[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
ADDING TO UNCERTAINTY: SMALL BUSINESSES' PERSPECTIVES ON THE TAX CLIFF
=======================================================================
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
SECOND SESSION
__________
HEARING HELD
SEPTEMBER 13, 2012
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 112-086
Available via the GPO Website: www.fdsys.gov
_____
U.S. GOVERNMENT PRINTING OFFICE
76-499 WASHINGTON : 2012
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
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
CHUCK FLEISCHMANN, Tennessee
JEFF LANDRY, Louisiana
JAIME HERRERA BEUTLER, Washington
ALLEN WEST, Florida
RENEE ELLMERS, North Carolina
JOE WALSH, Illinois
LOU BARLETTA, Pennsylvania
RICHARD HANNA, New York
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
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
----------
Page
OPENING STATEMENTS
Hon. Joe Walsh................................................... 1
Hon. Kurt Schrader............................................... 2
WITNESSES
Theresa Kern, MA Steel Erectors, Inc., Palos Heights, IL......... 3
Doug Harmon, CEO, Twin City Die Castings Co., Minneapolis, MN.... 6
Scott Hodge, President, The Tax Foundation, Washington, DC....... 8
Jeffrey A. Porter, CPA, MST, Porter & Associates, CPAs,
Huntington, WV................................................. 10
APPENDIX
Prepared Statements:
Theresa Kern, MA Steel Erectors, Inc., Palos Heights, IL..... 24
Doug Harmon, CEO, Twin City Die Castings Co., Minneapolis, MN 29
Scott Hodge, President, The Tax Foundation, Washington, DC... 35
Jeffrey A. Porter, CPA, MST, Porter & Associates, CPAs,
Huntington, WV............................................. 43
Questions for the Record:
None.
Answers for the Record:
None.
Additional Materials for the Record:
Open Mic: Does the Expiration of Tax Rates Impact Your
Business?.................................................. 54
Statement of the National Association of Manufacturers....... 56
Statements from Small Businesses Submitted to the Small
Business Committee's Open Mic Web Forum.................... 60
Associated Builders and Contractors, Inc. Letter for the
Record..................................................... 67
American Dental Association Statement for the Record......... 69
National Small Business Network Comments for the Record...... 71
ADDING TO UNCERTAINTY: SMALL BUSINESSES' PERSPECTIVES ON THE TAX CLIFF
----------
THURSDAY, SEPTEMBER 13, 2012
House of Representatives,
Subcommittee on Economic Growth,
Tax and Capital Access,
Committee on Small Business,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:15 a.m., in
room 2360, Rayburn House Office Building, Hon. Joe Walsh
(chairman of the Subcommittee) presiding.
Present: Representatives Walsh, Chabot, Mulvaney, Schrader,
Clarke, Cicilline, and Chu.
Chairman Walsh. Welcome, everybody. This hearing of the
Small Business Subcommittee on Economic Growth, Tax and Capital
Access is called to order.
I would like to thank the witnesses for appearing today to
discuss one of the most important issues facing small
businesses and, for that matter, our economy: The looming
expiration of the 2001 and 2003 tax rates.
Despite a feeble economic recovery at home, economic
turbulence abroad, and a series of political and policy actions
in Washington that have left small businesses as uncertain as
ever, many of our Nation's small firms have learned to survive
and adapt to whatever the marketplace or Washington has thrown
at them. Understanding the challenges they face and how we in
Congress can foster an environment where they can succeed is a
constant focus of this Committee.
Most businesses in the United States are small, and unlike
many of their large counterparts that are subject to corporate
income taxes, the vast majority of small businesses are
organized as pass-through entities, where the taxes are paid by
their owners at individual rates. Acknowledging and
understanding this distinction is important.
While there is broad agreement that allowing all of the tax
relief enacted in 2001 and 2003 to expire is inappropriate and
should be avoided, there is wide disagreement on the
composition of an extension and what it means for small
businesses.
The Obama administration and some of my colleagues on the
other side propose that taxes should revert to higher rates for
taxpayers earning more than $200,000 a year. They claim that
this proposal would only raise taxes on 3 percent of small
businesses. But that 3 percent figure accounts for more than
900,000 small businesses.
Most of my Republican colleagues and I support an across-
the-board extension of current lower tax rates. We believe that
imposing the higher marginal rates on earners making more than
$200,000 a year would most directly affect those small firms
responsible for generating the majority of small business
income and new jobs.
We would also note that, in addition to higher marginal
rates on these businesses, the administration's proposal could
also result in small pass-through businesses being taxed at
rates higher than some of our Nation's largest multibillion
corporations. That is not my definition of tax fairness.
Finally, in addition to the prospect of higher marginal
income tax rates, small businesses must also contend with
uncertainty created by the expiration of the estate tax and how
this unresolved policy issue affects long-term business
planning.
The purpose of today's hearing is to examine these issues
in more detail and to understand how policy actions in
Washington are continuing to create uncertainty for small
businesses.
Before I yield to Ranking Member Schrader for his opening
statement, I ask for unanimous consent to insert into the
record these statements small businesses have submitted to the
committee's open mic web forum regarding their concerns about
higher taxes and tax uncertainty.
Without objection, so ordered.
Chairman Walsh. I now happily yield to Ranking Member
Schrader for his opening statement.
Mr. Schrader. Thank you, Mr. Chairman.
I appreciate the committee's indulgence and apologize to
the panel and others for being here late. I had some
constituents come in unexpectedly, and they came a long way. I
am from Oregon. So one does what one has to do.
The economy has been gaining strength, largely because of
the powerful role played by small businesses in America's
economy. It has been a tough haul the last few years, been a
very tough haul. It has been our history that small firms have
been the biggest job creators in America, bolstering the
economy in the tough times and bringing us out of the depths of
these recessions. This has been a tough one. This has been a
very tough one.
When it comes to providing assistance and assuring small
firms that they have the tools they really need, one thing has
been clear. The Internal Revenue Code has provided a lot of
obstacles to each and every one of us.
As I have said in previous hearings, as a small businessman
myself there was a time when I did my own taxes for my
business. That has long since gone away, long since gone away.
A lot of small firms depend on certain tax incentives to
offset the costs of innovation and expansion, and I have
supported those temporary tax provisions and extenders because
it is important to give small business men and women every tool
in the toolbox in these tough and difficult times.
The expiration of many of these tax provisions is fast
approaching, the so-called fiscal cliff that we all hear about;
and small business owners have some very difficult choices to
make and don't know which way to turn, given the uncertainty
that has been created out there. Your input here today will be
vital, I believe, in helping the chairman, myself, and the rest
of the Members of Congress decide which of the extenders are of
great value, which are of some value, and which are of less
value.
As many of you know, we have our own budget to deal with.
We seem to have a great deal of trouble passing budgets these
days, which is a shame, because you have to do that every year
and plan in advance. We have a long way to go to catch up with
a lot of you all.
And right now, in my humble opinion--this is myself
talking--there is a lot of rhetoric on both sides about taxing
this group or not taxing that group or taxing people below
certain income levels. I come from Oregon. $250,000, you are
pretty darn well off if you have got $250,000. So this rhetoric
about millionaires' tax and 250 I think misses the mark.
What many of us are looking for in the real world is
comprehensive tax reform and, as the chairman indicated, not
just for corporate America, not just for C corps. Most of
American businesses, most American small businesses are S Corps
or LLCs or partnerships or sole proprietors. This is a group
that we want to make sure gains through tax reform.
