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




 
                    TAX REFORM AND THE TAX TREATMENT
                            OF CAPITAL GAINS

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

                             JOINT HEARING

                               before the

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

                                and the

                           FINANCE COMMITTEE
                              U.S. SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 20, 2012

                               __________

                           Serial No. 112-29

                               __________

         Printed for the use of the Committee on Ways and Means




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                      COMMITTEE ON WAYS AND MEANS

                     DAVE CAMP, Michigan, Chairman

WALLY HERGER, California             SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas                   CHARLES B. RANGEL, New York
KEVIN BRADY, Texas                   FORTNEY PETE STARK, California
PAUL RYAN, Wisconsin                 JIM MCDERMOTT, Washington
DEVIN NUNES, California              JOHN LEWIS, Georgia
PATRICK J. TIBERI, Ohio              RICHARD E. NEAL, Massachusetts
DAVID G. REICHERT, Washington        XAVIER BECERRA, California
CHARLES W. BOUSTANY, JR., Louisiana  LLOYD DOGGETT, Texas
PETER J. ROSKAM, Illinois            MIKE THOMPSON, California
JIM GERLACH, Pennsylvania            JOHN B. LARSON, Connecticut
TOM PRICE, Georgia                   EARL BLUMENAUER, Oregon
VERN BUCHANAN, Florida               RON KIND, Wisconsin
ADRIAN SMITH, Nebraska               BILL PASCRELL, JR., New Jersey
AARON SCHOCK, Illinois               SHELLEY BERKLEY, Nevada
LYNN JENKINS, Kansas                 JOSEPH CROWLEY, New York
ERIK PAULSEN, Minnesota
KENNY MARCHANT, Texas
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

         Jennifer Safavian, Staff Director and General Counsel

                  Janice Mays, Minority Chief Counsel

                                 ______

                          COMMITTEE ON FINANCE

                     MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West         ORRIN G. HATCH, Utah
Virginia                             CHUCK GRASSLEY, Iowa
KENT CONRAD, North Dakota            OLYMPIA J. SNOWE, Maine
JEFF BINGAMAN, New Mexico            JON KYL, Arizona
JOHN F. KERRY, Massachusetts         MIKE CRAPO, Idaho
RON WYDEN, Oregon                    PAT ROBERTS, Kansas
CHARLES E. SCHUMER, New York         MICHAEL B. ENZI, Wyoming
DEBBIE STABENOW, Michigan            JOHN CORNYN, Texas
MARIA CANTWELL, Washington           TOM COBURN, Oklahoma
BILL NELSON, Florida                 JOHN THUNE, South Dakota
ROBERT MENENDEZ, New Jersey          RICHARD BURR, North Carolina
THOMAS R. CARPER, Delaware
BENJAMIN L. CARDIN, Maryland

                    Russell Sullivan, Staff Director

               Chris Campbell, Republican Staff Director


                            C O N T E N T S

                               __________
                                                                   Page

Advisory of September 20, 2012 announcing the hearing............     2

                               WITNESSES

Mr. David H. Brockway, Partner, Bingham McCutchen, LLP...........     8
Dr. Lawrence B. Lindsey, President & CEO, The Lindsey Group......    20
Dr. Leonard E. Burman, Daniel Patrick Moynihan Professor of 
  Public Affairs at the Maxwell School, Syracuse University......    36
Mr. David L. Verrill, Founder and Managing Director, Hub Angels 
  Investment Group, LLC..........................................    53
Mr. William D. Stanfill, General Partner, Montegra Capital Income 
  Fund, Founding Partner, TrailHead Ventures, L.P................    65

                       SUBMISSIONS FOR THE RECORD

Alliance for Savings and Investment, statement...................   101
American Council for Capital Formation 1, statement..............   105
American Council for Capital Formation 2, statement..............   114
American Farm Bureau Federation, statement.......................   123
Associated Builders and Contractors, statement...................   124
Center for Fiscal Equity, statement..............................   125
Edison Electric Institute, statement.............................   130
Investment Company Institute, statement..........................   135
National Small Business Network, statement.......................   140
Sidman, statement................................................   145
Small Business Investor Alliance, statement......................   148
Tomcich, statement...............................................   153
U.S. Chamber of Commerce, statement..............................   154

                        QUESTIONS FOR THE RECORD

Mr. David H. Brockway............................................    90
Dr. Lawrence B. Lindsey..........................................    96


                    TAX REFORM AND THE TAX TREATMENT
                            OF CAPITAL GAINS

                              ----------                              


                      THURSDAY, SEPTEMBER 20, 2012

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                                     Washington, DC
    The committee met, pursuant to call, at 10:10 a.m., in Room 
HVC-210, Capitol Visitor Center, the Honorable Dave Camp 
[chairman of the Committee on Ways and Means] presiding.
    [The advisory of the hearing follows:]

HEARING ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

 Chairmen Camp and Baucus Announce Joint Hearing on Tax Reform and the 
                     Tax Treatment of Capital Gains

                                                 September 13, 2012

    Congressman Dave Camp (R-MI), Chairman of the House Committee on 
Ways and Means, and Senator Max Baucus (D-MT), Chairman of the Senate 
Committee on Finance, today announced that the Committees will hold a 
joint hearing to review the tax treatment of capital gains in the 
context of comprehensive tax reform. The joint hearing will take place 
on Thursday, September 20, 2012, in Room HVC-210 of the Capitol Visitor 
Center, beginning at 10:00 A.M.
      
    This hearing was originally scheduled for 10:00 A.M. on Thursday, 
June 28, 2012, in Room HVC-210 of the Capitol Visitor Center, but was 
postponed.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committees and for 
inclusion in the printed record of the hearing. Invited witnesses will 
include the witnesses who were invited to appear at the originally 
scheduled hearing.
      

BACKGROUND:

      
    The maximum capital gains tax rate currently is 15 percent, as 
compared to the maximum individual ordinary income tax rate of 35 
percent. Absent Congressional action, the maximum statutory capital 
gains rate will increase to 20 percent on January 1, 2013, while the 
maximum individual ordinary income tax rate will increase to 39.6 
percent. Beginning in 2013, however, an additional 3.8 percent tax will 
be imposed on net investment income earned by certain individuals. 
``Net investment income'' includes, among other items, capital gains. 
Furthermore, the 2013 scheduled restoration of the ``Pease limitation'' 
on itemized deductions will impose a roughly 1.2 percent marginal rate 
on capital gains, bringing the top federal rate on capital gains to 25 
percent in 2013.
      
    With regard to the joint hearing, Chairman Camp made the following 
statement:
      
    ``The taxation of capital gains is one of the most widely discussed 
areas of our individual tax system, and it needs to be reviewed as part 
of comprehensive tax reform. With both the Ways and Means Committee and 
the Senate Finance Committee actively pursuing tax reform, it will be 
critical for Congress's two tax-writing panels to continue working 
closely together. This is the third time this Congress that our two 
committees have convened a joint hearing, and I look forward to 
continuing the dialogue on these critical issues.''
      
    Speaking about the upcoming hearing, Chairman Baucus said, ``It has 
been more than 25 years since the last major tax reform occurred. The 
world has changed drastically in that time and America's tax code 
hasn't kept up. It's time we had a tax code for the 21st century, one 
that can create jobs, spark innovation and expand opportunity. I look 
forward to working with Chairman Camp as we work on a balanced, common-
sense plan to reform the tax code and create the jobs we need to 
improve our economy.''

