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





 PRO-GROWTH TAX POLICY: WHY SMALL BUSINESSES NEED INDIVIDUAL TAX REFORM

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

                                HEARING

                               before the

        SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS

                                 of the

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                              HEARING HELD
                            NOVEMBER 3, 2011

                               __________







            Small Business Committee Document Number 112-043
          Available via the GPO Website: http://www.fdsys.gov


                                _____

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                   HOUSE COMMITTEE ON SMALL BUSINESS

                     SAM GRAVES, Missouri, Chairman
                       ROSCOE BARTLETT, Maryland
                           STEVE CHABOT, Ohio
                            STEVE KING, Iowa
                         MIKE COFFMAN, Colorado
                     MICK MULVANEY, South Carolina
                         SCOTT TIPTON, Colorado
                         JEFF LANDRY, Louisiana
                   JAIME HERRERA BEUTLER, Washington
                          ALLEN WEST, Florida
                     RENEE ELLMERS, North Carolina
                          JOE WALSH, Illinois
                       LOU BARLETTA, Pennsylvania
                        RICHARD HANNA, New York
                       ROBERT SCHILLING, Illinois
               NYDIA VELAZQUEZ, New York, Ranking Member
                         KURT SCHRADER, Oregon
                        MARK CRITZ, Pennsylvania
                      JASON ALTMIRE, Pennsylvania
                        YVETTE CLARKE, New York
                          JUDY CHU, California
                     DAVID CICILLINE, Rhode Island
                       CEDRIC RICHMOND, Louisiana
                        JANICE HAHN, California
                         GARY PETERS, Michigan
                          BILL OWENS, New York
                      BILL KEATING, Massachusetts

                      Lori Salley, Staff Director
                    Paul Sass, Deputy Staff Director
                      Barry Pineles, Chief Counsel
                  Michael Day, Minority Staff Director


















                            C O N T E N T S

                              ----------                              

                           OPENING STATEMENTS

                                                                   Page
Walsh, Hon. Joe..................................................     1
Schrader, Hon. Kurt..............................................     2

                               WITNESSES

Robert J. Carroll, Principal, Qualitative Economics and 
  Statistics Group, Ernst and Young LLP, Washington, DC..........     4
Gary Marowske, President, Flame Furnace, Warren, Michigan........     6
William R. Smith, Chief Executive Officer, Termax Corporation, 
  Lake Zurich, IL................................................     8
Stephen Capp, President and CEO, Laserage Technology Corporation, 
  Waukegan, IL...................................................    10

                                APPENDIX

Prepared Statements:
    Robert J. Carroll, Principal, Qualitative Economics and 
      Statistics Group, Ernst and Young LLP, Washington, DC......    23
    Gary Marowske, President, Flame Furnace, Warren, Michigan,...    35
    William R. Smith, Chief Executive Officer, Termax 
      Corporation, Lake Zurich, IL...............................    41
    Stephen Capp, President and CEO, Laserage Technology 
      Corporation, Waukegan, IL..................................    47
Additional Materials for the Record:
    NRA Statement for the Record.................................    54
    Open Mic Statements for the Record...........................    63

 
 PRO-GROWTH TAX POLICY: WHY SMALL BUSINESSES NEED INDIVIDUAL TAX REFORM

                              ----------                              


                       THURSDAY, NOVEMBER 3, 2011

              House of Representatives,    
                   Committee on Small Business,    
                   Subcommittee on Economic Growth,
                                    Tax and Capital Access,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 10:00 a.m., in Room 
2360, Rayburn House Office Building. Hon. Joe Walsh [chairman 
of the subcommittee] presiding.
    Present: Representatives Walsh, Chabot, Mulvaney, Hanna, 
Schilling, Schrader, and Chu.
    Chairman Walsh. Welcome. Good morning, everyone. I call 
this hearing to order.
    I want to thank the witnesses for testifying today. We 
appreciate your participation. I will begin with a brief 
opening statement. But again, welcome and thanks for coming to 
this Subcommittee on Economic Growth, Tax and Capital Access 
hearing on Pro-Growth Tax Policy.
    The news today for small business owners is not good. The 
economic recovery is weak. Small businesses are still 
struggling. Credit remains tight and forecasts indicate weak 
hiring will continue. Washington, which should be making job 
creation easier, is instead creating more hurdles with the 
constant threats of higher taxes, excessive regulations, and 
our unsustainable debt. It seems that no one has a bigger 
target on his back than the small business owner.
    As Congress turns its attention to tax reform, the budget 
deficit, and pro-growth policies, today this Subcommittee will 
focus on the importance of tax reform to small businesses. 
Specifically, we will examine the need for individual tax 
reform for pass-through organizations--those that pass through 
their income and tax liability and pay taxes on their owner's 
individual tax returns rather than on a corporate return.
    According to a recent study by Ernst & Young, about 95 
percent of businesses, and over 80 percent of small businesses, 
are organized as pass-throughs. These companies, such as LLCs, 
partnerships, S corps, and sole proprietorships, represent 54 
percent of all business activity and employ 54 percent of the 
private sector workforce. Our local small business, not the 
government, will create the jobs and pull us out of this 
recession. The Internal Revenue Service's national taxpayer 
advocate has said that the most serious problem facing 
taxpayers is the complexity of the tax code and the need for 
reform. Studies have shown that the cost of tax compliance for 
small business is 67 percent higher than for larger entities.
    Pass-throughs are becoming more prevalent. Between 1986 and 
2005 their number more than doubled, while the number of C 
corporations declined. Enacting policies that will keep pass-
through entities taxes low will help small businesses to spur 
our economy. It is especially important that we consider 
revamping the tax code in a way that generates jobs and 
economic growth. Common sense tax and regulatory reform for 
small businesses will help us do just that.
    I recently introduced legislation, H.R. 2945, to index the 
capital gains tax to inflation. Americans should not have to 
pay capital gains tax on an asset purchased 20 years ago and 
sold today but increased in value only due to inflation. Making 
this simple change would allow small business owners to create 
jobs and grow the economy.
    Today we will hear from an economist and small business 
owners about why individual tax reform for these pass-through 
entities, and not just corporate tax reform, must be a 
fundamental part of tax reform.
    Finally, I must say a word about President Obama's Jobs 
Plan. In August 2009, the president said the last thing you 
want to do is to raise taxes in the middle of a recession. But 
yet that is what he has proposed. Small business owners know 
that you cannot raise taxes and expect employers to create jobs 
especially in a recession. But let us listen to our nation's 
best job creators and consider policies that will truly 
jumpstart hiring and lead to long-term economic growth.
    Again, thank you to our witnesses for participating today. 
I look forward to hearing input on how we can reform the tax 
code so our small businesses are able to expand, create jobs, 
and help our economy grow.
    I now yield happily to our Ranking Member Schrader for his 
opening statement.
    Mr. Schrader. Thank you very much, Mr. Chairman. Thank you 
all for being here today. Some of you have come quite a long 
way and I appreciate it.
    I agree with the chair. Entrepreneurs today face many, many 
challenges when they are starting a business. I, myself, am a 
veterinarian, 35 years, small business, private enterprise. 
Labor, access to capital, just a myriad of different problems, 
marketing, the whole nine yards. But one of the most important 
decisions you all make at any point in time is how you organize 
yourself regarding your tax structure. How you want to operate 
as a business.
    Today we are going to listen to the experts in the field, 
if you will, by boots on the ground, about how to--what is the 
best way to operate non-corporate business entities which most 
small business fall under? A lot of the discussion we have had 
to date has been about corporate tax reform, which I strongly 
support but corporate tax reform in and of itself would leave 
most small businesses behind. And a lot of us have operated as 
sole proprietors. I have been a sole proprietor, I have been a 
partnership, and I have been an LLC. And a lot of the 
discussions that I am hearing now would not really help me, or 
you, or most Americans out there that are the real job creators 
at the small business level.
    So I really appreciate that you are having this hearing on 
pass-through entities so we can raise America's consciousness 
about what really goes on. And I have had many a tax statements 
at the end of the year that showed I was making $200- to 
$300,000 and all I know is I was taking $60,000 home in cash at 
the end of the day. And a lot of my stuff was going back into 
the business and the statement did not mirror what was actually 
going on. So I really am looking forward to your comments 
about, you know, what really is going on here.
    The majority of small businesses use the pass-through 
structure. It offers the best opportunity for reinvesting 
savings back in the business and hiring employees. That is how 
you hire people. You make that investment. Small business non-
corporate entities actually employ over 50 percent of the total 
work force and report over a third of the business receipts 
that are out there. So we are an important force, I think, in 
America's economic recovery and economic development at the end 
of the day.
    So we have to really look at these unique challenges. I am 
very concerned on the super committee that there has been a lot 
of talk about tax reform. Some of my colleagues on the other 
side of the aisle have embraced the corporate without embracing 
the actual pass-through entities. Comprehensive tax reform is 
the way I think to bridge the differences between democrats and 
republicans. And so I am real pleased that my chair has held 
this hearing today because this is an area where we can 
actually have agreement. And frankly, by having this hearing 
and listening to you we can push the super committee to do the 
right thing and consider comprehensive tax reform that could 
lower all our rates, get rid of all these tax deductions, many 
of which do not benefit us compared to some of our bigger 
corporate entities, and actually get more money on the table at 
the end of the day to buy down our debt. That is I think the 
confidence that America has in not just Congress but our 
corporate and non-corporate business community to actually be 
competitive in the global environment hinges on, I think, to 
comprehensive tax reform.
    People are looking for guidance. People are looking for 
someone to step up to the plate and make the big decisions that 
make us think that jeez, we actually have an opportunity to 
compete in this global economy. We can kick China's and India's 
butt instead of the opposite happening at this point in time. 
And a lot of American small businesses are the ones that are 
going to be doing that.
    So with that I want to thank you all for being here and I 
yield back, Mr. Chair.
    Chairman Walsh. Thank you, Ranking Member Schrader. This is 
so nice. We probably could have written each other's opening 
statements.
    If Subcommittee members have an opening statement prepared, 
I ask that it be submitted for the record. To our witnesses, 
you will each have five minutes to deliver your testimony. The 
light will start out as green. When you have one minute 
remaining the light will turn yellow. Finally, it will turn red 
at the end of your five minutes. And depending on what I think 
about your testimony--just kidding.

