it raises the cost of capital, which 
discourages capital formation. That is also problematic.
    Using something Donald said earlier, you know, economic 
fundamentals, not tax considerations, should drive decision-
making, and the double tax I think violates that principle.
    Chairman TIBERI. Thank you.
    Dr. Marron.
    Mr. MARRON. I agree as well. There are lots of plans over 
time that said, you know, if you could go back to the beginning 
and redesign a tax system from scratch, how would you want to 
design it? And there are different ways of doing it, but they 
all have this feature that you eliminate the double tax.
    Chairman TIBERI. Mr. Tarnay, if you were forced to go and 
become a C corp, how would that impact your ability as a CFO to 
create jobs from your current tax system?
    Mr. TARNAY. I think it would diminish it greatly. A small 
business owner thinks one way: I made a dollar. I should pay 
tax on that dollar. Not a dollar and then, after I get some 
money from it, then pay tax at the individual level. This is 
how they think. One-time tax on that earnings. Flow-through 
entities allow for that.
    Chairman TIBERI. Ms. Thompson, you had mentioned that you 
do tax returns for a variety of clients, a lot of small 
business owners. How would a majority of your clients be 
impacted if we forced all businesses to pay at a C corp rate?
    Ms. THOMPSON. Without knowing all of the details of the tax 
reform and if you were purely to say everything is going to 
stay in place except you are now going to be corporations and 
you are going to need to double-tax employees, they would be 
hurt tremendously. I have had clients who have been C 
corporations in the past who, when they went to sell their 
business, they end up paying more than 50 percent in taxes, and 
it was overwhelming to them. So it would really hurt them 
significantly if they had to go a C corp level tax and pay 
double.
    Chairman TIBERI. Thank you.
    I will yield time to Mr. Neal.
    Mr. NEAL. Thank you, Mr. Chairman.
    Dr. Carroll, you mentioned that ESOP entities tended to do 
better in the recession in terms of retirement savings, and you 
know that is something I have in interest in.
    Mr. CARROLL. Yeah. In a number of different metrics, based 
on some analysis that I have done, it looks like the ESOPs did 
fare better during the recession than--S corp ESOPs fared 
better during the recession. They grew at a faster rate. They 
added more jobs. Generally, they have higher average wages; 
and, generally, they have a greater retirement security.
    Mr. NEAL. Let me follow up on the point Mr. Thompson was 
making to you about anti-abuse rules. You pointed out that if 
the corporate tax was significantly lowered, that the lower 
rates don't usually foster abuse, I think what he was trying to 
get at was that abuse might arise if the corporate rate was at 
15 percent and the highest individual rate was at 35 percent. 
In this scenario, would you see some movement of earnings to 
the corporate form?
    Mr. CARROLL. Oh, there is movement between--at a high 
level, there is movement between the flow-through sector and 
the C corporation sector, depending on the relationship of the 
individual tax rate and the corporate tax rate. We saw that 
after the 1986 Act with the repeal of the general utilities 
doctrine and as well as the change in the relationship of the 
rates, we saw a movement that, some research that I did a while 
back, ascribed to the change in the rates. Austan Goolsbee has 
done some research in the area as well that has found that the 
number of businesses or the level of activity within each 
sector is sensitive to the relative taxation.
    Mr. NEAL. Thank you, Mr. Chairman.
    Chairman TIBERI. Thank you.
    Mr. Paulsen is recognized.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    And maybe I will just follow up with Mr. Tarnay. I didn't 
get to ask you a question before, but you listed several items 
as a part of your testimony that were important for tax reform 
to be in consideration. And, you know, we all agree tax reform 
is necessary. You have got the corporate component, you have 
got the pass-through entities which we are talking about today, 
but can you just discuss in greater detail a couple of the 
items or maybe the top handful of the most important issues 
that should be focused on that would be the best--I mean, the 
absolute best, actually, to help spur economic growth and 
capital formation and investment, if there is just sort of a 
top wish list that should absolutely be focused on.