FOCUS OF THE HEARING:

      
    The hearing will focus on the taxation of capital gains in the 
context of comprehensive tax reform. It will explore several tax reform 
policy issues relating to the treatment of capital gains, including 
background on capital gains taxation and its history, the impact of the 
capital gains tax rate on investor behavior, the treatment of capital 
gains as compared to ordinary income, the revenue-maximizing rate on 
capital gains, the distribution of capital gains income across taxpayer 
income levels, and the types of assets eligible for capital gains 
treatment.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
written comments for the hearing record must follow the appropriate 
link on the hearing page of the Committee website and complete the 
informational forms. From the Committee homepage, http://
waysandmeans.house.gov, select ``Hearings.'' Select the hearing for 
which you would like to submit, and click on the link entitled, ``Click 
here to provide a submission for the record.'' Once you have followed 
the online instructions, submit all requested information. ATTACH your 
submission as a Word document, in compliance with the formatting 
requirements listed below, by the close of business on Thursday, 
October 4, 2012. Finally, please note that due to the change in House 
mail policy, the U.S. Capitol Police will refuse sealed-package 
deliveries to all House Office Buildings. For questions, or if you 
encounter technical problems, please call (202) 225-3625 or (202) 225-
2610.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item not in compliance with these 
guidelines will not be printed but will be maintained in the Committee 
files for review and use by the Committee.
      
    1. All submissions and supplementary materials must be provided in 
Word format and MUST NOT exceed a total of 10 pages, including 
attachments. Witnesses and submitters are advised that the Committee 
relies on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental 
sheet must accompany each submission listing the name, company, 
address, telephone, and fax numbers of each witness.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days' notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://www.waysandmeans.house.gov/.
      
    Present: Representatives Camp, Herger, Johnson, Brady, Nunes, 
Tiberi, Reichert, Boustany, Roskam, Gerlach, Price, Buchanan, Smith, 
Jenkins, Paulsen, Marchant, Berg, Black, Reed, Levin, Rangel, Neal, 
Becerra, Larson, Blumenauer, and Pascrell.
      
    Senators Baucus, Wyden, Carper, and Hatch.

                                 