STATEMENTS OF ROBERT J. CARROLL, PRINCIPAL, ERNST & YOUNG, LLP; 
 GARY MAROWSKE, PRESIDENT, FLAME FURNACE, TESTIFYING ON BEHALF 
 OF AIR CONDITIONING CONTRACTORS OF AMERICA; WILLIAM R. SMITH, 
PRESIDENT AND CEO, TERMAX CORPORATION, TESTIFYING ON BEHALF OF 
 PRECISION METAL FORMING ASSOCIATION; STEPHEN CAPP, PRESIDENT 
AND CEO, LASERAGE TECHNOLOGY CORPORATION, TESTIFYING ON BEHALF 
       OF THE NATIONAL FEDERATION OF INDEPENDENT BUSINESS

    Chairman Walsh. Our first witness is Robert Carroll. Mr. 
Carroll is a principal with Ernst & Young, LLP's qualitative 
economics and statistics group. He is an advisor to public and 
private tax clients on federal tax policy, including revenue 
and economic effects. He received his B.S. from the State 
University of New York at Albany and his Ph.D. in Economics 
from Syracuse University.
    Welcome, Mr. Carroll. You have five minutes to present your 
testimony.

                 STATEMENT OF ROBERT J. CARROLL

    Mr. Carroll. Well, thank you very much, Chairman Walsh, 
Ranking Member Schrader, 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 more narrow reform of the business tax system. 
Earlier this year I analyzed the economic footprint of the 
flow-through sector on behalf of the S corporation Association, 
and I have been working with various private sector clients to 
evaluate and understand various aspects of tax reform.
    Today, I would like to share my perspectives and provide 
some results from the study on the flow-through sector we 
prepared earlier this year. 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 54 percent of the 
private sector workforce, and report 36 percent of all business 
receipts. Individual owners of flow-through businesses report 
54 percent of all business net income. These individual owners 
also pay 44 percent of business taxes when filing their 
individual tax returns. The flow-through business form provides 
firms with flexibility in how they organize and structure 
operations. Businesses can choose between several different 
organizational forms which may better match their management 
needs and capital requirements. 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 tax reform might affect this 
sector.
    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 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 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. 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.
    There is a growing consensus for the need to lower the 
corporate income tax rate. The United States has the second 
highest statutory corporate income tax rate, second only to 
Japan. The U.S. corporate income tax rate is also high relative 
to several other measures. In today's global economy, the high 
U.S. corporate tax rate, combined with other features of the 
corporate income tax, make it more difficult for the U.S. to 
attract investment and also may be adversely affecting workers' 
wages.
    With the substantial evidence that the U.S. corporate rate 
and tax system is out of step internationally, corporate tax 
reform is an important component of an overall approach to 
improving the current tax system. But the focus on corporate 
tax reform has also drawn attention to how flow-through 
businesses might be affected by such a reform. As with any such 
endeavor, 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, the production activities or 
manufacturing deduction, and the charitable giving deduction.
    In total, flow-through businesses use about 23 percent of 
the roughly 120 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 United States. As tax reform progresses, it is important to 
understand and consider all of these issues with an eye towards 
bringing about the tax reform that is most conclusive to 
increased growth and job creation. The path towards 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 Subcommittee should be commended for holding this 
hearing to better understand the role the flow-through sector 
plays in the U.S. economy. Thank you, and I would be pleased to 
address any questions the Subcommittee may have.
    [The statement of Mr. Carroll follows on page 23.]
    Chairman Walsh. Thank you, Mr. Carroll.
    I now yield to Ranking Member Schrader for the purpose of 
introducing our next witness.
    Mr. Schrader. Well, thank you, Mr. Chairman. It is my 
pleasure to introduce Gary Marowske, president of Flame Furnace 
in Warren, Michigan. You have come a long way.
    His company was founded in 1949. Still in business. That is 
a great thing. Currently has 70 employees. Hopefully more in 
the near future. And Flame Furnace is one of the leading HVAC 
residential services in the Detroit Metro area. So welcome to 
our Committee.