A lot of proposals out there for it. It means different
things to different people. Everyone sees it through their own
eyes, if you will. But there are some very exciting proposals
about just getting back to basics, eliminating maybe all tax
breaks and reducing tax rates.
So today I hope we have an opportunity to chat about which
of the extenders are most important should we decide to
continue with that policy and what effect eliminating all tax
breaks would have on small businesses if we are able to buy
down your tax rates dramatically like has been proposed in
several different bipartisan proposals out there.
So look forward to hearing from the Committee, Mr.
Chairman, and appreciate you having this hearing.
Chairman Walsh. Thank you, Congressman Schrader.
If Subcommittee members have an opening statement prepared,
I ask that they be submitted for the record.
Chairman Walsh. Each witness will have 5 minutes to deliver
your testimony. Try your best to adhere to that limit.
We will begin with Theresa Kern, our first witness. She is
the owner of MA Steel Erectors, Inc., a construction company
located in the greater Chicago area of my home State, Illinois.
MA Steel Erectors has been in business for more than 30 years
and is organized as a Subchapter S business. Ms. Kern will be
testifying today on behalf of the Women Construction Owners &
Executives, where she recently served as that organization's
president.
Ms. Kern, thank you for appearing today. I look forward to
your testimony.
STATEMENT OF THERESA KERN, MA STEEL ERECTORS, INC., PALOS
HEIGHTS, ILLINOIS, TESTIFYING ON BEHALF OF WOMEN CONSTRUCTION
OWNERS AND EXECUTIVES, USA
Ms. Kern. Good morning, Mr. Chairman, members of the
Subcommittee. My name is Theresa Kern, and I am the owner and
president of MA Steel Erectors, headquartered in Palos Heights,
Illinois. We are a union-signatory specialty trade
subcontractor that provides labor to install reinforcing steel
in commercial, industrial, heavy, and high-rise construction
projects. MA Steel is incorporated as a Subchapter S pass-
through corporate entity, and I am the sole shareholder.
I am testifying today as both a small business owner and in
my capacity as immediate past president of Women Construction
Owners & Executives, a 30-year-old national organization whose
mission is to simply create contracting opportunities for our
members, women who have chosen to build a career and a business
in the nontraditional construction industry.
Thank you for giving me the opportunity to testify before
you today at this very important hearing.
As you know, the lingering economic recession has
significantly damaged the construction industry, and most small
businesses in our industry have been hit disproportionately
hard. Yet WCOE members are optimistic about the future as the
construction industry economy begins a slow recovery.
The future tax policy of the United States will have a
profound effect on our members' ability to stabilize and then
grow their businesses. MA Steel is a labor-intensive business,
as are most construction companies, and business growth has a
direct correlation to creating badly needed jobs to help the
American economy grow and prosper.
While media headlines blare ``corporations don't pay their
fair share'', let me assure you that small business
corporations not only pay their fair share but are a major
contributor to the economy as well as the tax base of this
country and have often been referred to as the lifeblood of the
U.S. economic growth engine.
Ernst & Young is reporting that 90 percent of all U.S.
businesses are corporate pass-through entities and employ more
than 50 percent of the private-sector workforce while
representing over a third of all U.S. business receipts. Pass-
through entities are Sub S corporations, S Corps, and limited
liability corporations, LLCs, that have specific limits as to
the number and type of shareholders. IRS reports that there are
over 4.5 million Subchapter S corporations alone. It is often
said that small businesses are the cornerstone of the American
economy and corporate pass-through entities are the cornerstone
of America's small business community.
Generally, entrepreneurs are advised by their CPA or
attorney to incorporate using one of these congressionally
chartered tools in order to separate her business from her
household assets without the onerous paperwork and reporting
requirements of a C Corp.
Congress also decided in 1958 that these special privately
held corporate entities would not be taxed as a corporation,
but rather, because the owner-entrepreneur was investing her
own money into the enterprise to get it started and often to
keep it running, the income or loss generated by the Sub S or
LLC corp would be reported by the owner on their individual tax
returns as earned income or loss. The pass-through corporation,
whether a Sub S or LLC, is therefore not liable for income tax,
but the shareholder is. The business's entire profit or loss is
passed through to the individuals who report it on their
household tax return at the rate for their total household tax
bracket. Conversely, profit distributions to C corp owners are
treated as dividend income to the shareholders and currently
taxed at up to 15 percent.
When the media trumpets headlines like ``90 percent of
corporations pay no taxes'', they may be statistically correct,
but these are not corporations as the general public defines
corporations. These are mostly small business owners who have
been advised to protect their household assets by incorporating
and to use an LLC or Sub S corporate structure to eliminate the
requirement for big corporate boards of directors, annual
meetings, elections, expensive audits, and activist
shareholders. With the 2002 passage of Sarbanes-Oxley, which
mandated even more rigorous reporting requirements for C corps,
pass-through entities are even more attractive.
What is critically important to understand is that profits
in a business incorporated as a Sub S or LLC entity does not
translate to cash in the pocket of the owner. But a loss in a
business nearly always requires the owner to either forego her
own salary or even invest more of her own money into the firm.
There is one other thing that all corporate pass-through
entity owners know. While the company may show a profit in the
financial statements, there may be no cash in her corporate or
personal bank account. Further, there is no relationship
between the amount of profit a Sub S or LLC entity shows on a
financial statement and the amount of money an owner has
actually withdrawn.
Please let me also explain one of the anomalies about the
construction industry. Unique to construction is the issuance
of a surety bond, which is a guarantee of performance on a
project that an owner of a construction company must
collateralize with the business's balance sheet and personal
assets. Nearly all construction projects require a surety bond
performance guarantee from all of the contractors and
subcontractors working on a project. Because construction
company balance sheets have taken a severe hit during the past
4 years, banks and bonding companies are insisting that balance
sheets be strengthened by keeping profits in the company.
It is important to note here that the surety bond on a
specific project cannot be released until the final retention
is released at completion and acceptance by the owner. My
ability to begin a new project is restricted by my balance
sheet, which remains encumbered until those assets are released
when the bonded work is accepted and final payment received, a
process that often takes many, many months after project
completion. If I want to take on another project prior to the
release of the retention money in order to keep my crews busy,
I need to have sufficient assets available to secure another
bond.
Let us assume I am lucky enough for MA Steel to make a nice
profit this year. My bank and bonding company will require that
I not only pay myself a minimal amount but that I leave the
profits in the business in order to show a stronger financial
position. As a Sub S corp, however, all of that nice profit
will be reported as income to me, and I will have to pay tax on
it, even though I may not have one penny of it in my personal
checking account.
When we are talking about an average contract value of
$500,000 and dozens of projects a year, it is not unrealistic
to expect annual business profits to exceed $250,000, all of
which is reported as retained earnings in the business and as
income to me. Yet the majority of that profit stays in the
business and never makes it to my personal checking account for
my own use.
I am liable for payment of the income taxes due on this
phantom income at the individual tax rate. Increasing the rate
of this tax by even 10 percent will have a significant
deleterious effect on my ability to grow my business. I have to
keep the profits in the business per demands of the bank and
bonding company if I want to grow, yet I have to take the
profits out of the business to be able to pay the taxes.
The members of WCOE fully support simplification of the Tax
Code and closing tax loopholes that are beneficial only to the
most sophisticated financial analysts. We also support efforts
to decrease the Federal budget deficit, but to do it on the
backs of America's robust entrepreneurial community will be
counterproductive.
I would like to give you one more relevant example of what
the current uncertainty with the Tax Code means to small
business owners like me.