    Chairman CAMP. Good morning. Thank you for joining us today 
for the third joint hearing of this Congress House Ways and 
Means Committee and the Senate Finance Committee. Prior to this 
Congress, our two committees had not met together for tax 
related hearings in more than 70 years.
    Through this series of hearings, as well as the ones we 
have held on our own and with the Joint Committee on Taxation, 
we have had very productive discussions about steps that we 
need to take to transform today's broken Tax Code from one that 
hinders to one that fosters greater investment and job 
creation. And after more than 43 consecutive months of 
unemployment over 8 percent, it is no secret that we are in a 
jobs crisis and comprehensive tax reform is a part of achieving 
much needed economic growth.
    Today's hearing focuses on capital gains in the context of 
comprehensive tax reform. For nearly its entire history, our 
income tax system has taxed capital gains differently than 
other income. Even in the years following the 1986 Tax Reform 
Act, when the capital gains and ordinary income tax rates were 
aligned, we still recognized that capital investments raised 
specific tax policy questions and therefore required various 
rules to distinguish between capital gains and ordinary income.
    Today the maximum capital gains tax rate is 15 percent as 
compared to the maximum individual ordinary income tax rate of 
35 percent. And while the focus of this hearing is a longer-
term view on capital gains as a part of comprehensive tax 
reform, we can't forget that, absent congressional action to 
stop the impending tax hikes we face at the year's end, the 
maximum capital gains rate will increase to 25 percent and the 
maximum individual ordinary income tax rate will increase to 
40.8 percent when certain hidden marginal tax rate increases 
are factored in.
    The potential tax increases that we face next year would 
have a devastating effect on the economy. According to the 
Joint Committee on Taxation, a failure to enact a 1-year 
extension of the low tax policies first enacted in 2001 and 
2003, including an AMT patch, would result in a $384 billion 
tax increase. On the other hand, extending these policies on a 
permanent basis or, as Republicans have called for, enacting 
comprehensive tax reform consistent with historic revenue 
levels would prevent a tax increase of more than $4 trillion 
over the next decade.
    Clearly those increases serve as a stark reminder that 
without action, more and more revenue that could be used to 
invest and hire will be taken out of the economy. And as we 
consider the economic impact of the tax burden associated with 
capital gains, it is critical that we focus on the total 
integrated rate, which is nearly 45 percent, not just the 
statutory rate of 15 percent.
    The capital gains tax is often though not always a double 
layer of taxation. For example, in the case of shares of stock, 
a company's income is first taxed at the corporate rate. Then 
when shareholders of the company later decide to sell their 
stock, they are subject to capital gains tax on the sale. But 
the value of the stock they sell already has been reduced by 
the fact that the corporation previously paid out a portion of 
its earnings as taxes.
    So, even if we make current low tax policies permanent, the 
top integrated rate on capital gains is actually 44.75 percent, 
a 35 percent first layer of tax and a 15 percent capital gains 
tax. If we allow current low tax policies to expire, the top 
integrated rate on capital gains would exceed 50 percent. Along 
these same lines, I believe it is important to mention that 
regardless of what rate we apply to capital gains, we should 
strive to retain parity between the rates for capital gains and 
dividends. Just as we need to eliminate the lock-out effect 
that our worldwide tax system imposes on foreign earnings, we 
should also not restore the lock-in effect on domestic 
corporate earnings that makes it more tax efficient to retain 
earnings inside a corporation when it might be more productive 
to push the cash out to shareholders so they can reinvest it 
elsewhere in the economy.
    There are compelling reasons for providing a preferential 
tax treatment for capital gains, but we all know there are 
important tradeoffs to be considered with each piece in the 
complex process of comprehensive tax reform. One of the main 
objectives for this hearing is to examine the tradeoffs 
inherent in different proposals for capital gains taxation. I 
look forward to hearing from our panel of witnesses who are 
assembled here today, and I want to thank all of you for your 
time for coming today.
    And with that, I will yield to my colleague, the chairman 
of the Senate Finance Committee, for his opening statement.
    Senator BAUCUS. I thank you very much, Mr. Chairman.
    I appreciate this joint hearing. I believe we should have 
more, frankly. I believe that in this partisan time, we are so 
polarized that the facts count. The more we have hearings, the 
more we can ask factual questions and the more witnesses give 
us factual responses, not political responses, then the closer 
we are going to be to reaching some kind of an agreement, 
hopefully, after the election, lame duck, and in the following 
years. But more hearings like this, just asking questions 
slowly, perhaps painfully, will help us get to a good result 
after the election.
    Winston Churchill once said, the pessimist sees the 
difficulty in every opportunity, and the optimist sees the 
opportunity in every difficulty. As you work on comprehensive 
tax reform, the treatment of capital gains is one of the most 
difficult issues we face. Some are pessimistic and don't 
believe we can agree. I am optimistic; we need to come together 
and find a workable solution.
    Through that process, there are four considerations. First, 
we need to consider the capital gains rate to compare to the 
rates on wage income, dividends and corporate income. The tax 
rate and the capital gains is currently lower than the rate on 
wage income. Some say this is to avoid double taxation. But 
most of the time, that claim doesn't prove true. Only a third 
of capital gains come from sales of corporate stock; the rest 
have never previously been taxed before reaching individuals.
    Second, we need to consider how capital gains rates affect 
different income brackets. Capital gains grow 
disproportionately to high-income taxpayers. Last year, capital 
gains represented half the income of the top one-tenth of a 
percent of earners with 3 percent for the lowest 80 percent of 
taxpayers. Low capital gains rates are the main reason why many 
wealthy individuals pay lower tax rates than middle class 
families.
    Third, we need to consider our low savings rate. Americans 
need to save over their lifetimes. This is an opportunity for 
our witnesses to talk about the relationship between tax rates 
and capital gains and national savings.
    Fourth, we must consider complexity. Experts tell us that 
about half of the U.S. Tax Code, more than 20,000 pages, exists 
solely to deal with capital gains. That complexity, as well as 
the wide gap between the tax rates on income and capital gains 
invites people to use all kinds of shenanigans to game the 
system. Our entire Tax Code, including this treatment of 
capital gains, needs to be rebuilt for the 21st century. We 
need a system focused on broad-based economic growth and jobs.
    I am glad today to be joined by Chairman Camp and my 
colleagues from the House, but in order to get tax reform done, 
we need members of both parties and both chambers willing to 
tackle these issues with an open mind. So let's set aside our 
differences, political differences, and listen. Let's see this 
as an opportunity, let's be optimistic that we can reform the 
code to spark growth, create jobs and strengthen our economy.
    Chairman CAMP. Thank you very much, Chairman Baucus.
    Let me now yield to the ranking member of the Ways and 
Means Committee, Mr. Levin, for his opening statement.
    Mr. LEVIN. Thank you very much.
    And we welcome the witnesses and welcome the opportunity to 
have this joint hearing. I remember back when I was in the 
state legislature, we held joint hearings, and they were semi-
revolutionary, and I think it is a useful approach. I think we 
all realize that when it comes to tax reform that it is 
integrated that in a sense, almost every issue relates to every 
other issue. But I will resist the temptation to use the 
integrated nature of taxes to talk about other issues, 
including the difficult issues that we are facing and that 
divide us as to, for example, the taxation on high incomes. 
There is a new CRS report that very much questions the argument 
that the high income tax break promotes economic growth. But 
let me concentrate instead on this issue of capital gains. I 
think the issue as to how to tax capital gains will be one of 
the major and likely most controversial issues as we undertake 
tax reform. The reduced rate on long-term capital gains is one 
of the largest individual tax expenditures, as we know, adding 
up to hundreds of billions of dollars over a decade. It is 
also, as Mr. Baucus has said, a source of considerable 
complexity.
    I noted that, in reviewing the testimony for this hearing, 
that by some estimates, fully half of the Tax Code is devoted 
to defining the difference between capital gains and ordinary 
income, and I am not sure it is half, but I remember our tax 
course back in law school trying to wrestle with these issues, 
and it took up maybe half of the time. When there is a 
significant capital gains preference, there is a lot of 
pressure on these rules, because the greater the tax preference 
for capital gains the greater the incentive to try to 
recharacterize ordinary income as capital gains.
    That, for example, is the source of the battle over carried 
interest. So it is useful for all of us to really understand 
the issues surrounding capital gains. That includes its 
history. We have mostly had a preferential rate, but as we 
know, the 1986 tax reform eliminated it. And it includes the 
various arguments for why you might want a lower rate, whether 
that is double taxation of corporate income, inflation, the so-
called lock-in effect and incentive to invest, among others.
    It is also important that we understand the evidence about 
the different rationales and how they hold up to reality. As 
mentioned by the chairman of the Finance Committee, most 
capital gains are realized by the highest earners. Some 71 
percent of the benefit of the preferential rate on capital 
gains goes to those making more than $1 million a year, 
according to the Joint Committee on Taxation. So there is a 
real consequence from the preferential rate as to the 
progressivity of our tax system.
    Both our committees will have to wrestle with these issues 
as tax reform moves forward. So I look forward eagerly to this 
testimony and hope that it will help us inform that process. 
Thank you.
    Chairman CAMP. Thank you, Mr. Levin.
    I now yield to the ranking member of the Senate Finance 
Committee, Senator Hatch, for his opening statement.
    Senator HATCH. Thank you so much, Chairman Baucus and 
Chairman Camp, for holding this joint hearing.
    From 1921 through 1987 and then again after 1990, capital 
gains have been taxed at a lower rate than ordinary income. A 
number of justifications have been given as to why we have 
preferential treatment for capital gains. For example, the 
lock-in effect is usually given as a reason for having 
preferential treatment for capital gains. Since capital gains 
are only taken into account when realized by a sale or 
exchange, investors can avoid paying the capital gains tax by 
simply holding on to their capital assets. As a result, the 
capital gains tax has a lock-in effect, which reduces the 
liquidity of assets and discourages taxpayers from switching 
from one investment to another. Other important reasons given 
for preferential treatment for capital gains are that a low 
capital gains tax increases savings and investment, counteracts 
the two levels of taxation of corporate income and corrects the 
income tax law's bias against savings.
    Next year, an additional tax on capital gains is scheduled 
to go into effect. As part of the President's health care law, 
a new 3.8 percent tax on the net investment income of single 
taxpayers earning more than $200,000 and married couples 
earning more than $250,000 goes into effect. These amounts are 
not indexed for inflation, and with the scheduled expiration of 
the 2001, 2003 and 2010 tax relief at the end of this year, 
capital gains will be subject to a 23.8 percent tax beginning 
in 2013, a whopping 59 percent increase from current law. 
According to the OECD, the United States has the most 
progressive tax system in the industrialized world. Should we 
make it even more progressive by raising the tax rate on 
capital gains? The top 10 percent of households already pay 70 
percent of all Federal income taxes. So when is enough 
progressivity achieved?
    Over 50 years ago, a leading tax scholar wrote that 
everything there now is to say on the problem of capital gains 
has already been said. I disagree. I think the issue of 
preferential treatment of capital gains is critically important 
today with new evidence being generated, as witnessed by the 
joint report of the staff of the Joint Committee on Taxation 
and the Congressional Budget Office issued in June.
    We have a very distinguished panel here with us today.
    I welcome each one of you, as do all of us, to this 
hearing. And we all have a great desire to hear what these 
witnesses have to say.
    Thank you, Mr. Chairman.
    Chairman CAMP. Well, thank you, Senator Hatch.
    And without objection, any other member who wishes to have 
an opening statement included in the formal hearing record may 
submit one in writing.
    We are fortunate to have a panel of witnesses here this 
morning with a wealth of experience in private practice, 
academia and government. Let me briefly introduce them.
    First, I would like to welcome David Brockway, the former 
chief of staff of the Joint Committee on Taxation during the 
process leading up to the enactment of the Tax Reform Act of 
1986 and currently a partner at Bingham McCutchen here in 
Washington.
    Second, we will hear from Larry Lindsey, who is currently 
president and CEO of the Lindsey Group. Dr. Lindsey formerly 
served as director of the President's National Economic Council 
and is a governor on the board of the Federal Reserve.
    And third, we will hear from Leonard Burman, who is a 
professor of public affairs at the Maxwell School at Syracuse 
University. Dr. Burman is the co-founder and former director of 
the Urban-Brookings Tax Policy Center.
    And fourth, we will hear from David Verrill, who is the 
founder and managing director of Hub Angels Investment Group in 
Cambridge, Massachusetts. He has recently assumed the role of 
chairman of the Angel Capital Association.
    And finally, we will hear from William Stanfill, a general 
partner at the Montegra Capital Income Fund and a founding 
partner of TrailHead Ventures, L.P. Mr. Stanfill has been in 
the investment management business for over 40 years.
    And thank you all for being with us today. The committee 
has received each of your written statements, and they will be 
made part of the formal hearing record. Each of you will be 
recognized for 5 minutes for your oral remarks.
    And Mr. Brockway, we will begin with you. You are 
recognized for 5 minutes.

  STATEMENT OF DAVID H. BROCKWAY, PARTNER, BINGHAM McCUTCHEN, 
                     LLP, WASHINGTON, D.C.