                   STATEMENT OF GARY MAROWSKE

    Mr. Marowske. Thank you. And thank you, Chairman Walsh. And 
again, Ranking Member Schrader.
    I will flip through my comments. I appreciate the 
opportunity to testify before you here this morning.
    Again, my name is Gary Marowske and I am the president of 
Flame Heating and Cooling, Plumbing, Electrical in Warren, 
Michigan. We supply services in heating, cooling, plumbing, and 
indoor air quality equipment throughout southeastern Michigan. 
Like a lot of small businesses in the HVAC industry, Flame is a 
family-owned company started in 1949 by my father, Bob 
Marowske, from a humble beginning. We have been blessed and 
grown steadily and today we employ--it is actually about 75 
now. We screwed up on what we gave you--workers. We have a 
fleet of more than 60 vehicles and have installed over 75,000 
comfort systems over the last 60 years.
    I am a proud member of the Air Conditioning Contractors of 
America of where I am the chairman of the Government Relations 
Committee. The ACCA's member companies epitomize the spirit and 
entrepreneurship of America's small businesses. Nearly three-
fourths of ACCA member companies have fewer than 25 employees 
and 92 percent have fewer than 100 employees. Most start out 
with technical skills, a truck, and the American dream as they 
are going to create their own business.
    It is my honor and privilege to give voice to the small 
business contractors of the heating, ventilating, air 
conditioning, refrigeration industry on the ongoing and much 
needed debate about tax reform. The contribution of small 
businesses to our economy is often overlooked, but companies 
like mine employ 70 percent of the American workforce and are 
the chief source of new jobs in an economic recovery. I 
wholeheartedly agree that tax reform must address the 
individual rates because of their impact on small businesses. 
Not everyone understands that sole proprietors, partnerships, 
and S corps shareholders pay taxes on business income through 
individual tax rates.
    Flame Furnace is organized as an S corp, as are most of the 
small businesses in the specialty construction trades, in part 
because it protects the owners and shareholders from business 
liabilities and debts. And on the debt part, 95 percent of all 
small businesses owners must also personally guarantee all bank 
debt, vehicle leases, office equipment, et cetera. And it also 
facilitates as a sub-S and easy transfer of ownership through 
stock, through family members, or whomever you would like to 
pass it on.
    Changes to the individual tax rates have a direct impact on 
pass-through entities, so Congress should be very careful 
before enacting any tax reform proposals that tinker with the 
individual tax rates. In 2009, only 7 percent of federal tax 
revenue came from the income taxes paid directly by C corps, 
what most people assume a corporation to be. Individual income 
tax revenue, including net from all the pass-through businesses 
was 44 percent of the federal tax revenue in 2009. 
Unfortunately, it is impossible to say exactly how much came 
from income tax on the pass-through companies.
    As you contemplate changes to individual rates and the 
corporate and international tax codes, I want to take this 
opportunity to point out that America's small businesses are 
looking for a simple, rational, permanent tax code that will 
encourage prosperity and foster job creation. The tax code is a 
powerful tool that can affect individual corporate behaviors in 
a way that advanced beneficial public policies, like allowing 
homeowners to take a deduction on their mortgage interest, 
permitting small businesses, such as my company to use enhanced 
Section 179 expensing limits and bonus depreciation. These 
incentives work, and my company and thousands of ACCA companies 
have used them to buy new trucks, office equipment, other 
investments.
    An example is the Homeowner's 25C Residential Energy 
Efficiency Tax Credit for installing qualified high-efficiency 
furnaces, boilers, air conditioners, et cetera. The 25C tax 
credits are easy to take advantage of and they do not favor the 
wealthy according to IRS statistics. Fully, 93 percent of tax 
credit claims under 25C and 25D for solar, geo, wind, and 
photovoltaic properties were made by taxpayers who have an 
adjusted gross income of no more than $200,000, which is 
indicative of a middle class tax.
    The 25C tax credits highlight how a simple tax incentive 
can help individuals and small businesses create an economic 
benefit. Americans spent more than $25 billion on energy 
improvements to their homes that qualified for the tax credits. 
Now, consider the National Association of Homebuilders that 
estimates every $100,000 in remodeling expenditures generates 
1.11 new jobs. Congress needs to extend the 25C tax credits 
beyond their expiration at the end of this year, restore the 
tax value to 1,500 as my associations. My personal opinion is 
if we want to drive individual behavior, save energy, create 
economic activity, we ought to raise the credit to 5,000 and 
you will see more than a payback on that.
    Another important change to the tax code would be to bring 
the depreciation schedules for HVACR equipment and other 
building components more in line with reality. According to the 
tax code, commercial HVACR equipment must be depreciated over 
39 years. And if any of you own a building, you know that the 
air conditioner does not last 39 years. This would include 
doctors' offices, home small businesses, car dealerships. That 
type of building this would apply to.
    Let me close by saying the small business community needs 
certainty. We have all applauded the repeal of the Form 1099 
filing provision in April. We are hopeful that the Senate can 
pass and repeal the 3 percent withholding tax on government 
contracts, but the effort to pass these two small business 
priorities highlights the piecemeal and short-term approach 
Congress has taken with regard to the tax code.
    Last year extended more than 60 tax incentives that 
benefitted individuals and small businesses just two weeks 
before they were set to expire and that makes it tough for 
planning for a small business for advertising, marketing. 
Included in the bill were a temporary extension of the Bush tax 
cuts, short-term estate tax reduction, and short-term extension 
of bonus depreciation and modification to Section 179 expensing 
rules, a one-year extension of the alternative minimum tax 
patch, and a temporary extension of the residential energy tax 
credits described above.
    While extension of these tax incentives is greatly 
appreciated, the timing and nature of their extension make it 
very difficult for businesses to make business decisions. 
America's small business owners are crippled and worried about 
what may or may not happen next year. By sending the right 
signals to America's small businesses, Congress can eliminate 
the fear of the unknown and I can assure you American small 
businesses will rise up and create new jobs.
    With that I conclude my comments, and I will be happy to 
answer any questions. Thank you again for the opportunity to 
testify. I hope I did not put you to sleep.
    [The statement of Mr. Marowske follows on page 35.]
    Chairman Walsh. Not even close. Thank you, Mr. Marowske.
    Let us keep our Midwest vent going here. Mr. Carroll, you 
are from Ohio, right?
    Mr. Carroll. I am actually originally from New York.
    Chairman Walsh. Oh, okay. All right. Close enough.
    Let us turn to Illinois. Our next witness is William R. 
Smith. Mr. Smith is president and CEO of Termax Corporation in 
Lake Zurich, Illinois, which I have the honor to represent. 
Termax is a small family manufacturing and engineering company 
specializing in metal and plastic fasteners. Mr. Smith is 
testifying on behalf, as well, of the Precision Metal Forming 
Association.
    Welcome, sir. You have five minutes. Thanks.