    Mr. TARNAY. I think the timing in the requirements of an S 
corporation, because it is complex because of the levels of--if 
you have certain stock structures, you can't be an S 
corporation, certain number of shareholders, you couldn't be--I 
think that could be simplified. I don't agree with the 
alternative minimum tax, but I think that if you can't take it 
away then I think it needs to be revised and simplified.
    Mr. PAULSEN. Okay.
    Mr. TARNAY. Those are the two.
    Mr. PAULSEN. Do you have any idea how many small business 
entities end up falling into sort of the alternative minimum 
tax because of their pass-through income? And maybe, Mr. 
Carroll, you may know. You kind of nodded your head.
    Mr. CARROLL. I actually don't know the answer to that 
question, but it is a very interesting question.
    Mr. PAULSEN. Okay. Well, Mr. Chairman, if we can somehow 
have tax staff to look into that, too. Because I know the 
alternative minimum tax is something that keeps trapping more 
and more people, and a lot of these people--small businesses 
that pay also under the individual rates obviously would get 
trapped in that. So I yield back.
    Chairman TIBERI. Thank you.
    Mr. Berg is recognized.
    Mr. BERG. Thank you, Mr. Chairman.
    We have seen a lot of statistics that show our corporate 
rate relationship to other countries across the world. My 
question is, tell me about the pass-through entities in these 
other countries; and, again, maybe, Dr. Carroll, you could 
start.
    Mr. CARROLL. Yeah. A lot of other countries push businesses 
into the corporate form in pursuit of limited liability. That 
is one of the distinguishing features I think between the U.S. 
and other countries, is it is much easier to get limited 
liability in this country because of the flow-through form and 
the various organizational forms in that sector. And so that is 
one of the reasons we have a much larger flow-through sector 
than most other nations.
    You know, I think that is--one could also do a comparison 
of the kind of the tax rates that the flow-through income 
received by individuals in the U.S. is subject to as compared 
to other nations. I am less familiar with those statistics.
    Mr. BERG. Mr. Chairman, my question, kind of here in 
America we are trying to keep those two rates pretty close. I 
argue that we should look at the net rate and not the gross 
rate. But my question related to other countries, is their 
pass-through rate similar to their corporate rate or is there a 
disparity in these other countries that we are aware of?
    Mr. CARROLL. I think there does--without having looked at 
the data in detail, my sense would be that there tends to be 
some disparity. The corporate tax rates tend not to be 
particularly high relative to individual tax rates. There are a 
few countries that have tried to apply, in a sense, separate 
tax systems, particularly in the Nordic countries where they 
treat partnership income, you know, very differently than the 
income of wage earners in order to coordinate the corporate 
sector tax and the flow-through sector tax.
    Mr. BERG. Let me, Mr. Chairman, wrap up just--my question, 
when that nets out to the individual, the stockholder, where we 
are competing with another country that has a low corporate 
income tax, are they paying a very high personal income tax so 
that net that that person is paying, you know----
    Mr. CARROLL. Yeah. So looking at it a different way, if you 
look at kind of the net after-tax amount received for a dollar 
invested in the corporate sector abroad, you know, kind of what 
is the sum total of the double tax on corporate profits, for a 
dollar paid out as dividends, that tax bite when you look at 
both levels, the corporate and individual level, tends to be 
higher abroad than here. The U.S. tends to have a higher level 
of tax on a dollar invested in the corporate sector and paid 
out as dividends than our major trading partners. And if the 
rate were to go up, the dividends and capital gains rates were 
to go up, then that difference would become fairly substantial.
    Mr. BERG. Thank you. Thank you, Mr. Chairman.
    Chairman TIBERI. Thank you, Mr. Berg.
    Ms. Berkeley is recognized.
    Ms. BERKLEY. Thank you, Mr. Tiberi.
    I kind of caught something, Ms. Thompson, that you said, 
and I just wanted to make sure that I understand it completely. 