    Mr. BROCKWAY. Thank you very much, Mr. Chairman.
    I am a strong advocate of comprehensive tax reform and want 
to commend Congress for thinking about this issue very 
seriously. I think that the Code desperately needs reformation. 
But I am not here today to advocate comprehensive tax reform or 
advocate any particular treatment of capital gains.
    I am here more to discuss my experiences in the 1986 
legislation and the likely treatment of capital gains in 
comprehensive tax reform. You have some great witnesses here 
today, and I think their is very informative, and useful in 
thinking about whether you wish to have comprehensive tax 
reform or not. The experience that I had in 1986 strongly 
suggests to me that it is highly unlikely that you will find it 
possible to have comprehensive tax reform with a top rate below 
30 percent without raising the capital gains rate close to 30 
percent or probably, once you are in the neighborhood, to 30 
percent or less--whatever the top ordinary incomes rate is, 25 
percent, 28 percent.
    Therefore, I tend to view the capital gains issue in the 
context of tax reform as a gating issue. If, after you 
understand the policy issues in regard to taxation of capital 
gains, you believe that it is fundamental to keep a 
differential in the rate structure between capital gains and 
ordinary income, then I think you have to think seriously about 
whether you wish to go forward with comprehensive tax reform. 
On the other hand, if you come to the same conclusion the 
Congress did in 1986 that overall the benefits of comprehensive 
tax reform outweigh the detriments of raising the tax rate on 
capital gains, then I think it is sensible to move forward.
    In any event, given the design constraints that governed 
the 1986 Act, it was not possible at that time to reach a 
reduction in the top rate on ordinary income to 28 percent 
without also increasing the capital gains rate to that level. 
Raising of the capital gains rate to that level was absolutely 
not an objective in that process. In both Houses, there was 
great resistance to doing that. It was simply the only way that 
the legislation would move forward under the constraints that 
Congress was operating under.
    Those constraints were revenue neutrality and 
distributional neutrality together with a significant shift in 
tax burden off of the individual sector onto the corporate 
sector. That is, the legislation we raised about $20 billion a 
year in base broadeners from the corporate sector and used that 
to help subsidize a reduction in the individual tax rates, 
which might be on the order of magnitude of something like $40 
billion a year right now. It was a very large shift. And 
finally, the design constraints were governed by the estimating 
process of the Joint Committee staff, both distributional 
analysis and revenue analysis, using traditional revenue 
estimating methods. That is, they did not take into account any 
potential change in the overall performance of the economy that 
the legislation might produce. They assumed that the economy 
would operate at the same levels as in the CBO baseline.
    Those constraints were consciously designed and executed as 
a ``time out'' from the partisan ideological struggles in 
regard to the size and role of the Federal Government and, for 
want of a better term, the class warfare issues that were 
facing Congress. Obviously, these are still issues today, but, 
at that point, without that time out, I think that it would not 
have been possible to secure the bipartisan support that was 
necessary for that legislation to pass either House.
    I recognize what you are hearing this morning is designed 
to focus on capital gains, not the design constraints of 
overall comprehensive tax reform, but to my view, that is the 
key to the entire process, and it is the key, in the end of the 
day, to the tax treatment of capital gains in any such 
legislation.
    The situation you are dealing with today is different from 
1986 in a number of respects, and you are obviously free to 
adopt whatever design constraints you think are appropriate for 
this context. But my suspicion is that you are going to find 
that the forces that caused those designs constraints to be 
adopted in 1986 will be the same today. You are going to have a 
much tougher time of it this time around, however. Right now, 
you do have to decide whether you are going to look at current 
policy or current law for setting both the revenue target and 
the distributional target. And I think the distributional 
target in that regard may even be more important. You also have 
to answer the question whether you are going to adopt dynamic 
revenue scoring. That wasn't really an issue in 1986, but it 
will be front and center at this point. And you will also have 
to decide whether you are going to look at changes in the 
relevant tax burden on income classes or whether you are going 
to look at the changes in the relevant after-tax income. 
Particularly if you are thinking about taxation of capital 
gains and you are thinking about dynamic scoring, you have to 
ask the question, are people relatively in the same position 
after tax as they were before or not, not what the charts show 
about how much tax each particular income group pays. I think 
have I have reached my time limit.
    Chairman CAMP. The time has expired, yes. Thank you very 
much Mr. Brockway.
    [The prepared statement of Mr. Brockway follows:]

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    Chairman CAMP. Dr. Lindsey you are recognized for five 
minutes.

   STATEMENT OF LAWRENCE B. LINDSEY, PRESIDENT AND CEO, THE 
                   LINDSEY GROUP, FAIRFAX, VA

    Mr. LINDSEY. Thank you, Mr. Chairman.
    I would like to thank both committees for staging this 
hearing. I think it is very important. I think we need to put 
this a little bit in the economic context. Given the hole that 
we are in in the country, I think our whole focus should be on 
making America the best place in the world in which to invest, 
start a business and create jobs. It is as simple as that.
    There is in that context a very strong relationship between 
the rate of taxation and the level of economic activity that is 
being taxed. I would like to discuss that. It is not as strong 
as some believe. It is stronger than many believe.
    Finally, I would like to point out that the revenue 
collected from capital gains taxation depends not only on the 
capital gains tax rate but on the tax rate on ordinary income 
as well.
    And those are the three thoughts I would like to leave you 
with today.
    Let me begin with the effect of taxation on 
entrepreneurship and job creation. As Chairman Camp pointed 
out, the effect of taxation of capital gains is much higher. It 
is really not a taxation of capital gains; it is a taxation of 
capital income. It is one tax levied on top of another tax.
    Moreover, if you look at the way we tax other types of 
receipt of capital income, such as dividends, we will be having 
an effective tax rate on capital income of over 60 percent next 
year. Frankly, that is a preposterously high rate of tax for a 
country that wants to compete on a global economic basis. It is 
simply too high. We have to consider a way around it.
    That said, I understand the dilemma of the tradeoffs 
between capital gains taxation and ordinary income taxation. 
And I do come down on the side on net of bringing them closer 
together; on balance, raising the capital gains rate and 
cutting the tax rate on others, other forms of income.
    In doing that, I think we need to keep in mind the 
experiment we are going to be running but now running backward. 
We did some extensive work in 2001 and in preparation for the 
2003 tax cut on the effects of dividend and capital gains 
taxation on the level of equity prices, not just because people 
hold equities, but many, many millions of Americans hold it 
through pension funds. And frankly, we were very concerned with 
the plight of the Nation's pension funds back then.
    The estimate we came up with was that the capital gains 
change would have ended up raising the level of the S&P by 
about 8 percent. And I would point out that Allen Sinai, who 
has long been one of the Nation's premier economic modelers, 
estimates that if we go over the cliff and all those taxes you 
were talking about take effect, that the decline in the S&P 
from current levels as a result of that tax would be 19.6 
percent. So we are talking about a rather substantial possible 
effect.
    I also think it is important that you keep in mind what 
happens on the small business level, and that is with regard to 
ordinary income tax rates. We are going to have an effective 
tax rate on the cash flow of small businesses next year of 
roughly 44 percent. If you look at any partnership and you look 
at the traditional partnership draw argument, most of that draw 
was to pay income taxes. I can tell you, as a small business 
man, that is where most of my owner's draw goes; it simply goes 
to pay income taxes. And that money at the margin isn't coming 
from me; it is coming from my ability to reinvest in my 
business and my ability to invest in other businesses. And so 
the idea that this is somehow sterile money that doesn't affect 
the performance of the economy I really don't think comports 
with the facts.
    If I could ask you quickly to turn to table one, I would 
like to show you the experiment we ran in the 1990s and what 
its effect was. I was a little bit startled, and you might 
remember that what we did then was to raise the ordinary income 
tax rate--by the way, this is on page 6 in the testimony--and 
leave the capital gains rate unchanged. What I found 
interesting was that, between 1992 and 1994, when this tax took 
effect the AGI, adjusted gross income, reported by high-income 
taxpayers actually declined. This was in the prosperous 1990s. 
When I did the numbers back, I found that the response was the 
same as it had been in the 1980s to the reduction of the tax 
rate, an income elasticity of about .7 percent--elasticity of 
.7. Capital gains, on the other hand, surged; proprietary 
income declined. So the fact that there is an effect of tax 
rates on the behavior of small businesses I think is 
incontrovertible, and it is shown even in the 1990s data.
    Similarly, if you would--I know we are running out of time 
here--turn to figure 2, you can see what the effect of that was 
on revenue. We did an analysis of what happened. It turned out 
that about 62 percent of the expected revenue did not actually 
materialize from the 1993 tax rate increase on high-income 
taxpayers; it reduced--it came from--resulted in less economic 
activity.
    Let me conclude then--I realize my time is up--with three 
points I would like to leave you with. First, tax rates need to 
be moderate. Once tax rates in general start to hit 40 percent, 
they begin to, although they still raise more revenue, the 
effect on the private sector is profound.
    Second, capital gains taxation should be as neutral as 
possible with regard to other capital taxation. Currently, we 
are encouraging too much borrowing and not enough equity 
investment.
    And finally, I think that the conclusion should be that the 
ordinary and capital gains tax rate should probably be reduced. 
I think it would lead to significant efficiency gains.
    Thank you, and I apologize for going over, Mr. Camp.
    [The prepared statement of Mr. Lindsey follows:]

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    Chairman CAMP. Thank you, Dr. Lindsey.
    Dr. Burman, you are recognized for 5 minutes.