                 STATEMENT OF WILLIAM R. SMITH

    Mr. Smith. Thank you, Chairman Walsh, Ranking Member 
Schrader, members of the Committee. Thanks for the opportunity 
to be here today.
    My name is William Smith. I am the president and CEO of 
Termax based on Lake Zurich, Illinois. We are members of the 
Precision Metal Forming Association that has about 1,000 member 
companies representing $113 billion in precision metal products 
in that industry. About two-thirds of our member companies are 
structured as subchapter S corps or similar pass-throughs, as 
is Termax Corp. The industry average is about 50 employees per 
business, most of which are family-owned like ours.
    My father founded the company in 1971, and in 1998, my 
brother and I took over the operations where we have seen the 
company grow to about 250 employees and we hold over 60 
patents. Now, while primarily servicing the automotive 
industry, our company manufactures clips and fasteners for many 
industries, including appliances, lighting, toys, construction, 
automotive, and we are the number one exporter of parts in the 
world for these sorts of things.
    Now, before taking over the family business in '98, I 
worked as a CPA, certified public accountant, for roughly 20 
years, also a small business, giving me a unique perspective to 
understand both the production and finance sides of 
manufacturing in America. In my experience as a CPA, the vast 
majority of manufacturers are structured as S corporations, 
LLCs, and partnerships, or other pass-through entities. 
Everybody has statistics. Our statistics showed that 50 percent 
of all private employers are structured this way, and among the 
PMA member companies we know that 64 percent are also pass-
through entities.
    We are structured this way because we are family-owned. We 
have a limited number of shareholders and owners who are often 
our siblings and increasingly our children and grandchildren. 
It just makes sense. Manufacturers like us pay our income taxes 
at the individual rate. We claim deductions and credits at that 
personal level. This means that the financial and manufacturing 
success of our employees and businesses are directly tied to 
that of the business owners. The Smith Family.
    The majority of manufacturers leave most of the money in 
the business, directly reinvesting in our employees, 
facilities, and equipment. And this is really the important 
point there. We are getting taxed on monies that we never see. 
It is just being held there. Now, due to our current U.S. tax 
code, we are taxed on income we do not take out of the company 
but leave in the business to reinvest. This means we have fewer 
resources to put towards hiring, training, and buying new 
machines. In my experience, smaller manufacturers, based on 
wage and K-1 income, pay 36 percent in taxes. They distribute 
18 percent to owners and reinvest 46 percent in the business. 
And that is conservative. We, at Termax, we distribute 10 
percent to the owners. The rest is either used for taxes or 
reinvestment. So the more money that goes into taxes, the less 
that is reinvested for our employees and machinery.
    These funds are taxed at the current 35 percent individual 
rate, set to increase to 39.6 percent. If statutory rates 
increase by nearly 5 percent as scheduled, business owners have 
to take it out of the pie somewhere, either from the owners' 
families, or from the reinvestment in the employees and 
company, usually both. Tax increases result in reduced cash 
flow in the business, causing a major unintended ripple effect, 
limiting access to capital.
    Banking and other lending requirements have toughened, 
forcing most owners to leave retained earnings in the business 
for the sole purpose of meeting collateral requirements. The 
current system penalizes and taxes business owners who leave 
money in the business for reinvestment, resulting in reduced 
ability to secure loans. Therefore, increased tax liability 
means less money in the business, which will restrict the 
ability of a small business to access timely and sufficient 
credit to purchase machines, expand their facilities, hire new 
employees. This is particularly true for a pass-through entity 
like ours, who is taxed regardless of the actual distribution 
made to the owner.
    This is clearly a politically charged issue. But from the 
standpoint of the small business owner we must do what we can 
to reduce our effective tax rate so we can increase our 
investment in new technologies and people to remain globally 
competitive. Over the last few years Termax has seen our 
American competitors decrease to just two from approximately 
eight, while our foreign competitors have increased 
dramatically, four to five times what they were previously.
    This is where tax deduction credits come in as the only 
tool we have to reduce our effective tax rate and give us an 
incentive to take action at that time. All manufacturing 
companies claim deductions and credits, from the R&D credits to 
bonus depreciation. Our company expects to spend $1.5 million 
in 2011 on R&D just to develop new technologies for the 
automotive and construction industries. This is why removing 
deductions credits such as the Section 199 deduction for all 
businesses will increase the effective tax rate burden on all S 
corporations and pass-throughs.
    So some have asked why S corporations simply do not convert 
to becoming your traditional C corporation. First, the costs 
associated with the conversion are astronomical, especially for 
a small business. Another reason is due to the family-owned 
structure of the business. When an owner passes a company down 
to the next generation there is a much greater tax liability in 
a C corp. This is akin to the family farm being sold to pay 
taxes.
    If you ask them, most manufacturers want stability 
simplification of globally competitive effective rates. A prime 
example is the alternate minimum tax, the forerunner of the 
current millionaire's tax that is being discussed. As a 
business owner, the most important questions are what is my 
total federal, state, and tax liability? What is left over for 
me to invest and grow my business and create jobs?
    Thanks for the opportunity. Sorry it took a little long.
    [The statement of Mr. Smith follows on page 41.]
    Chairman Walsh. No, thank you very much.
    Our last witness is Stephen Capp. Mr. Capp is president and 
CEO of Laserage Technology Corporation of Waukegan, Illinois, 
which I am also honored to represent. Laserage specializes in 
custom laser services for diverse material applications. Mr. 
Capp is testifying on behalf of the National Federation of 
Independent Business. Welcome, sir. You, as well, have five 
minutes to present your testimony.