Chairman Walsh. Ms. Kern, thank you. I need to stop you
right there. You are doing great. I need to stop you right
there. Your entire testimony will be part of the record----
Ms. Kern. Okay.
Chairman Walsh [continuing]. But we need to move onto the
other witnesses. But thank you very, very much.
Ms. Kern. Okay. All right. Thank you.
Chairman Walsh. Let's move to Doug Harmon, our next
witness. He is CEO of Twin City Die Castings Company, a second-
generation family owned business located in Minneapolis,
Minnesota. Twin City Die Castings is a Subchapter S business
employing about 250 full-time workers. He is testifying today
on behalf of the North American Die Casting Association, where
he serves as a member of that organization's government affairs
committee and board of governors.
Mr. Harmon, thank you for appearing today. We look forward
to your testimony.
STATEMENT OF DOUG HARMON, CEO, TWIN CITY DIE CASTINGS CO.,
MINNEAPOLIS, MINNESOTA, TESTIFYING ON BEHALF OF NORTH AMERICAN
DIE CASTING ASSOCIATION
Mr. Harmon. Good morning, Chairman Walsh, Ranking Member
Schrader, and members of the Committee. Thank you for the
opportunity to testify today.
I am here to discuss the severe economic consequences that
small manufacturers will face due to the so-called fiscal cliff
as it relates to taxes that will occur in January, 2013, unless
Congress intervenes. Failure to act on the looming year-end tax
increases would yield the largest tax increases in American
history.
My name is Doug Harmon. I am the CEO and owner of Twin City
Die Castings Company, a second-generation family owned business
employing 250 employees. We manufacture hundreds of different
types of precision aluminum and magnesium die castings for the
automotive, recreational, industrial equipment, defense,
aerospace, computer, and medical industries.
I am testifying today on behalf of the North American Die
Casting Association, where I serve as a member of the
Government Affairs Committee and on the board. NADCA is the
sole trade and technical association representing over 300
U.S.-based companies and industry suppliers that produce and
sell castings essential to the manufacturing process.
Twin City Die Castings is one of the oldest die casting
companies in North America. It was founded in 1919. My father
took a gamble and purchased the small business in 1974 with
family savings. After college, my brothers and I joined the
business. My dad taught us not only how to produce quality
castings but the need to invest in our employees and the shop.
On the table in front of me are just a few examples of the
wide variety of castings we have produced. This happens to be a
military application, a hospital application, and an automotive
application.
We operate three die casting facilities in the U.S., and we
are exporting 22 percent of our total castings in eight
different countries around the world. In all our operations we
provide good-paying blue collar jobs, health reimbursement
accounts, and other benefits to our employees, whom we consider
as members of our extended family.
The recession hit our industry and my company hard. A
number of die casters that had been in business for more than
25 years were forced to shut their doors. We were faced with
downsizing our workforce to 155 workers from 250 when millions
of dollars of orders simply dried up. Fortunately, orders have
been slowly coming back, and we were able to rehire many of our
employees, but we are still not back to pre-recession
production and sales levels.
In 2012, we have been much more cautious in our hiring and
the types of capital improvements that we have undertaken,
given the uncertainty of our taxes and the fragile economy. For
manufacturers like me, this tax cliff is a serious threat.
Not knowing whether or not Congress will renew the Bush-era
tax cuts and the pro-business tax extenders, which expired at
the end of 2011, is keeping many die casters and, for that
matter, most manufacturers from investing as much as they could
to grow their business, purchase new equipment, and hire more
employees. In order for die casters to prosper in this country,
we need two things: stability with a pro-growth approach and
transparency in our Tax Code.
How die casters are organized and the way we pay taxes has
the single greatest impact on our industry. Our company is
structured as a Subchapter S corporation, where the individual
owners pay the taxes. More than 70 percent of manufacturers are
structured as S corporations or other flow-through entities,
meaning they pay taxes at the individual rate. Since we are put
in the top tax bracket, we could see our rates jump to 39.6
percent from 35 percent. We could also face a 3.8 percent tax
on certain types of investment income passed in the Affordable
Care Act effective in 2013.
On top of these increases, small businesses like mine will
also have to deal with a .9 percent surtax on wage income
earned above $200,000 for individuals and $250,000 for couples.
Bottom line for Twin City Die Castings Company is that if
the current tax rates are not renewed by January 1, 2013, and
individual rates increase by nearly 5 percent, we will face a
hefty increase in our tax bill. We will not be able to
reinstate the 401(k) match for our employees' retirement, nor
will we have the extra funds to increase our workers' health
reimbursement accounts.
Unlike larger corporations, small manufacturers like us are
required to provide a personal guarantee for most loans when
purchasing capital equipment or expanding our facilities. This
means as a small business owner I put my family's home on the
line and take significant risks if I want to grow the business
and compete in the global economy. This is where tax deductions
and credits come in as the only tool we have to reduce our
effective tax rate unless Washington can finally act on a
comprehensive tax reform.
Several key business tax breaks currently available are set
to change or expire entirely after December 31, 2011. In
particular, we urge lawmakers to renew tax extenders widely
used by manufacturing companies such as the R&D credit, bonus
depreciation, and section 179 expensing. These historic capital
investment incentives have had a positive impact and
incentivized manufacturing, purchasing, and job creation in
recent years.
In conclusion, small manufacturers cannot compete globally
or even survive domestically if we do not continually invest in
equipment and our people. This is why tax reform is so
important to manufacturing companies across the country, to
free up capital for investing in people and equipment, to
provide more certainty so we can plan for future years. We
cannot afford to fix our Nation's problems on the backs of
small businesses and their employees.
Thank you for the opportunity to testify before the
Committee today, and I look forward to answering your
questions.
Chairman Walsh. Thank you, Mr. Harmon.
I now would like to introduce Scott Hodge, president of the
Tax Foundation, a nonpartisan tax research group based right
here in Washington, DC.
Mr. Hodge, welcome. I look forward to your testimony.
STATEMENT OF SCOTT HODGE, PRESIDENT, THE TAX FOUNDATION,
WASHINGTON, DC
Mr. Hodge. Well, thank you, Mr. Chairman, Mr. Schrader, and
members of the Committee. I appreciate the opportunity to talk
about this really important issue.
As we have heard, American entrepreneurs are facing a lot
of uncertainty right now not only with the stalled economy but
obviously the fiscal cliff that we are facing at the end of the
year. And, unfortunately, there is many in Washington who say,
well, we shouldn't worry about the economic impact of allowing
these top tax rates to expire because only 2 percent of pass-
through businesses will be impacted.
Now, I think this view is badly mistaken. I think it is
like saying that, well, we shouldn't worry about the economic
impact of cancer because NIH tells us that only .5 percent of
Americans will be diagnosed with cancer this year. Well, as you
know, we spend tens of billions of dollars each year on cancer
research, testing, and treatment because we understand how much
it costs the economy each year in lost productivity, not to
mention about a half a million of us that are expected to die
of cancer this year.
And it is the same with the impact of higher taxes on
business. The issue is not how few businesses will be impacted.
The relevant economic question is how much business income will
be hit with higher taxes. And no matter how you parse the data,
the evidence is very clear that the vast majority of pass-
through business income is earned by high-income taxpayers, and
they would be disproportionately harmed by a such a tax
increase.