    STATEMENT OF LEONARD E. BURMAN, DANIEL PATRICK MOYNIHAN 
  PROFESSOR OF PUBLIC AFFAIRS AT THE MAXWELL SCHOOL, SYRACUSE 
                    UNIVERSITY, SYRACUSE, NY

    Mr. BURMAN. Thank you very much for inviting me to speak 
before my two favorite tax committees on a very important 
subject.
    I think when you get around to comprehensive tax reform, 
capital gains will be very important. It is a special pleasure 
to be on a panel with David Brockway, who is one of the heroes 
in the 1986 tax reform. And I remember I was a staffer at the 
Treasury Department working on capital gains, and I heard that 
the draft proposal would tax capital gains the same as other 
income. And my first reaction was, that is a terrible idea. I 
was a few years out of grad school and the first thing I 
thought, and Larry mentioned this, is that it would raise the 
effective tax rate on corporate capital.
    I have obviously come around in the intervening years that 
taxing capital gains like other income was actually genius. It 
was the thing that made the income tax rate cuts in 1986 
possible. And I also think that the story in graduate school is 
vastly over-simplified. And in fact, taxing capital gains at a 
lower rate than other income can do more harm than good.
    First, I will mention the equity issue, which obviously is 
a concern. That was a big part of the reason why capital gains 
were taxed like other income, because capital gains are so 
skewed by income. The top 400 taxpayers in 2009 had 16 percent 
of the capital gains. It is very hard to maintain the 
progressivity of the income tax, and certainly without very, 
very high tax rates at the top, without taxing capital gains as 
something close to ordinary income tax rates.
    The other issue is, do we need to lower capital gains tax 
rates to boost the economy? I certainly agree with Larry that 
we need the economy to grow robustly in the years to come, and 
we wouldn't want to do anything that would cause the economy to 
stall. But the issue for capital gains is complicated. For one 
thing, it is the single biggest factor behind individual income 
tax shelters. The differential in tax rates between ordinary 
income and capital gains, 35 percent, 15 percent, is a huge 
incentive to convert ordinary income into capital gains. And 
there is a whole industry devoted to making compensation of 
high-income people into capital gains.
    The kinds of investments that produce these tax shelters 
are extremely inefficient. They often involve things that would 
make no sense to invest in absent the tax consequences, but you 
have money that could be going into productive investments that 
goes into investments that only make sense because of the tax 
break on capital gains.
    There is also just an enormous amount of wasted human 
capital. Some of the smartest people, certainly in the tax 
profession, maybe in the country, are devoted to figuring out 
clever ways to get around the rules the IRS has put in place to 
try to keep people from converting ordinary income into capital 
gains. Those people, under other circumstances, might be able 
to invent products that people would want to buy in the rest of 
the world. I think that would be a better way for them to spend 
their time.
    It also affects allocation of labor. There is a big 
incentive for very talented high-income people to engage in 
activities where they can earn their income in the form of 
capital gains; private equity, hedge funds. The people who do 
that, I think two of them are sitting to my left, I think they 
do enormously valuable work. But we shouldn't have a tax 
subsidy that tilts the balance in favor of that line of 
business relative to others. It should be neutral.
    Now, there is the issue of cost of capital for 
corporations. It is certainly true that taxing capital gains 
and dividends, as well as taxing corporate income, can result 
in a double tax. But a lower tax rate on capital gains is a 
very blunt, poorly targeted instrument for dealing with that. 
Some corporations pay a lot of tax; some corporations pay very 
little tax. A lot of capital gains are on assets other than 
corporate stock. We provide a capital gains tax break on all 
assets not just stock. President Bush had a proposal that would 
have targeted capital gains and dividend relief to actually 
companies that were paying tax.
    Other countries have what is called corporate tax 
integration, a system where you get a tax credit for the tax 
paid at the corporate level. That would save revenue, and it 
would eliminate a lot of the incentives for tax sheltering that 
exist under the current system.
    There is the issue of lock in. I have actually done a lot 
of research on this. There certainly is an incentive to hold 
onto assets to avoid paying tax on capital gains, but the 
economic impact of that is vastly overstated. There is a chart 
in my testimony comparing individual capital gains with 
corporate capital gains. The tax rates changed at different 
times, and the two lines are almost indistinguishable.
    I also have a proposal in my testimony for providing a tax 
credit effectively for capital gains taxes paid against the 
estate tax that would reduce the strongest incentive to, the 
so-called angel of death loophole, that if you hold your assets 
until you die, you avoid tax altogether.
    There are a number of issues I can talk about in Q and A. 
There is an argument to not tax capital gains because of 
inflation; that you don't want to tax savings at a higher rate 
to encourage entrepreneurship. I believe all of those arguments 
are arguments for lowering tax rates on capital overall. They 
are not an argument for a lower tax rate on capital gains. I 
think using the capital gains tax as a way to cut ordinary 
income tax rates would be a win-win. It would reduce the 
incentive for tax sheltering, and potentially it could be the 
basis for another bipartisan plan like the Tax Reform Act of 
1986. I would hope that that would be the direction you would 
go.
    Chairman CAMP. Thank you very much, Dr. Burman.
    [The prepared statement of Mr. Burman follows:]

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    Chairman CAMP. Mr. Verrill, you are recognized for 5 
minutes.