                   STATEMENT OF STEPHEN CAPP

    Mr. Capp. Thank you. Good morning, Chairman Walsh, Ranking 
Member Schrader, and members of the Subcommittee.
    My name is Steve Capp. I am the president and CEO of 
Laserage Technology Corporation. I am pleased to be here as a 
small business owner and member of the National Federation of 
Business (NFIB), the nation's leading small business advocacy 
organization, to discuss the impact of federal income taxation 
on Laserage.
    My father and I started Laserage in 1979. Now we are based 
in Waukegan, Illinois. When we started Laserage, we were a tiny 
contract manufacturer with one laser. Over 32 years we have 
added 135 employees and 65 lasers. We specialize in laser 
processing materials for the medical device industry, but we 
also work with the electronics, LED, aerospace, and other 
industries. Currently, we export about 50 percent of the 
product that we manufacture.
    Like many small business owners, taxes are a major concern 
for us. In fact, 4 of the top 10 issues in the latest NFIB 
Problems and Priorities Surveys are tax issues, particularly, 
tax rates and complexity. Small business owners are encouraged 
that Congress is considering tax reform, but reform must 
recognize the issues impacting small businesses and pass-
throughs.
    First, I want to discuss why a business like mine chose a 
pass-through entity. An owner chooses a pass-through business 
structure for a variety of reasons, generally because of 
liability protection or tax efficiency. Laserage is a pass-
through business, an S corporation. Not unlike a lot of closely 
owned businesses, we were originally organized as a C corp. 
Ending the double taxation of our profits and gains as a C corp 
was our primary reason for converting into an S corp. Simply 
put, double taxation of our shareholders' profits and gains 
made their investment in our company less attractive.
    Frequently, business sales of closely held businesses are 
structured as asset sales, unlike sales of public companies 
which are usually stock sales. As a C corp, an asset sale would 
first be taxed at the corporate level and then a second time 
when the after-tax proceeds are distributed to the 
shareholders. As an S corp and an asset sale, the sale only 
faces one layer of taxation at the shareholder level. 
Obviously, the single layer of tax makes the investment in our 
company more attractive. While the conversion adds complexity, 
this was a good decision for our company, and we urge that the 
S corporation pass-through structure continue to be supported 
by Congress.
    Second, as a pass-through business, individual tax rates 
are especially important. As an S corporation, we pay tax on 
our business income at the individual level. Keeping these 
rates low is important to keeping my company competitive. Over 
the last few years, my company's operating costs have increased 
steadily. My company has been getting strong pressure from some 
of our largest customers to begin production in a low cost 
country. To this point we have successfully resisted taking 
that action by remaining price competitive without resulting to 
leaving the United States, primarily by adopting what is known 
as lean manufacturing techniques and improving the efficiency 
of our production methods.
    But there are limits to what productivity enhancements can 
accomplish. And we anticipate that at some point we will have 
to establish some offshore production capacity or lose very 
significant customers. If federal tax rates increase, that will 
simply add to the pressure on us to move some of our 
manufacturing offshore. For this reason, mindful that all of 
the current individual income tax rates are set to expire at 
the end of this year, I encourage Congress to keep tax rates 
low for all small business owners.
    Third, tax reform must recognize the issue impacting pass-
throughs and small businesses. Much of the debate surrounding 
tax reform is focused on eliminating deductions and closing 
loopholes to reduce taxes. If that is the path for tax reform, 
Congress should keep some basic principles in mind pertaining 
to first, the tax rate; second, encouraging capital investment; 
and third, reducing complexity and compliance costs.
    First, rates must be kept similar to pass-throughs and C 
corps. The current tax rates for pass-throughs are similar to C 
corps. If the rates were to go down for C corps but remain 
unchanged or go up for my S corp, it would put Laserage at a 
distinct disadvantage.
    Second, tax policies do affect capital investments. Let me 
explain. As a manufacturer, I operate a capital-intensive 
business. Last year we purchased $1.1 million in capital 
equipment, and this year we will purchase another $850,000 of 
equipment. We were able to use accelerated depreciation for 
these costs, and it absolutely influenced our capital 
investment program. We simply could not have afforded this 
level of capital investments without these benefits. In 
addition, as a manufacturer we rely on Section 199 domestic 
production deductions. Losing these deductions and credits 
without corresponding relief will also place our company at a 
disadvantage.
    Finally, one simple step that Congress can take is to 
simplify the tax code and make permanent expiring provisions. 
Last year, Laserage's income tax return, technically an 
information return, was 416 pages long. Apart from costing an 
enormous amount of internal accounting personnel time and 
efforts, Laserage was forced to pay an outside auditing firm 
$9,100 in professional fees to prepare the tax filing. My own 
return, which includes my share of Laserage's S corporation 
taxable income, was 28 pages and cost me $2,500 to prepare. We 
should not have to spend so much time and incur so much expense 
for tax compliance. It is not good for us, it is not good for 
the economy, and it is not good for Uncle Sam.
    In conclusion, tax reform can be an effective tool for 
economic growth but must include small business and pass-
throughs. The majority of private sector employees, 54 percent, 
work for pass-through businesses. Small businesses in 
particular account for a vast majority of new jobs. The 
Congress has the opportunity to reform our complicated tax code 
but you must make sure to do it right. Tax reform must add the 
concerns of both pass-throughs and corporate businesses.
    Thank you for this opportunity to appear before this 
Committee on these important issues, and I look forward to any 
questions. Thank you.
    [The statement of Mr. Capp follows on page 47.]
    Chairman Walsh. Thank you. Thank you, Mr. Capp, and thanks 
to all of the witnesses for our testimony.
    Let me begin our questioning with sort of a broad issue 
that each of you touched upon, and I would like it if you could 
give me sort of your broad overview.
    Generally speaking, would a system with lower marginal 
rates and a much broader tax base be preferable to pass-through 
entities than what we have now with a code with its numerous 
rates and deductions? Generally speaking, would that sort of 
move be preferable?
    Let us start with Mr. Carroll and work our way down.
    Mr. Carroll. Generally, that approach, a lower rate, a 
broader base follows in the tradition of the 1986 Tax Reform 
Act. Economists will tell you that the welfare loss or 
efficiency cost of the tax system is related to the square of 
the tax rate as opposed to just the tax rate, so high marginal 
rates are particularly harmful from an economic perspective. So 
that is, I think, an important consideration. Lower tax rates 
are usually beneficial from an economic perspective.
    In the area of flow-throughs, high tax rates, high 
individual tax rates have been found to adversely affect 
investment decisions, hiring decisions, and the growth of small 
businesses. So that is clearly a consideration. In evaluating a 
broad tax reform, I think one needs to really look at the 
effects of the broad reform on job creation and economic growth 
and where low tax rates will, I think, be generally conducive 
to that goal.
    Chairman Walsh. Mr. Marowske, in general, a move toward 
lower marginal rates, a broader base, and in general getting 
rid of a lot of these deductions, is that preferable?
    Mr. Marowske. Oh, I would say most definitely. You know, by 
basically sharing the wealth and spreading it over and reducing 
the rates you are going to put more capital back into the 
market. You are going to have more investment. You are going to 
have much more activity. And you will see a definite growth. I 
do not know all the numbers like Ernst & Young off the top of 
my head but anything you can do to reduce the rate and then 
spread the tax base around is going to be nothing but positive 
on our whole economy.
    Chairman Walsh. Mr. Smith.
    Mr. Smith. I think it depends. A company that is highly 
capital intensive, such as our two companies are going to have, 
if you take away the deductions that relate specifically to 
capital investment--machinery, that sort of thing--those are 
going to have a very negative effect, a bigger effect on a 
manufacturing company than they would on a restaurant or a 
service industry. So I think it needs careful consideration on 
both sides.
    Chairman Walsh. Mr. Capp.
    Mr. Capp. I agree with Mr. Smith. You have to be careful 