In fact, Tax Foundation research has determined that nearly
40 percent of any new revenue raised by boosting these top tax
rates would come from the most successful businesses; and based
on the most recent revenue estimates, we expect this could
amount to a tax increase of $377 billion over the next 10 years
on these pass-through businesses. And by all accounts, that
would amount to a success tax on our best and brightest
entrepreneurs and probably the largest tax increase on small
business in American history.
To understand the impact of this, we need to understand
some basic facts.
First, there are more than 30 million pass-through
businesses today, compared to less than 2 million traditional
corporations. And there is now more business income that is
taxed under the individual Tax Code than under the traditional
C code. And Treasury estimates that as much as 40 percent of
all business taxes are now paid on individual tax forms, and
high-income individuals earn the vast majority of this business
income.
The Joint Committee on Taxation now estimates that if the
Bush-era tax rates were to expire 53 percent of net business
income will be reported on returns that will have a marginal
tax rate of either 36 percent or 39.6 percent. IRS data shows
that 72 percent of all pass-through income is earned by
taxpayers earning over $200,000 a year, and 36 percent of all
that pass-through income is earned by people with a million
dollars or more on their tax returns.
The economic evidence is very clear, and it suggests that
increasing top marginal income tax rates on individuals would
be very detrimental to America's long-term economic growth.
Economists at the OECD have determined that high personal
income taxes are second only to corporate income taxes in their
harmful effects on long-term economic growth.
It is well known that the U.S. has the highest corporate
tax rate in the world today, but I bet few of you realize that
America has the most progressive personal income tax system in
the industrialized world. What that means is the top 10 percent
of taxpayers pays a larger share of the income tax burden than
their counterparts in high tax countries such as France and
Sweden.
The economic research is quite clear that there is a big
trade-off between tax policies that enhance growth and tax
policies that are aimed at equity. Meaning the more we try to
make the income tax system more progressive, the more we
undermine the factors that lead to economic growth such as
investment, risk taking, entrepreneurship, and productivity.
Our economists estimate that cutting the top personal
income tax rate by 10 percentage points could lead to an
increase in total GDP growth of 7.5 percentage points over a
10-year period of time. We would see even greater economic
growth by cutting the corporate rate by 10 percentage points.
Let me conclude, Mr. Chairman, by saying, you know, they
say when you tax something you get less of it. So why would we
want fewer small businesses, lower wages, and less economic
growth? Because those are the consequences of allowing the top
tax rates to expire on January 1. But by reforming the Tax Code
and cutting tax rates on businesses, we would see higher
economic growth, higher wages, and better living standards for
all Americans, and that should be priority number one for all
public policies.
Thank you very much, Mr. Chairman.
Chairman Walsh. Thank you, Mr. Hodge.
I now yield to Ranking Member Schrader so he may introduce
our next witness.
Mr. Schrader. Thank you very much, Mr. Chairman.
It is my pleasure to introduce Jeffrey Porter, founder and
owner of Porter & Associates in Huntington, West Virginia. His
firm concentrates on providing tax planning and business advice
for small and medium businesses and high net worth individuals.
Mr. Porter has been active in the American Institute of
Certified Public Accountants, a group we should probably take
advice from more often, for over 20 years and currently serves
as the vice chair of the Tax Division Tax Executive Committee.
Welcome, Mr. Porter.
STATEMENT OF JEFFREY A. PORTER, CPA, MST, PORTER & ASSOCIATES,
CPAS, HUNTINGTON, WEST VIRGINIA, TESTIFYING ON BEHALF OF THE
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Mr. Porter. Thank you.
Good morning, Chairman Walsh, Ranking Member Schrader, and
members of the Subcommittee. I am Jeffrey Porter, vice chair of
the American Institute of CPAs' Tax Executive Committee and a
sole practitioner at Porter & Associates in Huntington, West
Virginia. I consider myself a small business, and I provide tax
planning and business advisory services for small- to medium-
sized businesses and their owners. On behalf of the AICPA, I am
pleased to have the opportunity to testify today on the topic
of the small business perspectives on the tax cliff.
This year has been an extraordinary year for uncertainty in
taxes as well as the macro economy, making it difficult for
small businesses and their owners to make informed business and
financial decisions. Unfortunately, this uncertainty is not
limited to one or two provisions but instead affects many areas
of the Internal Revenue Code. The uncertainty becomes even more
unsettling when you look at the potential changes in tax
treatment for some of these items.
For example, qualified dividends are currently taxed at a
maximum rate of 15 percent. However, beginning next year, the
same dividends might be subject to an income tax rate of 39.6.
Multiyear planning and the ability to predict or at least
to estimate business profits and taxes are critical in
operating a business. It is also essential to know the future
income tax rates in structuring major business transactions,
such as in the sale of a business or of its assets. In order to
determine a sales price acceptable to both the buyer and
seller, both parties need to understand their potential tax
liability for the current year as well as any future year.
Without this information, it is extremely difficult for either
party to make an informed decision.
Tax considerations are even more substantial if the sale is
structured as an installment sale and the seller will report
income or capital gains over a number of years. This situation
happens frequently, since banks are hesitant to lend money in
many types of these transactions.
Next, I would like to discuss the tax extenders, which in
the last several years have repeatedly created uncertainty and
confusion. The on-again, off-again nature of extenders, coupled
with retroactive tax law changes, make long-term planning
difficult. They result in the filing of amended returns and
significantly increase the overall complexity.
Two of the most significant tax incentives for businesses
to invest in machinery and equipment, the section 179 election
and bonus depreciation, are both part of these extenders. These
areas have a substantial impact on businesses, as the ability
to write off a substantial capital expenditure at one time may
determine whether a business owner purchases an asset this
year, next year, or perhaps not at all. Although income taxes
are not the only factor in making most business decisions,
prudent business owners want to understand the tax consequences
of a transaction.
We also urge you to address the AMT rules. The AMT tax
rates and exemption levels are not indexed for inflation; and,
as a result, the AMT exemption has become an annual problem.
For example, there is currently no AMT patch for 2012. As a
result, estimated tax planning for small businesses has to take
into account the lower AMT exemption amount. This means that
many small businesses will essentially provide the government
with an interest-free loan or risk paying an underpayment
penalty if the AMT patch is not passed retroactively. It is a
no-win situation for these taxpayers.
It is important for Congress to reach an agreement with
regard to the expiring tax provisions as soon as possible. The
uncertainty of the tax law unnecessarily impedes long-term
planning for businesses and prevents owners from making
informed decisions.
I also strongly urge you not to underestimate the effect
the tax cliff has on tax administration. If Congress waits
until late in the year or even into next year to enact tax law
changes, the IRS and commercial software vendors must scramble
to revise tax forms and update software. As we experienced just
a couple years ago, this process would likely delay the initial
date when many taxpayers, including small business owners, can
file their income tax returns. As a result, affected taxpayers
would receive their refund checks later than usual, which is
particularly concerning for businesses operating under a tight
cash flow.
Last-minute changes are also very problematic for CPAs. Our
members, a vast majority of whom are small businesses
themselves, would face an increasingly compressed and perhaps
hectic busy season. They would need to educate clients on the
changes in the rules, advise owners on the tax consequences of
business transactions, assist small businesses with tax and
cash flow planning, and prepare income tax returns, all in a
relatively short period of time.
Thank you again for the opportunity to testify, and I would
be pleased to answer any questions you may have.
Chairman Walsh. Thank you, Mr. Porter.
Thank you to all the witnesses.
I just have one quick question, because I want to hear from
my colleagues, Congressman Schrader, and everyone else.