 STATEMENT OF DAVID L. VERRILL, FOUNDER AND MANAGING DIRECTOR, 
        HUB ANGELS INVESTMENT GROUP, LLC, CAMBRIDGE, MA

    Mr. VERRILL. Thank you, Chairman Camp, Chairman Baucus, 
Ranking Member Hatch, Ranking Member Levin and members of both 
committees.
    Thank you for inviting the Angel Capital Association to 
speak before this joint hearing on tax reform and treatment of 
capital gains.
    The impact of the capital gains tax rate is of significant 
importance to those collectively referred to as Angel 
investors. Those are individuals who provide most of the seed 
stage capital to start up businesses that drive our Nation's 
innovation economy.
    My name is David Verrill, and I am founder of the Hub 
Angels in Boston, actually Cambridge, and chair of the Angel 
Capital Association. Please know that the ACA supports a 
maximum capital gains rate of 15 percent.
    The story of Angel investing is a story of success in 
America. Here is what we do: First, Angel-backed companies are 
the well spring of our innovation economy. We fund early-stage 
high-growth companies that generate new high-paying jobs. Last 
year, Angels helped start more than 65,000 companies by 
investing more than $22 billion out of their own wallets. These 
investments created more than 165,000 jobs in 2011. This 
included companies like Advanced Battery Concepts in Michigan 
and RightNow Technologies in Montana, where our chairmen 
represent.
    Second, Angels invest on every Main Street in every State 
and every business sector. We invest where we live in every 
congressional district. We provide not just capital but time, 
expertise, mentorship and governance, often to first-time 
entrepreneurs who dearly need all the help they can get.
    I should point out that the 60 members of your two 
committees represent 37 States and 150 of the 170 ACA member 
groups. You know better than I do how important these young 
companies are to your State and our national tax base.
    Third, Angels are the only source of capital for many, many 
startups. Angel groups like mine focus on development of 
disruptive technologies in critically important sectors, 
including medical breakthroughs. In fact, one of our biggest 
hits this year was Intelligent Biosystems, a DNA sequencing 
company. We invest, even though more than half of the companies 
that we invest in will fail and will lose our invested capital 
in those companies. Just 7 percent of investments account for 
75 percent of the positive returns. Those positive returns have 
to make up for the losses. This is a very, very illiquid and 
long-term investment space.
    Fourth, Angels invest their own money of their own free 
will and capacity. We don't tend to invest other people's 
capital, just ours. There is no market for this private stock. 
We have no way of predicting if or when a company will exit and 
when we will make our investment return.
    Fifth, successful Angel investments create a virtuous 
cycle. Angels tend to plow returns back into more startups and 
the teams of those successful companies pay more taxes, consume 
more products and services and, even better, many of them 
become Angel investors themselves.
    An increase in capital gains would reduce Angel investment 
in these promising companies at the very time we need to create 
jobs in the United States. It would be taking our foot off the 
gas pedal just when we need to accelerate this economic engine 
of growth. And make no mistake, Angel investors are the source 
of much of this capital and drivers of much of this growth.
    Let me provide you with some data. First, Angel investors 
support up to 90 percent of the outside equity raised by 
startups. These companies are too embryonic to qualify for bank 
loans and too small or too early for most venture capital 
firms.
    Second, Angel investing is far more prevalent than venture 
capital in seed stage companies, startup companies. This is the 
stage when companies need a few hundred thousand dollars to 
just get started.
    And third, private investment by accredited investors 
overall generates more new capital to our economy than the 
public equity markets.
    So here is the dilemma: Raising the capital gains rate 
significantly will force many Angels to turn away from an asset 
class in which they are the most experienced recognized experts 
and dominant players. There are no replacements for Angels.
    And I would note, as mentioned previously, there are other 
pending tax changes to the code that would increase a 5 percent 
increase in the effective tax rate on Angel investors next 
year.
    The best way to ensure a strong flow of Angel capital into 
innovative small businesses throughout this country is to 
provide tax incentives and education to allow and encourage 
private citizens to risk more of their own capital to support 
startups and early stage businesses.
    With that driving force in mind, the ACA advocates for a 
maximum capital gains rate of 15 percent. Consistency in this 
rate has led to a tremendous surge in Angel investment over the 
past decade alone.
    Second, we ask your support for reinstatement of the 100 
percent exclusion of the capital gains tax on qualified small 
business stock, Section 1202, led by Senators Kerry and Olympia 
Snowe, which is included in the Senate version of the tax 
extender bill. We encourage the House to support it as well.
    Third, we recommend Congress consider instituting tax 
credit policies in support of Angel investors, like the Senate 
bill 256, supported by Senators Pryor and Scott Brown of 
Massachusetts; 22 States in our Nation have tax credits for a 
reason. They create jobs. We should have a tax credit at the 
Federal level.
    As my fellow panelists have commented, tax policy is 
complex. My point is simple. If Angel investors are taxed more, 
they will have less to invest.
    Thank you for the opportunity to speak today. I would be 
happy to answer any questions about Angel investing. I do have 
additional materials on Angel investing in the U.S. and 
respectfully request that that be accepted into the record.
    Chairman CAMP. Without objection.
    Thank you Mr. Verrill.
    [The prepared statement of Mr. Verrill follows:]

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    Chairman CAMP. Mr. Stanfill, you are recognized for 5 
minutes.

  STATEMENT OF WILLIAM D. STANFILL, GENERAL PARTNER, MONTEGRA 
  CAPITAL INCOME FUND, FOUNDING PARTNER, TRAILHEAD VENTURES, 
                        L.P., DENVER, CO

    Mr. STANFILL. Chairman Camp, Chairman Baucus, Members of 
the Committees, it will come as no surprise to any of you that 
I am closer to the end of my career than beginning. Therefore, 
permit me to lead with my conclusion: The sky will not fall if 
capital gains go up.
    I have been in the investment business for 45 years; first 
as a broker with Dean Witter, then as a money manager, a 
venture capitalist, an Angel investor and an asset-based 
lender. During the course of my career, capital gains rates 
have ranged from the current 15 percent to as high as 28 
percent. The capital gains rate has had little impact on our 
investment planning, our ability to attract investors or the 
financial results of those investments.
    As for the capital gains rate going forward, tell me what 
the rate will be, make sure it is fair, and we will work within 
the guidelines.
    During my career, I have competed for investors with all 
types of investment funds, oil and gas exploration funds, real 
estate development funds, timber funds, private equity, hedge 
funds, you name it. They all had souped-up tax treatments, 
accelerated depreciation, up-front deductions for exploration 
and development, special rates for timber sales, big interest 
deductions for leveraged buyouts. Invariably they spent more 
time and energy on the tax structure of the deal than on the 
economic merits of the investment.
    Frequently investors I lost to these sophisticated product 
offerings would boast about the money they saved on taxes. 
Seldom did they care about the rate of return from the deal. 
Occasionally, they screamed when they had to repay recaptured 
taxes.
    My goals and the goals of the firms and individuals I have 
worked with are simple: Make money by leveraging the 
creativity, talent and passion of entrepreneurs. Tax rates are 
merely part of the landscape. We are looking to leverage 
talent, not tax breaks. We manage risk, not the Tax Code.
    The preferential tax rates for capital gains and dividends 
are simply a windfall for wealthy investors. In my view, this 
special tax treatment is neither fair nor equitable nor 
available to any other professional endeavor. After all, a 
gifted teacher, who is inspiring and challenging our children 
and enriching human capital, gets no such special treatment.
    I would caution members of the joint committee to be 
skeptical when people like me testify to you that we give lip 
service to the idea of the level playing field. We make 
campaign contributions. We hire lawyers and lobbyists to 
persuade you that if the field is not level, it should be 
tipped in our favor. In addition, we prepare elaborate 
spreadsheets to prove our point, while rejecting data that may 
lead to different conclusions resulting in what Woody Brock 
refers to as the dialogue of the deaf in his book ``American 
Gridlock.''
    Frankly, I was reluctant to testify on this occasion, for 
like the vast majority of my fellow citizens, my faith in the 
U.S. Congress to set aside party and ideology and do the 
People's business has been dashed. But I am nothing if not 
resilient and hope springs eternal, so here I am urging you to 
lead and to find a win-win solution and forge comprehensive tax 
reform.
    What better way to begin than to tax all income--wages, 
dividends, capital gains, carried interest, royalties--alike. 
End preferences, close loopholes, eliminate most deductions, 
add a dash of progressivity. Let the market, not the Tax Code, 
determine the allocation of investment capital. Let various 
legal and accounting and lobbying industries refocus on more 
productive work.
    You have choices to make, change in the Tax Code in favor 
of equity, transparency and predictability, or continue to 
stroke the flames of public cynicism, a divisive option that 
ensures the widening gap between the government and the 
governed. I wish you good luck in your efforts. I look forward 
to your questions. Thank you.
    Chairman CAMP. Thank you, Mr. Stanfill.
    [The prepared statement of Mr. Stanfill follows:]