what you do. Obviously, I think overall it is a good thing. But 
those tax deductions and credits, there is a purpose for giving 
incentives to, especially in capital intensive businesses like 
ours to invest and reinvest in our company and create more 
jobs. So you know, within reason, I think, as long as they are 
carefully considered, I think the answer to that is yes.
    Chairman Walsh. Last quick question from me and how about a 
brief answer from each of you? Tax reform is being bantered 
about up here as we all know and probably will continue to be. 
If you were in front of the super committee right now and you 
could weigh in, when it comes to this issue, tax reform and 
specifically how it impacts pass-through entities, what is one 
word of caution or one word of advocacy--what would you 
advocate for if you had a moment or two in front of the super 
committee? Let us start with Mr. Capp and then quickly work our 
way down.
    Mr. Capp. I would say lower taxes and also certainty. There 
are a lot of things that we are not doing because we are not 
sure what the tax code is going to be. I mean, lower taxes and 
put some certainty in it so we know what we have to do and 
where we have to go.
    Chairman Walsh. Mr. Smith.
    Mr. Smith. Well, as I stated in my testimony, I agree with 
Mr. Capp here. The problem we have is uncertainty. We would 
like for years and years of consistency. We can compete with 
anybody in the world if we know where things are going to be. 
But because of the state of flux that our tax code has been in 
for years it creates very big disincentives for companies like 
ours.
    Mr. Marowske. As I said in my testimony also is the same 
thing, is the uncertainty, not being able to plan, not knowing 
what is going to happen. You are doing one thing one year, one 
thing the next year. Frankly, I am a national sales tax--my 
personal opinion is, you know, it is fair and it is even and it 
allows the capital to stay within the companies.
    Chairman Walsh. Mr. Carroll, conclude. What is one specific 
tax reform you might advocate for when it comes to these pass-
through entities?
    Mr. Carroll. I think I would have some difficulty 
advocating a specific reform. I would think that one would want 
to take a very broad view. In addition to the certainty, also a 
stable tax system that will not change--that is going to 
provide some certainty over a period of time. One of the things 
that did happen in the '86 Act is the tax system changed fairly 
quickly several years after the '86 Act. It in a sense 
unraveled with some important risk to the tax base--even though 
the '86 Tax Reform Act lowered rates and broadened the base, 
the tax base was narrowed and tax rates went back up.
    The other thing I would think that they should carefully 
consider is trying to avoid unintended consequences. There are 
a lot of interrelationships in the tax system as well as the 
economy and trying to avoid unintended consequences, and I 
think that would be a very useful objective.
    Chairman Walsh. Thank you. Let me now turn to my California 
colleagues, Congresswoman Chu.
    Ms. Chu. Thank you, Mr. Chair.
    Mr. Carroll, I am interested in your opinion as an 
economist. If we do tax reform we want to make sure that we do 
it right so that it is effective, helps the U.S. economy, and 
will create jobs. And there was new data from the U.S. 
Department of Treasury that shows that the ownership of these 
larger pass-throughs, in particular subchapter S corporations, 
is highly concentrated amongst wealthy taxpayers. If we are 
trying to help small businesses, is a high-end rate tax cut the 
best strategy? And how can we ensure that we are hitting the 
right set of small business owners that really need the tax 
relief?
    Mr. Carroll. I think one needs to take a very broad review 
on tax reform and really consider the interrelationships. One 
of the problems I think that exist in our current tax code is 
the double tax on corporate profits and the idea that the 
corporate tax is basically a second layer of tax on equity 
finance investment that distorts a number of very important 
economic decisions. And it raises the cost of capital on 
investment generally. It leads to the misallocation of capital 
by creating a wedge between investment and the corporate and 
the non-corporate sector. It accentuates or increases--it leads 
to a tax bias for debt finance resulting in greater leverage of 
firms, which is problematic in periods, particularly 
problematic in periods of economic distress, economic 
weaknesses. Companies that are more highly leveraged may have 
more difficulty.
    So I think the double tax is a very, very significant 
issue. And so if one is looking for--I think it is very 
important to, when one is thinking about the pass-through 
sector and flow-throughs, that is a vehicle, a way in which 
businesses are able to avoid the adverse effects of the double 
tax and it is very, very helpful to the economy. So rather than 
trying to push more firms into the double tax I think one needs 
to kind of look at it the other way and think about how relief 
from the double tax can be expanded.
    Most other developed nations have explicitly provided 
relief from the double tax by either providing relief at the 
shareholder level or at the company level. In the U.S., it is 
only recently, since the beginning of the last decade in 2003 
through the lower rates and dividends and gains that we 
provided some relief. But even with that relief we are still at 
the high end of the overall tax on corporate dividends and 
capital gains combined with the corporate level tax.
    Ms. Chu. But I guess my question really is would it be 
beneficial equally to all strata of business owners?
    Mr. Carroll. Again, I think one needs to--one needs to 
really think about what is going to be most conducive to job 
creation and economic growth. And I think the more equal 
treatment between the two sectors would probably be very 
helpful.
    Ms. Chu. The report also mentions that some pass-throughs 
are passive holding companies in which there are no 
entrepreneurial activity. These companies do not hire any 
employees. And many are sole proprietors and independent 
contractors. But on the other hand there are pass-throughs like 
the small businesses that have testified here today that are, 
indeed, doing entrepreneurial work and hiring people. So how 
could we refine the tax strategy so that we really emphasize 
the job creators?
    Mr. Carroll. Yeah, I guess I would go back again to the 
double tax. I really see the double tax as a significant 
problem, the high corporate tax rate and trying to address that 
issue. Rather than trying to expand the scope of the double tax 
by perhaps subjecting--a lot of the debate is really focused--
this part of the debate is focused on where do you draw the 
line between the corporate sector and the non-corporate sector? 
I think because of the harmful effects of the double tax, the 
way in which it raises the cost of capital, increases the bias 
for debt finance, drives a wedge between the two sectors, 
redrawing the line so more economic activity is subject to the 
double tax I think is problematic.
    Ms. Chu. Let me ask about the Joint Committee on Taxation 
analysis, which showed that the proposal to reduce the 
corporate tax rate to 25 percent could require some pretty 
hefty repeals of the tax expenditures that encourage job 
creation. How would the repeal of some of these job creation 
tax expenditures impact small businesses?
    Mr. Carroll. Well, I think weighing the benefits of 
corporate rate reduction base broadening, one has to be very 
careful. I agree with the sentiments of Mr. Smith and Mr. Capp 
in terms of talking about some of the capital intensive 
provisions. I think one has to go through each tax expenditure, 
each special tax provision and really think about and weigh the 
positive benefits that those provisions provide to the economy, 
provisions like accelerator deprecation, like the R&D credit, 
many other provisions. All of these provisions were put into 
the code by the Congress with good intentions with the notion 
that they were providing some economic benefit to the tax code. 
And there are significant economic benefits from a lower 
corporate tax rate, but I think one has to weigh that very 
carefully.
    Ms. Chu. In fact, Mr. Marowske, you talked about the fact 
that you have, of course, a lot of equipment in your air 
conditioning business. And how important are certain tax cuts 
to your business? Which tax credits would be most critical to 
your business and other small businesses like yours?
    Mr. Marowske. We are not nearly as capital intensive as Mr. 
Capp or Mr. Smith's company. We do not have large investments 
in machinery. Ours is mostly vehicles. For us, you know, it 
used to be the investment tax credit, which was a great thing 
for purchasing vehicles and machinery. If I remember there was 
a 10 percent credit on the purchase of equipment. That was back 
in the 70s and 80s.
    In our industry, incentives on training and human resources 
issues would be a tremendous advantage because we are very 
labor intensive in the service industry. We have basically no 
minimal capital investment.
    Ms. Chu. Thank you. I yield back.
    Chairman Walsh. Thank you. Let me now turn to a fellow 
Illinois, Congressman Bobby Schilling.