Mr. Hodge, the Joint Tax Committee estimates that the
administration's proposal for higher marginal rates will apply
to more than 50 percent of small business income. You focused
on income in your testimony, as opposed to the aggregate number
of small businesses affected. Why is that emphasis more
important, focusing on income as opposed to the number of small
businesses that might be affected?
Mr. Hodge. Mr. Chairman, it really has do with the economic
power or success of these businesses, as opposed to just their
sheer number.
As you mentioned in your opening remarks, these are over
900,000 small businesses. But these are really the most
successful, dynamic, and hopefully growing businesses; and,
thus, they will bear the disproportionate share of any tax
increase.
Chairman Walsh. One quick follow-up on another topic. I
suppose then that wouldn't be, by definition, a follow-up. So a
quick question on another topic.
Undoubtedly, when I am home talking to small business
owners every single day, the estate tax comes up----
Mr. Hodge. Oh, yes.
Chairman Walsh [continuing]. Again hitting us at the end of
the year. How does this tax inhibit small business decision-
making?
Mr. Hodge. Well, there is the uncertainty that Mr. Porter
talked about. And I don't know any small business person today
who can plan around what is going to happen with the estate
tax. But there is an awful lot of money spent, I think
needlessly, on preparing for the estate tax. And there are some
economic estimates that say the compliance costs and economic
burden of the estate tax actually exceeds the amount of revenue
that it generates for the Federal Government.
The real people getting rich here today off the estate tax,
maybe to a small degree the Federal Treasury, but are really
the insurance companies, Mr. Porter and his colleagues that are
helping people try to minimize their estate tax burden, plan
for it, and avoid having their company sold or undermined as a
result of those higher taxes.
Chairman Walsh. Quickly, in terms of promoting economic
growth, what is the appropriate estate tax exemption and rate?
Is there one?
Mr. Hodge. There should be no estate tax. The estate tax is
double, triple taxation, in some cases, even more. It is really
an abomination. And, unfortunately, it is sold as a way of
controlling long-term wealth or the concentration of wealth. It
really does not have that impact.
In many respects for many small businesses, it is an
accidental tax, because they weren't thinking about it. And all
of a sudden the owner passes away, the family now is left to
sell the business, and, to me, that is a crushing effect on the
economy.
Chairman Walsh. Thank you. Thank you, Mr. Hodge.
Congressman Schrader.
Mr. Schrader. Thank you, Mr. Chairman.
Good testimony. I am worried about our small business men
and women, how we get out of this at the end of the day, and a
lot of different competing proposals.
As I alluded to in my opening remarks, unfortunately, we
have to balance our budget, too. So while we would love to be
Santa Claus to everybody, we have to make some very tough
decisions. Hopefully, we will get around to making some tough
decisions one of these days in Congress. But it is important
for us to have information, and that is why we have you guys
here.
A couple quick things. I don't care who takes this
particularly, but I was interested in explaining for folks, I
think the panel has some pretty good understanding, but, you
know, the profit. Everyone says $250,000--I said it in my
remarks--is a lot of money for an individual. But when you are
a heavily capitalized business, a lot of that can be taken up
and you don't ever see that income on your balance sheet. There
is two or three things that come to my mind, but it would be
more powerful hearing from you.
In a business, making big investments either in equipment
or in personnel, how does that show up on your income tax
statement and how might it affect how much you actually take
home at the end of the day?
Ms. Kern. Well, the $250,000 that may show up on your
financial statement reverts to your personal tax return. But
the problem is it never leaves the business because your bank,
your bonding company, they require those assets to remain in
the business so that the business is qualified to be extended a
line of credit or purchase equipment. You know, it is
collateral. So, in some cases, you don't even see that
$250,000. It just sits in your business and has to stay there.
It depends on what your bank requires of you to extend their
line of credit to you if you need one.
Mr. Schrader. And your principal payments?
Ms. Kern. The principal payments on what?
Mr. Schrader. Say your big piece of machinery, big piece of
equipment.
Ms. Kern. Oh, absolutely.
Mr. Schrader. You don't take home that either, and yet that
would appear potentially on your tax statements----
Ms. Kern. Right.
Mr. Schrader. [continuing]. As money that you would have.
Ms. Kern. Right.
Mr. Harmon. We are a very capital-intensive business, as is
the die casting industry as a whole. And I know if you go back
and look at our investments in our business, we have averaged
close to $3 million a year in investments, new equipment, new
CNC machines, different technologies.
We are in a global economy. We have to compete with the
Chinese. And to do that we have to be more productive. We have
to hire young kids that have technical abilities in
programming, these machine cells. This is where we have a
machine, a robot, and a trim press. But it takes a heavy
investment.
We are over $40 million in sales, between $40 and $50
million in sales, and $250,000 of profit is nothing. That is
less than a percentage point of profit on sales. We need those
funds to invest in equipment.
But even more so, it is the people. We have a lot of
training needs and technology seminars, things like that. We
need to invest in our people and equipment.
Quite honestly, since the recession, we have had to cut
back on benefits. In 2009, we had to pull benefits back, cut
hours, cut salaried people's wages. We are now just starting to
get back to where we can get some of those back in place.
And now all of a sudden to have a 15 percent tax increase--
I mean, from 35 percent to 39.5 percent, besides some of the
other taxes that come into play, it could be a 15, 20 percent
increase in our tax burden. So it is just critical for
manufacturing companies that are capital-intensive to have that
money available.
The other thing is covenants with the bank. We owe millions
of dollars to the bank because we have had to borrow over the
years to build our company up. And so there are covenants on
what an executive can get such as what I can get for a pay
increase, and what I can pull out of the company in a dividend.
So I am under the control of the bank that we borrow money
with.
It is so important to have those funds available, again,
for the training and giving our employees' benefits back and
also for the equipment expansion. These are good blue collar
paying jobs. I had our IT manager run an analysis of last year
on what our average wage was, and it was over $50,000. These
are good paying middle-class jobs that are being impacted here.
Mr. Schrader. Mr. Porter, real quick, as an accountant, you
must be pulling your hair out, the fact that we don't have
anything closely resembling certainty in terms of what to
advise your clients to do at the end of the tax season here.
And you lived through this nightmare 2 years ago.
Mr. Porter. Absolutely.
Mr. Schrader. And curious if it is different this time and
how you try and advise people. And, frankly, it is pretty
obvious, I think to everybody at least here in Washington, DC,
we are going to do absolutely nothing until after the election.
And then, frankly, it depends a lot on who wins the Presidency
as to whether or not we do anything in the lame duck session.
What impact is that going to have on our economy and small
business men and women?
Mr. Porter. Well, we did live through it 2 years ago. And I
think it is probably a little more severe this time, just again
because we have got the whole election cycle that we are into,
and it makes it a little harder to even handicap what we think
is going to happen.
You know, many times you are telling your clients you don't
know. You know, you will try to sit down and you will say,
well, we think if this happens then this may happen. And if we
think this happens, then this may happen. And that certainly
doesn't bring any consistency or continuity for the clients to
make business decisions about what they are wanting to do and
invest moneys.
Mr. Schrader. And I guess one of the concerns I have would
be that while we sit here in Washington assuming, well, geez,
the deadline isn't until--taxes aren't--you know, we have got
time. It is not January 1, April 15. But maybe some of you
could talk about the timeline that businesses have to have to
make decisions. There is a certain lead time you need between
your decision--you have to assume certain things if you are
going to make investments in this economy. Particularly if you
are a tool and die manufacturer, are you going to depreciate
off this equipment? Do you buy it now? Assuming the tax breaks
go away. If they continue, what do you do? I think there is a
timeline I think that businesses have to make decisions by that
we don't take into account here in Washington, DC.