Secretary Geithner has suggested that some pass-through 
entities are--in fact, very large firms, not the traditional 
small businesses, at least I think of it--these large firms 
have revenues in the tens of millions of dollars. Mr. Paulsen, 
I think, asked you what the impact of being taxed as a C 
corporation would be on your clients. Could you share with us 
what percentage of your clients are of the size that Secretary 
Geithner was referring to?
    Ms. THOMPSON. That is not the level of my clients. My 
clients are very small businesses. They have probably four to 
six members and revenues are probably----
    Ms. BERKLEY. You mean employees or members?
    Ms. THOMPSON. No, owners of the company. So you are talking 
about either C, S, or pass-through entity owners. There is 
probably four to six of them. So they are very small from the 
measure of owners. As far as revenue, they are probably, I am 
going to say, $25 million or less.
    Ms. BERKLEY. Okay. So the comments that Secretary Geithner 
made would not----
    Ms. THOMPSON. It is not typical of my firm.
    Ms. BERKLEY. All right.
    And, Mr. Marron, in your opinion, what percentage of pass-
throughs are of the very large size that Secretary Geithner was 
referring to?
    Mr. MARRON. It is a very small percentage of the population 
but a significant fraction of the economic activity.
    Ms. BERKLEY. Please say that again.
    Mr. MARRON. If you do it by counting the number of firms or 
the number of businesses, the number that are in that size 
range appears to be very small. But because they are large, 
they account for a fairly large fraction of the economic 
activity, whether it is assets or revenues or income that are 
accounted for by pass-throughs as a whole.
    Ms. BERKLEY. All right. Thank you very much.
    Chairman TIBERI. Thank you.
    Dr. Boustany is recognized.
    Mr. BOUSTANY. Thank you, Mr. Chairman.
    Dr. Marron's testimony talked about partnership activity 
conducted through large partnerships and not small businesses, 
but aren't many of these large partnerships actually joint 
ventures whose partners happen to be corporations themselves? 
Dr. Carroll.
    Mr. CARROLL. Yeah. There is a significant fraction of 
partnership income where--stated a different way, the owners of 
partnerships can be individuals or corporations, unlike, say, 
an S corporation where there is a restriction. Only individuals 
can own an S corporation. A sole proprietor, by definition, is 
an individual. But for partnerships, based on the statistics I 
have seen, roughly 50 percent of partnership income results 
from partnerships that have corporate owners. So you could 
think of two companies that engage in a partnership, a joint 
venture to do something, build a project, and then they 
distribute the income to the two corporate owners. So about 
half of the partnership activity seems to be owned by 
corporations.
    Mr. BOUSTANY. So if we were to tax those entities, those 
large partnerships or joint ventures like C corps, then in 
effect we are subjecting them to triple taxation; is that 
correct?
    Mr. CARROLL. Yeah. If you did that, there is a long 
tradition of having flow-through treatment of partnerships for 
that very reason that, you know, if they are owned by the other 
businesses, just as if a C corporation owned another C 
corporation, then you wouldn't want to kind of have multiple 
layers of tax in the same activity. There is usually a 
dividends-received deduction associated with income that flows 
from one part of a complex business unit to another.
    Mr. BOUSTANY. So, in effect, a joint venture is being 
taxed, the corporate partners are being taxed, and then the 
shareholders of the corporate partners would be taxed. So, in 
effect, really triple taxation.
    Mr. CARROLL. Right, that was the change.
    Mr. BOUSTANY. Thank you. I yield back, Mr. Chairman.
    Chairman TIBERI. Thank you, Dr. Boustany.
    Thank you all, all the witnesses who are here today; and 
members are advised that members may submit written questions 
to our witnesses. Those questions and the witnesses' answers 
will be made part of the record of today's hearing.
    Again, thank you to the four of you for appearing today. It 
has been an educational discussion, and I hope just the 
beginning, and it is hopefully helpful in moving the 
conversation forward on comprehensive tax reform.
    This hearing is adjourned.
    [Whereupon, at 10:42 a.m., the subcommittee was adjourned.]
    [Submissions for the Record follow:]

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