    Mr. Schilling. Thank you, Chairman.
    Mr. Capp, I also started out my small company with a C 
corporation, and for the exact same reasons changed over to an 
S corp. But, you know, coming from Illinois, we just took the 
largest tax increase--individual tax increase, state taxes in 
the history of the state. Corporate tax rates also went up and, 
you know, I find it very interesting that some folks around 
believe that higher taxes are going to actually help 
unemployment and then also help the revenue funds of states or 
the country per se. But in Illinois, for example, since the 
largest tax increase in the history of the state happened, we 
have already lost over 89,000 jobs in Illinois.
    So, you know, the thing that is nice about being small 
business folks is that we get it. And with us starting up our 
business, one of the fears that I have is that a lot of the 
small businesses, including myself, had I not been able to put 
that money back in to my business and invest into it, I do not 
know if I would have made it.
    And my fear is that as we continue to want to tax the job 
creators, you know, it is going to be a problem for the guy who 
is sitting in his garage trying to figure out how to get this 
thing off the ground. You know, and what are we doing to our 
Steve Jobs guys? I mean, look at Apple Computer. I mean, it is 
just amazing the process. And one of the things that is very 
scary to me--I am fresh in. I came straight from the restaurant 
business to Washington, D.C. And a lot of times in Washington 
we tend not to look at the unintended consequences. In business 
we are forced to look at--if I am going to, you know, make an 
investment into my business I look at 10 years as to how this 
is going to either adversely--how it is going to affect our 
business.
    So I think that that is something that is very, very 
important. And I think when we do any type of tax reforms we do 
have to be careful because we see a difference here between the 
two businesses. You know, he is buying vehicles and you are 
buying a lot of equipment for inside, so I think that it is one 
of those where you come in with the scalpel. You be very 
careful on how you do it because the write-off of the equipment 
is pretty imperative. But at the same time I think the key 
thing that I am hearing here is basically, you know, give us a 
little leeway here. And I think it is great and I give all of 
you credit for coming here today because I think that if we 
were to listen to the small businesses, or as I call them the 
final 3 feet, the people that are actually putting people to 
work. Sorry for the rant.
    But what I wanted to do is just, Mr. Capp, when you talked 
about the '01 tax breaks, can you tell me a little bit more 
specifically how that affected your business?
    Mr. Capp. Specifically, the '01 tax breaks?
    Mr. Schilling. Yeah. Like what was different from prior to 
'01? How it helped you?
    Mr. Capp. I think, you know, it allowed us to take a look 
at equipment and other things and really, you know, gave us 
more incentive to push, you know, equipment or money back into 
the business to grow the business and buy the equipment that we 
needed to create the jobs was the primary thing.
    Mr. Schilling. Okay. You know, I guess this is kind of a 
pretty simple question. I think I already know the answer and I 
am just going to kind of roll right down the line here. Do you 
believe that more regulation from the federal government and 
higher taxes is going to help you create more jobs?
    Mr. Capp. The answer to that is absolutely not. We have so 
many people in our company now. At least part of their job is 
dealing with regulation and it seems to be getting more and 
more and more. And when I got people that I am paying to deal 
with regulation, they are not doing productive things, making 
the business grow or focusing on customers, things like that. 
So the answer to that, absolutely.
    Mr. Smith. Well, obviously. I mean, it is a no-brainer 
answer. We also have--we ended up hiring an OSHA-compliance 
staff person just to make sure that we are in compliance with 
OSHA. Now, that is outside of the scope of this process but 
obviously it hurts. If you think about it, tax accountants are 
really just--the whole tax code is a full employment act for 
accountants.
    Mr. Schilling. That individual that you hired, what is the 
cost to your company on that, sir?
    Mr. Smith. About $60,000 a year.
    Mr. Schilling. Sixty thousand, but we created a job. Is 
that correct?
    Mr. Smith. That is right.
    Mr. Marowske. Your question kind of is, hi, I am from the 
government. I am here to help you?
    Mr. Schilling. Yeah.
    Mr. Marowske. I would definitely--I would not be in favor 
nor anybody in our industry.
    Mr. Carroll. The only thing I think I would comment on is 
one could think of a lot of the regulations as in effect are 
imposing in some form additional taxes, additional expenses, 
additional time spent by entrepreneurs on complying with those 
regulations. So that is kind of a way of thinking about 
holistically the regulatory and tax environment as there are 
two sides of a similar coin.
    Mr. Schilling. Very good. Thank you for your time, 
Chairman.
    Chairman Walsh. Thank you, Mr. Schilling. Let me now turn 
to Congressman Hanna from New York.
    Mr. Hanna. Thank you, Chairman.
    Mr. Marowske, do you--you mentioned tax credits to 
homeowners to help them incentivize them. Do you think to 
improve the insulation of their homes or upgrade their heating 
systems or air conditioning, do you think that drives the 
decision to its ultimate conclusion?
    Mr. Marowske. Most definitely. Most definitely. You will 
see in your state you have some great utility incentives for 
people to--we call it home performance. Insulate windows, duct 
system, ceiling, many different things. And you have got some 
huge incentives via your utilities in New York State. But New 
York State probably is doing the best of any of your 50 states 
in that. My state of Michigan, it is a mishmash and a mess.
    Mr. Hanna. Do any of you gentlemen, Mr. Capp, Mr. Smith, 
Mr. Marowske know--Mr. Carroll may know in a broader way--what 
is your effective rate? I mean, we all know the actual rate 
that you pay or that is listed in the tax code but does anybody 
have an idea what your effective rate is after all the 
depreciation, tax credits, accelerated depreciation, et cetera?
    Mr. Capp. I do not think you can hold me to this but the 
last time I calculated it, it was about 27, 28 percent.
    Mr. Smith. For us, actually, the PMA, our association has 
created quite a comprehensive tax template for those things. I 
do not know if you have had a chance to review it or if you 
have seen this. Our particular company, including local and 
state taxes, is 35 percent right now. So that is what affects 
me and our company.
    Mr. Hanna. But that is not your--that is not your actual 
rate that you pay after all the----
    Mr. Smith. No, but again, that is after our base case, 
where we are right now, is it turns out to be 35 percent of the 
total dollars that are going into that. The actual federal 
taxes are approximately 27.7 percent.
    Mr. Hanna. Okay. So, Marowske, do you have any idea?
    Mr. Marowske. Honestly, I do not know. I would be taking a 
stab in the dark.
    Mr. Hanna. Mr. Carroll, what do you think it is for all the 
people you handle?
    Mr. Carroll. I do not prepare tax returns. I am an 
economist and I tend to work on tax policy issues so I have the 
virtue, I suppose, of not working on actual tax returns. I 
guess I would observe there are really different ways of 
thinking about tax rates. One could think of an average tax 
rate. One could think of an effective tax rate. One could think 
of a marginal effective tax rate that would take into account 
different features of the tax code in different ways. A 
favorite concept that is often used by economists to think 
about investment decisions, allocation of investment, the 
amount of investment in the economy is the marginal effective 
tax rate that would take into account not only the top line 
individual or corporate tax rate but also take into account the 
value of accelerated depreciation and investor level taxes on 
capital gains to indicate the variance of tax rates across 
different types of economic activities.
    Mr. Hanna. Do you think that advantage is given to capital 
investment for equipment, for example, with Mr. Smith? Do you 
think that they are pitted against someone who is less capital 
intensive than, say, Mr. Marowske's business which is mostly 
labor?
    Mr. Carroll. Yeah, I think there can be a fair amount of 
unevenness of tax rates across different economic activities, 
different industries, different sectors, companies that invest 
in particular assets versus others. There is a fair amount of 
unevenness and, yeah, that is certainly a consideration
    Mr. Hanna. So does that suggest to you that Mr. Marowske 
may be paying a disproportionate share based on the total 
volume of dollars he does compared with--
    Mr. Carroll. Yeah. I think one has to come back to, again, 
the value of the specific tax preferences. If one, for example, 
were to think that a provision like the R&D credit provided 
some significant spillover effects to the broader economy or 
one thought that incentives for some of the renewables--