Mr. Porter. I mentioned in my written testimony that I have
a client that is wanting to buy a $2 million press, but I can't
tell him what the depreciation schedules are going to be for
that. Because if he orders it today it is 6 or 8 months before
he actually gets that press and can place it into service. How
can he decide if he wants to buy that if he is not going to be
able to determine the after-tax costs? At this point, we can't
tell him with any certainty what that is.
Mr. Schrader. Mr. Hodge?
Mr. Hodge. I would also say that probably one of the
reasons the economy is as slow as it is is because of the
temporary nature of some of the fixes that we try to enact.
Expensing bonus depreciation are key to that. Had that been a
permanent law, then you could have businesses make those long-
term decisions which they can't now. And so I think that the
benefits--the economic benefits of expensing were completely
undermined by its temporary nature.
If Mr. Harmon wants to build a new factory, that is
probably a multiyear process. So he can't make that decision if
expensing is only in effect for 2 years. So it is really, I
think, important for lawmakers to understand that these
provisions need to be made permanent.
The R&D credit is another one which, as you I am sure have
heard from many constituents, is really ineffective because it
is simply on this temporary schedule. Half the Tax Code now is
on sort of a month-to-month or year-to-year lease. And that is
no way to run a tax system.
Mr. Schrader. So last question, just quick answer from each
of you because I am probably over my time, but there has been a
lot of discussion about tax reform. This is one of the few
times probably in my lifetime where we actually have a
confluence of horrific events and budgetary needs here in
Washington, DC, as well as at home, that comprehensive tax
reform has some buzz. And we have got a lot of big
corporations, probably mostly C Corps, come in and talk to us
about they would be willing to give up all of their tax breaks,
all of their tax extenders, R&D, bonus depreciation, oil
depletion allowances, you name it, in exchange for significant
rate reduction.
Mr. Hodge, you testified in that 8 to 10 percent rate
reduction, where we have the highest tax rates in the world as
of this past summer and stuff. Would it be advantageous--we
will go down this way, because I want to hear Mr. Porter's
summing up, given his background.
But would it be advantageous, do you think, for America and
maybe for your business, maybe think beyond your own personal
business, to get rid of all--almost all these tax breaks, maybe
a cadre of some, but almost all, which means you would have to
give up yours--let's assume that in this discussion--in order
to get a significant rate reduction, you know, from 36 down to
somewhere between 26 and 28, but down from 24 to about 15--if
you are really low income, hopefully, you are making a little
more than that, although in this economy, who knows--from 15
down to about 10 percent?
Ms. Kern, would you lead off with that?
Ms. Kern. I think everybody in this country is willing to
do their fair share. And I also do feel that if we had some
sort of a reduced tax rate that was commensurate with where we
are kind of at, or could be at now, I would be willing to do
that if in fact those tax loopholes were--or deductions--were
stopped for everybody.
You know, if it was a unilateral tax cut, reducing
people's, you know, deductions or whatever and if it was a good
tax rate that you could decide upon, I would be willing to do
that. And I am willing to pay my fair share if I make money.
Mr. Schrader. The bottom line.
Mr. Harmon. It would be nice--if the high tax rates that
American manufacturers pay would be reduced a little bit. I
would be willing to just keep the tax rate neutral. Why I am
here today is I just don't want to see these tax rates go up.
Again, in a capital-intensive business you need that money to
reinvest. That is my concern, if all of a sudden these rates go
up. I don't know how the calculations would be as far as
getting the tax rates neutral or maybe reducing it a bit. But
it is the increase that is my concern.
Mr. Schrader. Sure.
Mr. Hodge. We cannot separate corporate and individual tax
reform, unfortunately. Because if we broaden the corporate
base, we are going to be hitting the S Corps and the LLCs just
as hard. And, really, there is only about a hundred billion
dollars--I say only a hundred billion--worth of tax
expenditures in the corporate code, and those are shared
between the C Corps and the S Corps. So we have to be very
careful.
And not every loophole should be eliminated. Expensing, for
instance, is not--I would not consider a loophole.
And we have to be very, very careful about having
differential rates. This is the first time in the history of
the Tax Code that the top corporate rate and the top individual
rate are exactly the same at 35 percent. And we ought to keep
that parity so we don't have arbitraging between the business
forms. There are already various reasons, double taxation, and
so forth, to do so, but I don't think the rates should be part
of that. And I think we ought to keep that parity.
Yeah, there is a lot of provisions that ought to be
eliminated from the Code. But let's not throw out also the baby
with the bath water, such as expensing the R&D credit and so
forth.
Mr. Schrader. Mr. Porter.
Mr. Porter. I can tell you that many of my clients
regularly tell me they would like tax reform, and they
regularly suggest percentages that they think would be
appropriate. Many times I am not sure they know what they are
saying when they say that.
But as the AICPA, we are on record as supporting Congress
and encouraging Congress to do fundamental tax reform. We
believe that we need good, clear tax policy, we need
consistency so that businesses can plan, but we have not stated
a desire or a particular position for any rate. But we do
encourage Congress, and we have some principles that we think
you ought to consider, called the principles of good tax
policy, and it goes out and lays out what we think are
fundamentals in terms of similarly situated taxpayers being
treated the same so you can't game the system a lot.
But there is a lot of those, and we encourage you to take a
look at those, and we would be happy to assist in tax reform in
any way that we could.
Mr. Schrader. Thank you very much; and thank you, Mr.
Chairman.
Chairman Walsh. Thank you.
Maybe we all agree to something permanent. How about
permanency?
Congressman Chabot from Ohio.
Mr. Chabot. Thank you, Mr. Chairman.
Relative to the permanency of the tax cuts and the fact
that these were only for 10 years, the 2001 and 2003 cuts, I
was here at that time, and I think a little reflection on what
actually happened might be in order. In the then-Republican-
controlled House, we wanted to make these tax cuts permanent.
That was our goal.
Unfortunately, it doesn't become law unless it passes the
other body; and over in the Senate, they didn't have 60 votes
to make them permanent. In fact, the colleagues--our colleagues
on the other side of the aisle didn't want to cut taxes at all.
And so there was a compromise, and the compromise was, well, we
will make it for 10 years. And what we were hoping is we would
ultimately get the votes and be able to make these permanent.
Same thing with the death tax. The fact that you can--the
Federal Government can take up to 55 percent of what a person
has paid taxes on throughout their life when they die is just
abhorrent, as far as I am concerned. And the same compromise
happened there, where it scaled down year after year after year
and then went back up if we couldn't get our act together up
here in Congress.
But that was why the tax cuts weren't permanent, and I
would just like to have a response relative to how much better
would it be if the tax cuts were permanent for your businesses
and, if you think so, for the overall economy?
And I would be happy to hear from anybody who would like to
comment.
Ms. Kern. I think anytime that a business owner can have
permanency of ideas and guidelines it makes their business
prosper--at least try to prosper. And it is very difficult if
you have to keep changing your method of operation every few
years or every--whatever. I mean, we need to have some sort of
normalcy going forward. We have enough things that are hitting
us from every other possible place in the universe. If we could
have at least some guidelines in the tax law or in the estate
tax, we would know where to go from here to retirement,
hopefully, which is going to be a lot longer now than it was 5
years ago.
Mr. Chabot. Mr. Harmon, would you like to comment?