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    Chairman CAMP. We will now proceed with member questions 
for the witnesses.
    Due to the joint nature of today's hearing, questioning 
will alternate between Members of the Senate, as recognized by 
Chairman Baucus, and Members of the House, as recognized by 
myself, for a single round of questioning.
    Senators will be recognized in an order consistent with the 
rules and practices used at Senate Finance Committee hearings, 
and House Members will be recognized in an order consistent 
with the rules and practices used at Ways and Means Committee 
hearings. Each Member will have 3 minutes to question 
witnesses.
    So, with that, let me invite Chairman Baucus to begin the 
questioning.
    Senator BAUCUS. Thank you, Mr. Chairman.
    Mr. Verrill, that is very clever of you to mention Michigan 
and Montana. I coincidentally, because we are not a big State, 
spent one day working at RightNow Technologies. That company, 
as you know, has done quite well. It sold for $1.4 billion just 
about a year or two ago to Oracle. They've done very well.
    The question I have, though, is listening to you and 
comparing with what Mr. Brockway said, I hear you basically 
saying to keep capital gains rates for Angel investors down to 
15 percent so on and so forth because that is good for Angel 
investing.
    And Mr. Brockway has pointed out that, basically, you got a 
choice here: If you want comprehensive tax reform, Congress, 
you are going to have to raise the capital gains rate. That is, 
if you want to reduce the rates, the marginal rates on ordinary 
income, the only way you can do it is to get rid of a lot of 
the tax expenditures as well as capital gains differential or 
significantly raise capital gains rates. So are you saying, I 
am just asking the question, that we should focus more on Angel 
investing venture capital incentives for investment and forget 
about tax reform?
    Mr. VERRILL. Well, I think there is a clear difference 
between Angel investing and venture capital that I can talk 
more to.
    But in response to your question, I think the longer-term 
virtuous cycle of a tax benefit in terms of capital gains for 
Angels actually increases the amount of revenue that comes into 
the Federal Government over time rather than thinking of it as 
a tax break.
    Senator BAUCUS. My point is, are you basically saying to 
keep the capital gains rate very low, which means it is going 
to be very, very difficult to get the marginal rates down--you 
have lots of proposals around here. You got 25-10 and so forth. 
And as I think as Mr. Burman pointed out, it is virtually 
impossible to get to 25-10. In fact, it is impossible without 
either raising rates on middle-income Americans and/or raising 
capital gains rates.
    Mr. VERRILL. AC advocates for a low 15 percent capital gain 
rate, but equally importantly, consistency over time. We don't 
have a lock-up issue in the Angel world. We can't determine 
when we exit a company. So I think we need to have a long-term 
stable tax policy so that we can understand that when we invest 
today, we understand how it will be taxed in 5, 6, 7, 8 years 
from now.
    Senator BAUCUS. So do you--Mr. Brockway feels we should 
pursue comprehensive tax reform. Do you agree?
    Mr. VERRILL. I think that you people have a very difficult 
decision to figure that out.
    My personal opinion is that, and with respect to the ACA, 
that we can't have complete neutrality, we can't have complete 
comprehensive taxes that are across the board. We need to have 
some means of incenting people, particularly in my space, to 
continue to make investments in these companies. Nobody else 
will.
    Senator BAUCUS. Mr. Chairman, I think somebody forgot to 
push the clock. My 3 minutes is up.
    Chairman CAMP. You are not on the clock.
    Senator BAUCUS. I am not on the clock? Okay.
    Chairman CAMP. Mr. Chairman, you are not on the clock.
    Senator BAUCUS. Well, I will keep myself to the clock. 
Thanks.
    Chairman CAMP. Thank you.
    Dr. Lindsey, you mentioned in your testimony, and I also in 
my opening statement, the focus on the statutory rate might be 
misplaced when you consider that is often based on income that 
has already been taxed in another layer another place. And you 
said--sort of suggested we should look at this integrated tax 
rate. Can you elaborate on this, why that should be the focus 
for policymakers rather than whether there is a headline 
statutory rate of 15 or 20 percent?
    Mr. LINDSEY. Certainly. Just to keep the math simple, let's 
imagine we have--our objective here is to tax capital at a 
reasonable rate. And right now, if I am an investor who wants 
to earn through the corporate sector a dollar of dividends, the 
first thing that happens is the corporation is taxed at the 
margin at 35 percent on the money it earns, it has $0.65 left. 
I am then taxed at a 15 percent rate on that $0.65 that it is 
going to ship to me in dividends. That is another roughly 
$0.11. So the combined tax is not 15 on the thing; it is a 
number like 46. Now, if the capital gains tax is raised, if the 
ordinary income tax rate is raised, that number gets to be even 
higher. If you do it via dividends, we are going to see an 
effective tax rate in January on a dollar earned--63 percent. 
Nobody that I know of in the economics profession thinks that 
that would be an optimal situation.
    And the one point of agreement on this panel was that even 
if you raised the ordinary rate--excuse me, even if you raise 
the capital gains rate, it should be used to reduce the 
ordinary rate, because you have an interaction between the 
ordinary rate on taxation of income and capital gains rate that 
is very pernicious and comes right out of the cash flow of 
businesses. And I would strongly urge you to look at the rate 
in a comprehensive fashion.
    Chairman CAMP. I have a question for you and for Mr. Burman 
and for Mr. Verrill, if you could answer quickly. At one point, 
Congress had modified the capital gains so that investments 
held for less than a year had ordinary income, investments held 
for 1 to 5 years had a 25 percent rate and more than 5 years at 
an 18 percent. If you could, each of you, comment just on what 
the economic and tax policy considerations might be in multiple 
holding periods and rewarding what some people call patient 
capital, I would be interested in your views on that issue.
    Mr. LINDSEY. I think, as with most things in this area, 
that solves one problem and creates another. The problem that 
it creates is complexity. Capital gains, it is half the Tax 
Code. It also takes a lot of time to do your taxes right on it.
    You know, I was listening to his testimony, and I think 
there is another way of solving the problem of Angel investors, 
and that has to do with the limitation that we have on capital 
losses being applied to other income. I mean, the great risk to 
me as a prospective Angel investor is that I lose money on some 
investments, and if I happen to lose, the government washes its 
hands of me; it is no longer a partner with me. If I happen to 
make money, the government wants to come in and be a full 
partner with me. That is unfair. It is inefficient, and I think 
that that is a better remedy to pursue with regard to Angel 
investing than manipulating the rate.
    Chairman CAMP. Mr. Burman, quickly, I know we are running 
out of time here.
    Mr. BURMAN. The taxation on capital gains on realization 
already provides lower effective tax rates on long-held assets. 
Basically, you get to defer the tax, which is as valuable 
benefit. My former boss Bob Rubin liked the idea behind the 18 
percent rate for assets held 5 years or longer. I disagreed 
with him. I thought that we should actually be striving more 
toward neutrality.
    I also could say something about losses if you are 
interested because I think the issue is more complex.
    Chairman CAMP. All right. Thank you.
    Mr. Verrill.
    Mr. VERRILL. I think 1202 is the right direction. I don't 
think adding any phasing of years to it would help us because 
we simply don't know the term which we will own these equities; 
1202 could be made better. The holding period could be made 
less in general, from 5 to 2 years. The rollover period could 
be made longer. This isn't a mortgage transaction; this is a 
company. So I think 1202 really goes to solving that problem if 
we tweak it a bit.
    Chairman CAMP. All right. Thank you.
    Senator BAUCUS. Senator Hatch.
    Senator HATCH. Let me ask a question for Dr. Lindsey.
    A popular talking point on capital gains is the revenue 
maximizing rate. That is the tax rate on capital gains that 
will bring in the maximum amount of revenue to the Federal 
Government.
    But in your testimony, you believe too much attention is 
paid to the revenue maximizing rate, and the focus should be on 
the optimal or efficient rate of taxation, which is well below 
the revenue maximizing rate. Would you please comment on why 
the focus should be on the optimal or efficient rate of 
taxation and where that rate should be today and where you 