alternative fuels, solar, geothermal and so on--were providing 
spillover effects to the overall economy, then one might be 
able to justify the unevenness.
    You know, I think it was a couple of years ago that 
Congress had considered requiring the Joint Committee on 
Taxation to do a cost benefit analysis of each of the tax 
expenditures in the Internal Revenue Code with the notion of 
evaluating on a cost benefit basis whether those provisions 
were providing sufficient value to the economy to justify their 
presence in the code.
    Mr. Hanna. But then--my time is up. Thank you, Chairman.
    You said that, Mr. Capp, you were encouraged to invest in 
capital equipment because of the accelerated depreciation. Do 
you think, I mean, this is--do you think that you would not 
have done it otherwise? I mean, is that what I can infer from 
that?
    Mr. Capp. I think it is more a question of timing, when we 
would have done it. With the uncertainty of what the next 
year's tax code was going to be, we accelerated purchasing 
equipment that we probably would have pushed out and bought in 
a more timely manner for us.
    Mr. Hanna. Thank you, Chairman.
    Chairman Walsh. Thank you, Mr. Hanna. Let me now turn to 
Congressman Chabot from Ohio.
    Mr. Chabot. Thank you, Mr. Chairman. I apologize for being 
a little bit late. And if my questions have already been asked, 
I also apologize for that. I have got three different hearings 
going on at the same time and I am trying to bounce around and 
make all of them.
    Chairman Walsh. That is no excuse.
    Mr. Chabot. I know. Sorry, Joe.
    But in any event, mine are going to be kind of broad. When 
I first came up here back in the revolution, back in '94, Newt 
Gingrich's Contract with America, all that, there was some real 
serious talk about really reforming. We are talking about that 
now and we have got this super committee and are they going too 
long? You know, what is going to happen? But there were two 
competing philosophies. You basically had the Dick Armey 
philosophy, which was the flat tax and you can basically do 
your taxes on a postcard and send it in, although nowadays, you 
know, we do not do anything through the mail so we would 
probably e-mail it in or something on something even smaller. 
But that was sort of one philosophy.
    And then you had Billy Tauzin and Bill Archer, who was the 
chairman of the Ways and Means Committee at the time, who 
wanted to go for a consumption tax or a sales tax and get rid 
of the IRS altogether and get rid of income taxes altogether.
    And then we now have, you know, maybe a hybrid plan that 
one of the Republican presidential candidates has put forward, 
the infamous or wonderful or whatever you think about it, the 
9-9-9 Plan. And there are various versions. But I would just 
like to see, and perhaps Mr. Carroll, we could make this, you 
know, you are with a very large and prestigious accounting firm 
and if we went to one of those other things it would probably 
make it less likely that folks like those folks over there and 
a lot of other folks might need accountants and attorneys and 
things to figure all this stuff out. Maybe not. But at least in 
theory.
    So I would just like to throw it open for anybody who wants 
to take this on. And I have got about three minutes, so if you 
each want to take, you know, a little less than a minute and 
just go down the line. Maybe we will start with Mr. Capp down 
there.
    Mr. Capp. I am not entirely clear what you are looking for 
here.
    Mr. Chabot. Just basically what are the--would you prefer 
to have a flat tax? Would you prefer to have a national 
consumption or sales tax? Would you prefer a hybrid where we 
have both? Both are low right now but could potentially be 
jacked up down the road somewhere. Or do you think we ought to 
keep the stupid mess we have right now?
    Mr. Capp. I guess I tend to lean more towards a flatter 
tax. I know that there are a lot of other ones out there like 
sales tax and things like that. I think they have to be weighed 
very carefully when it comes to us as small business people, 
seeing to it that it does not disrupt the job creation at the 
small business level. So it could be really any one of those 
depending on exactly how it is approached and how it is 
actually executed.
    Mr. Chabot. Mr. Smith.
    Mr. Smith. You know, honestly, I do not care. What I care 
about is just consistency. And I do not think it is going to 
matter on a long run basis for a business like ours in any way. 
Of any approach that is taken I would like a 10-year or a 20-
year or a more--change after--for a period of time. That is 
really all I care about.
    Mr. Chabot. Okay. Thank you. Mr. Marowske.
    Mr. Marowske. You know, any one of them, as Mr. Capp 
mentioned, needs consideration, and whatever you do it needs to 
be, again, consistent and it needs to be fair. My gut reaction, 
as I mentioned a little earlier, is I like the national sales 
tax or consumption tax. If you have more money, earn more 
money, you are going to spend more money. And you are going to 
pay a higher level of tax but there are other, you know, 
drawbacks on that. People that are at minimum wage levels, you 
know, you have got to come up with something for that. So it 
needs some thought and some thinking. But it needs to be 
consistent, fair, and long term.
    Mr. Chabot. Thank you. Mr. Carroll, if you want to----
    Mr. Carroll. Yeah. A couple of thoughts on the choices--the 
flat tax, the sales tax, a potential hybrid--you know, one 
thing I would say is I would agree with the sentiments that a 
tax system that is predictable, provides some certainty, and 
that is stable would be particularly helpful. We currently have 
a tax code where 25 percent of the income tax will sunset at 
the end of 2012, so that creates a lot of uncertainty for 
people such as those who are sitting at the table with me. That 
makes it difficult, I think, to make business decisions and 
other decisions.
    Another comment I would make is the flat tax and the sales 
tax are both--are really very related. They are at least first 
cousins, if not second cousins. One of the characteristics both 
of those taxes share is fundamentally they do not tax the 
return to savings and investment. Both the sales tax and the 
flat tax are types of consumption taxes. And then I would go on 
to say that our current tax system is really a hybrid of some 
of these. We have features in our current tax code that make 
our tax code a bit more like a consumption tax through 
accelerated depreciation, through other expensing provisions, 
through 401(k)s, IRAs, defined benefit plans on the household 
side. Those provisions all reduce the tax on the return to 
savings and investment and the idea behind a consumption tax, 
one of the reasons a lot of economists like consumption taxes, 
is that by not taxing or taxing less the return to savings and 
investment, they are conducive to economic growth. But you do 
need to balance those systems from a distributional 
perspective. When you do not tax the return to savings and 
investment, where savings and investment is received primarily 
or disproportionately by higher income households, one needs to 
think about the distributional consequences of going in that 
direction. So those are a few observations I think are worth 
bringing up.
    Mr. Chabot. Thank you very much. Mr. Chairman, I have been 
informed I have yet a fourth meeting out in the hallway so I 
will have to take off. Thank you very much. I yield back.
    Chairman Walsh. Thank you. Thank you. Let me turn to 
Congressman Mulvaney. He is all good. Okay.
    Let me close and just revisit one quick question. I am 
going to ask you each for a yes or no answer. How does that 
sound? Understand that under the President's Jobs Plan, taxes 
on capital gains are going to increase. And if we let the '01 
and '03 tax rates expire, that will increase your taxes. Will 
tax increases like those help you purchase more equipment, 
create jobs, and will it grow the economy? Yes or no.
    Mr. Capp. No.
    Mr. Smith. No.
    Chairman Walsh. That was difficult.
    Mr. Marowske. No.
    Chairman Walsh. Mr. Carroll.
    Mr. Carroll. I guess I would have to say no.
    Chairman Walsh. Thank you. And thank you all for 
participating today. The Subcommittee will continue to closely 
follow these issues related to tax reform.
    Following the hearing we will be sending a letter to the 
Joint Select Committee on Deficit Reduction, which will have a 
critical role in determining this tax policy and reducing the 
deficit. And we will relay the concerns that have been 
expressed by the witnesses today.
    I also ask unanimous consent that the comments of several 
small business owners regarding the importance of individual 
tax reform, which were submitted through the Committee's 
website ``Open Mike,'' be admitted to the record. Without 
objection, so ordered.
    Finally, I ask unanimous consent that members have five 
legislative days to submit statements and supporting materials 
for the record. Without objection, so ordered.
    Where is my gavel? Let me now bang this. And without 
objection, the hearing is now adjourned. Thank you very much.
    [Whereupon, at 11:10 a.m., the subcommittee was adjourned.]







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