Mr. Harmon. Yes, permanency would be a wonderful thing in
the Tax Code. There is the R&D credit and there is bonus
depreciation. Some of these provisions that are out there would
have a significant impact on what you do year after year.
In manufacturing, we face global competition; and we have
got to continue to invest in the equipment, the technology that
is out there, training for our workforce, and the new research
and development that our country participates in and our
industry participates in.
Mr. Chabot. Thank you.
Mr. Hodge.
Mr. Hodge. Nothing undermines economic growth more than
uncertainty. And there is--as you know, there has been at least
5,000 changes to the Tax Code in the last 10 years. And I think
the economic benefits of these tax provisions, such as
expensing, such as the lower rates, have been undermined by the
uncertainty, by their temporary nature. And so the Tax
Foundation has always stood by the principle of certainty in
the tax system, that there shouldn't be wild changes, because
it really does undermine the economic impact of them. And I
think the more that we can set aside these arbitrary budget
rules and scoring rules and start thinking about sound policy
and the longevity of these things the more we are going to see
the economic benefits. But it is really because we adhere to
these really arbitrary and sometimes really silly budget rules
we undermine sound tax policy, and the economy is the big
loser.
Mr. Chabot. Thank you.
Mr. Porter, I have only got 1 minute left, so I wanted to
get to one final question, and I would be happy if anybody
wants to respond here.
You all, as small business folks, how would you respond to
this allegation that has been made far too frequently--I guess
because it is a campaign year, political year more than
others--but this allegation that business folks--and yourselves
included in that area--relative to taxes, you just don't want
to pay your fair share of taxes? You are these 1 percenters
that are trying to take advantage of the rest of our citizenry.
Any response to that? I assume you have probably heard this
before.
I see you nodding in affirmation, Ms. Kern. Would you like
to comment?
Ms. Kern. Well, as I mentioned before, I am not opposed to
paying my fair share and have been paying my fair share of
taxes for the past 31 years. It is when the tax structure is
out of whack that it kind of I think upsets people. But I don't
think that is a fair statement to make about small business.
As Mr. Harmon has mentioned, we provide health care, we
provide 401(k)s, or we try to do everything that we can for our
employees. I don't have 250 employees. I have 30 to 40
employees. And, again, they are mostly union--or they are
union-signatory except for the office people. So, I mean, their
health and welfare is, you know, $14 an hour. Their benefits
are $35 an hour on top of their pay scale.
So, you know, we do pay a lot of things to keep our people
employed; and that is the cost of doing business.
But I really take offense to the fact that we are trying to
scam anybody and not pay what we have to pay. If I make money,
I am more than happy to pay taxes and have in the past.
Mr. Chabot. Mr. Harmon?
Mr. Harmon. I think that is an offensive statement. I think
that small businesses and small----
Mr. Chabot. Just to be clear now, it is not my point of
view.
Mr. Harmon. No, no, no, I understand.
But the idea that we want to scam the system or not pay our
fair share, we want to pay our fair share. We want permanency
and stability in the Tax Code.
We are small businesses, small manufacturers. I read the
paper and see what some of the multinational companies pay. And
I can tell you we had a tough year last year, and we paid a lot
more taxes than GE did.
Mr. Hodge. Here are the actual facts: About 50 percent of
all American households pay no income taxes, and many of those
people get refundable tax credits even though they owe no
income taxes. And there is about $100 billion a year in
refundable tax credits coming out of the IRS. Actually, more in
refundable credits than what is available in the corporate code
for tax expenditures. But the top 1 percent of tax filers pays
a greater share of the income tax burden than the bottom 90
percent combined.
Mr. Chabot. Could you repeat that?
Mr. Hodge. Yes. The top 1 percent of tax filers pays a
greater share of the income tax burden than the bottom 90
percent combined. So that top 1 percent, which is comprised of
about 1.4 million tax filers, pays close to 40 percent of the
income taxes today. And that is a greater share of the burden
than is paid collectively by everyone earning under about
$120,000 a year combined.
Those are the facts from the IRS.
Mr. Chabot. Mr. Porter?
Mr. Porter. We certainly hope, as a profession, we are out
there helping everybody pay their fair share of taxes and do it
properly and report it in the way it should be reported.
Mr. Chabot. Very diplomatic answer. Thank you.
I yield back, Mr. Chairman.
Chairman Walsh. Thank you.
Congresswoman Chu.
Ms. Chu. Well, I certainly was impressed with your stories,
Mr. Harmon and Ms. Kern. Mr. Harmon, the success of your die
casting business, it being a second-generation family owned
business, and Ms. Kern, as a woman-owned business of a steel
erectors company, that is really impressive.
And I noted with interest, Ms. Kern, that you wanted to
partake of SBA's 504 loan program approved to small businesses
with long-term fixed rate financing for expansion or
modernization; and, also, Mr. Harmon, that you want to continue
your contracts with the defense industry. That is, of course,
critical to your company.
But I do have great concerns. Because if we extend all the
Bush tax cuts, it will increase our debt by $3.3 trillion over
the next 10 years; and in order to rein in our excessive
spending, the government would be forced to make cuts to
critical programs, such as small business loan programs, such
as the 504 loan program, as well as in the defense industry.
That is why I am concerned about extending those Bush-era tax
cuts, and that is why I support President Obama's tax plan.
Because we have to have an overall view of our budget here in
Washington, DC.
Mr. Hodge, you gave a passionate argument about not hurting
small businesses who are the entrepreneurs in this country, and
I certainly agree with that. I just want to make sure that
small businesses are truly the ones that are the beneficiaries
of our policy, and I want to ask you about what is really a
small business and whether the pass-throughs are really all
small businesses.
And, in fact, I have a suspicion that some of the pass-
throughs are not necessarily small business owners. They
include law firms, doctor offices, hedge funds, and lobbying
firms whose businesses are structured as partnerships for tax
purposes. They also include passive investors, such as those in
real estate partnerships. Passive investors don't participate
in any of the risky business decisions yet receive all the
benefits of the pass-throughs.
In addition, many S corporations that are defined as a
pass-through entity are not small. In 2009, only 0.3 percent of
S corporations had incomes exceeding $50 million, yet they
accounted for 35 percent of all S corporation incomes.
Isn't it overreaching to say that these are all struggling
small business owners? Should these very high-income earners be
in a different tax category? And how can we make sure that the
truly small business owners get the help they need?
Mr. Hodge. Well, we tend to think of these things in
monolithic terms. And while the official definition of a small
business may be ``firms under 500,'' according to the SBA,
small businesses--hopefully--become larger businesses, become
successful businesses. And raising taxes on these businesses as
they try to go through the stages of business life is
counterproductive to them becoming successful.
We all want these businesses, whether they start out as a
couple of college graduates with tremendous computer skills
becoming the next Bill Gates or Steven Jobs or Steve Wozniak,
they have to get there from here to there. And increasing their
taxes as they go along the way and simply drawing some
arbitrary line in the sand saying, oh, well, then at this
point, they become a big business, I think is simply arbitrary.
And there is no economic rationale for this. There is no
economic rationale to say that only 500 businesses is a small
business.
And the real problem here is that we have all of these
different business forms. It does treat some businesses
differently. And we need to maybe make sense out of it. But the
real point here is that higher taxes on these businesses is
counterproductive. It does have economic impacts, no matter how
you define what that business is.
Ms. Chu. Well, let me ask this: Of course, in the past 4
years, the administration had the Small Business Jobs Act. It
helped relieve small business tax burdens. It permanently
allowed qualified small businesses to carry back their general
business credits to offset 5 years of taxes. It put in place
the elimination of all capital gains taxes for those who invest
in small business and extended the 50 percent bonus
depreciation.
You made quite an argument of saying these are just
temporary provisions, that they are counterproductive. Are you
saying that we shouldn't have had these at all?
Mr. Hodge. Well, number one, in order to take advantage of
all of those, you need to have positive profits. You need to be
able to have income for which to deduct or make some of those
deductions from. So for a lot of those businesses, bonus
depreciation wasn't helpful because they simply did not have
enough income to take advantage of that.
I would prefer, rather than seeing these sort of targeted,
in a way, like pork barrel tax policy, see broader reform where
we absolutely lower tax rates across the board for all
individuals, all businesses, rather than try these sort of
shotgun approaches to specific constituencies.
Ms. Chu. So you wouldn't have had any of these provisions?
Mr. Hodge. I would have lowered rates across the board,
rather than try this sort of shotgun, as I say, targeted
approach.
Ms. Chu. Thank you.
I yield back.
Chairman Walsh. Thank you.
Congresswoman Clarke.
Ms. Clarke. Thank you very much, Mr. Chairman.
I want to also add my voice to both Mr. Harmon and Ms.
Kern. The success of your businesses and the growth and
development of them, the fact that you are operating a second-
generation company, Mr. Harmon, begs to ask the question--and,
Ms. Kern, having been in business for over 30 years now--that
you have had the experience of operating your businesses at
pre-2001 levels prior to the Bush tax cuts going into effect.
And so my question is, it seems to me that, prior to the
Bush tax cuts, your companies were successful. What the Bush
tax cuts have enabled you to do, I am assuming, is to bring
more capital into your companies. So when we talk about the
extension of the Bush tax cuts, I am wondering whether the
uncertainty is one of companies that may have started or have
been in a growth period during the Bush tax cut era versus
those companies that have been in existence prior to that. And
I wanted to know, what do you think is the best course of
action, given that we haven't done or addressed comprehensive
tax reform? And which is worse, the uncertainty of
reauthorizing Bush tax cuts or the stability of knowing one way
or another where you stand in terms of your companies and a
comprehensive Tax Code that meets the needs of your companies?
Mr. Harmon. That is a good question.
Again, our business has been around for 93 years. These tax
cuts took effect in 2001, 2003, the Bush-era tax cuts.
Around that time, if I am not mistaken, we were in a
recession. I think that might have been some of the stimulus
for some of these tax cuts.
But the other thing is that in manufacturing, and in our
business, we started facing global competition back in the
1980s. Japan came onboard with their manufacturing, so American
manufacturers had to really gear up for that. China came into
play in the mid-'90s, Mexico for a little bit in the early
1990s.
We didn't have this type of global competition. Before
1995, it wasn't a huge global-type economy and the competition
that we have today. Since China has come onboard, it has been
just extremely difficult. We have got to be investing in new
technologies, in new equipment, faster equipment to compete
with the Chinese products that come over to America.
So that is why these cuts that are in place help. It would
be nice to get them permanent, but the bonus depreciation and
the research and development credit are two that we can utilize
to help make us more competitive in the world market.
Ms. Clarke. And you would say that that applies to your
type of company as well?
Ms. Kern. It does but in a different way. I am primarily a
labor-intensive company, but I am also subject to the Fortune
500 companies that want to build a plant or want to relocate.
That impacts my work. We have had a really, really tough 4
years. The past 4 years have been awful.
But the other thing is the heavy and highway. We try to
supplement our work with roadwork. But, again, the
transportation bill hasn't been funded, and that is another
issue.
But, yes, it does. I was in business prior to the tax cuts,
but that was a different economy. We had more work then. So I
shudder to think of what we would have been like since 2001 if
those tax cuts weren't in place, because maybe a lot of us
wouldn't be here.
Ms. Clarke. The tax cuts, in and of themselves, are not the
end-all to be-all. Because, on the one hand, we are looking at
the overall national budget. And, as you stated, if we don't
have funding and transportation bills, which are a significant
part of what helps make your company robust, then there is
still a shortfall.
So it is truly a balancing act, just from what I have heard
from you both. And I think that we need to give a greater
degree of scrutiny beyond the expiration or the tax cliff as to
where the balance is. Because, right now, we are not striking
that balance in our rhetoric. We are not being as balanced as
we should be in really looking at the nuts and bolts of the
companies that fall within the small business arena. And you
two are examples of that.
However, there may be companies that don't face this same
type of global competition as does Mr. Harmon's company, and
there may be other companies that are much more reliant on a
domestic base clientele. So we really have to take a look at
that.
Because I am not convinced that these tax cuts are the end-
all to be-all. And that is some of what I hear the debate being
framed as, and I don't think that that is a healthy way of
looking at a 21st century economy and how we support our
entrepreneurs and small business, because there are so many
other variables that are bearing on it.
Did anyone else want to add anything there?
Mr. Hodge, you look like you have a light bulb going off.
Mr. Hodge. Well, Mr. Harmon's comments I think were very
illuminating, because he is dealing in the global economy. And,
as I mentioned, not only does the U.S. now have the highest
corporate tax rate in the world, at 35 percent, but the 35
percent individual rate that affects S corporations is also the
highest business tax rate in the world, by definition. So he is
now competing against a global economy with much, much lower
tax rates.
Actually, 75 countries have cut their corporate tax rates
in the last 5 years to be more competitive and to attract
business jobs and investment away from high-tax countries like
the United States. So it is incredibly important that not only
we cut our corporate rates so that we can be more competitive
but cut our individual rates so that these types of businesses
can also be competitive globally. And it is the expansion of
Mr. Harmon's company that can help Ms. Kern's company because
she would be doing the metalwork on his factory. So that
domestic investment is benefited by someone who can compete
globally.
Ms. Clarke. Clearly--and, Mr. Chairman, I am wrapping up. I
just wanted to say that when we look at the domestic budget
that helps to really provide a catalyst for their companies,
notwithstanding the tax cuts. If we are cutting defense
contracts, if we are cutting and are unable to put out a robust
transportation bill, then, notwithstanding that, the
competitiveness still is undercut by our inability to strike
that balance.
So I just wanted to make sure that we sort of give a much
more comprehensive look at what we are facing here and do our
very best to bear that in mind as we go forward.
And I thank you, Mr. Chairman.
Thank you very much for your testimony here today.
Chairman Walsh. Thank you.
A quick 10-second answer from each Ms. Kern and Mr. Harmon.
Directly, how would letting all these tax rates expire at the
end of the year impact your ability to hire more employees?
Mr. Harmon, quickly.
Mr. Harmon. Significant influence and impact by having the
tax rates expire. We would have to go back in a constriction
mode, I mean a survival mode.
Chairman Walsh. Ms. Kern, quickly.
Ms. Kern. We are surviving on just razor-thin margins right
now that are very difficult to maintain. And if they undo these
tax cuts, then that is definitely not going to help us survive.
Chairman Walsh. Thank you. I want to thank everybody for
your testimony. You have all provided important insight into
how actions and inactions in Washington affect what you all do
out in the real economy; and I, along with Congressman Schrader
and the whole Committee, wish you success in your current and
future endeavors.
I ask unanimous consent that Members have 5 legislative
days to submit any additional comments and material for the
record.
Without objection, so ordered.
Chairman Walsh. The hearing is now adjourned. Thanks.
[Whereupon, at 11:30 a.m., the Subcommittee was adjourned.]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]