would see that rate if the top corporate and individual tax 
rates were reduced to 25 percent?
    Mr. LINDSEY. Certainly, Senator, I think it is an important 
point. I am going to try and convert the words ``revenue 
maximizing rate'' into English. What it really means is the 
government is soaking you for as much as they can possibly 
squeeze out of you without regard to what it does to your 
business.
    So at the revenue maximizing rate, or beyond the revenue 
maximizing rate, the government is losing and the individual 
firm is losing. At the revenue maximizing rate they are just 
squeezing you for as much as possible, but that doesn't mean 
that it is best in society's interest. You only want to be at 
the revenue maximizing rate if all you care about is the 
government and you don't care at all about the private sector.
    If you take the standard assumptions we are using now, that 
even the Joint Tax Committee uses, and apply the loss to the 
private sector, to pull a dollar of revenue into the public 
sector, we are talking about $2.50 to $3 per dollar revenue. In 
other words, you are harming somebody out there by $2.50 or 
more just to collect another dollar by raising the tax rate.
    To me, that is not a cost-effective way of looking at 
taxation; and I do think you have to take into account the cost 
to the private sector, the dead-weight loss, the other 
efficiency costs, and not just try and get as much revenue as 
you can.
    Senator HATCH. Well, let me ask this next question to Mr. 
Verrill.
    As I stated in my opening statement, with the scheduled 
expiration of the Bush tax cuts at the end of this year, 
capital gains will be subject to a 23.8 percent tax beginning 
in 2013--a whopping 59 percent increase from current law. Now 
how would such an increase in the capital gains tax affect 
angel investment in early-stage companies, companies that in 
many cases are highly dependent upon such funding?
    Mr. VERRILL. I think the uncertainty of that is going to 
create a lot of people that sit on the sidelines and sit on 
their money. I think that fewer people will be contemplating 
investments early in the new year, and I think that will have a 
cascading effect on the number of companies started, the number 
of jobs created. I think we need to figure this out before the 
new tax year and give people solid ground on how they are going 
to be taxed. Even though it is a tax on the return, I think it 
will influence negatively the number of investments that people 
make early in 2013.
    Senator HATCH. Well, thank you.
    Thank you, Mr. Chairman.
    Chairman CAMP. Thank you.
    Mr. Levin is recognized.
    Mr. LEVIN. Thank you.
    Well, I think this has been so far a very sobering hearing, 
and I am glad we are holding it. Because I think there are a 
couple of lessons to be drawn. One is that we need to be 
optimistic but realistic; and, number two, I think we need to 
have much less talk about targets and more discussion about 
trade-offs. Because I think the testimony of several of you has 
very much underlined the need for us to talk about trade-offs.
    You know, I, some years ago, proposed some amendments to 
1202, and I guess the law now reflects the changes. But, again, 
if we are realistic, we wrestled with how we approached it; and 
it is a very limited and carefully crafted, up to a point, 
provision and doesn't affect most investment. And so I go back 
to the issue of trade-off and also the issue of equity.
    Mr. Verrill, as I said, 71 percent of the benefit of the 
preferential rate on capital gains goes to those making more 
than $1 million a year, according to Joint Tax. Do you have any 
idea as to how that would apply to angels? How much are we 
talking about in terms of the capital gains tax? Do you have 
any idea? I mean, you want to differentiate between angels and 
venture capitalists. What portion of this 71 percent is 
represented by angels? Would you know?
    Mr. VERRILL. Well, first of all, angels are sympathetic to 
venture capitalists because they are the ones who fund a 
relatively high percentage of our companies. In my portfolio, 
about three-quarters of the companies are funded by VCs. So we 
are important components to the value chain.
    The Kauffman Foundation did a study a couple of years ago 
that tried to get at the effect of an increase in the amount of 
income or investable capital on accreditation; and, 
surprisingly, it pointed out that something on the order of 
half of angel investors are not in the one percentile of 
income, that many of them are certainly accredited investors 
but investing significant amounts of their available capital.
    I don't have a figure for you. I apologize.
    Mr. LEVIN. Okay, I guess my time is up. Thank you.
    Senator BAUCUS [presiding]. All right. Next, Mr. Wyden.
    Senator WYDEN. Thank you very much, Mr. Chairman.
    A question for you, Dr. Burman. You and Mr. Brockway are 
really some of the heroes of the 1986 reform effort, and we 
dealing are some of the same challenges now. I wanted to ask 
you about a particular approach that might help to bring people 
together.
    We have heard again this morning that conservatives want to 
keep rates down, and progressives want to ensure fairness. And 
it seems to me that one of the ideas you are suggesting, Dr. 
Burman, the idea of an exclusion for capital gains, could 
achieve both. And let me just ask you about some math that we 
ran.
    If you, for example, had a 35 percent exclusion from 
capital gains and you were in a 15 percent bracket, that would 
result in an effective capital gains rate of about 9.75 
percent. That same exclusion in a 25 percent bracket would 
result in an effective rate of a little over 16 percent. So you 
could then say that there would be lower rates for capital 
gains and ordinary income rates, but you would also say there 
would be graduated rates so that those who earn most of their 
income from capital gains would pay higher rates.
    Wouldn't this kind of idea give us an opportunity to bridge 
the gap, much like what was done in 1986, so that conservatives 
would have a path for lower rates for capital income but 
progressives could see that there would be a clearly outlined 
fairness in tax reform?
    Mr. BURMAN. Mr. Wyden, as you know, I am a big admirer of 
yours because you worked tirelessly to try to advance 
bipartisan tax reform through your career.
    If there is a lower rate for capital gains, I think it 
would make a lot more sense to return to an exclusion, which 
was done for most of the history of the income tax until the 
1986 act. You are right that it would produce some more 
progressivity in the taxation of capital gains.
    The other thing is the current alternative rates are 
extremely complex. There is a 37-line work sheet----
    Senator WYDEN. A 37-line work sheet.
    Mr. BURMAN. Basically, it is like an alternative maximum 
tax on capital gains. I don't know that anybody still does 
their taxes by hand, but if they do you would probably hear 
screams from them in the middle of the night when they get to 
line 28.
    So I think it would be a good idea to restore an exclusion.
    Senator WYDEN. Thank you.
    Mr. Brockway, you want to chime in on that?
    I understand that some are going to favor as their first 
choice making ordinary income and capital gains essentially the 
same. I think that is going to be a real challenge in terms of 
creating a bipartisan approach again--and last couple of 
seconds, perhaps, for you, Mr. Brockway.
    Mr. BROCKWAY. Well, I don't have access to the estimating 
process anymore, so I am just going to speculate on this.
    If you are going to have a preference, I would probably say 
exclusion would be somewhat better. But I would have thought 
that most of the capital gain income is for taxpayers in the 
highest-income brackets, so I am not sure it would have a 
significant effect. There would be some people in lower-income 
brackets that would have substantial capital gains, but I don't 
think that the aggregate amount of capital gains for that group 
would be a large portion of the money.
    The comments I have been making about where I think you are 
going to be forced to be, as opposed to where you want to be 
and maybe what policy would lead you to be, is simply that, in 
constructing a reform package with a top rate at that level, 
and if you stay revenue neutral with current law or current 
policy, either one, as your baseline for the top-income class, 
the top 10 percent, and certainly if you get narrower than 
that, there aren't enough base broadeners out there that will 
pay for the rate cut to get into the 20s, other than attacking 
capital gains. There may be ones that I am not aware of, but 
certainly I don't think you are going to find enough in the tax 
expenditure budget. You are going to have to do something else. 
That is why I am saying that you have to----
    Senator WYDEN. My time is way up. I was just thinking about 
seniors on limited incomes who might have some stock and that 
kind of thing.
    Thank you for courtesy, Mr. Chairman.
    Chairman CAMP [presiding]. Thank you.
    Mr. Herger is recognized.
    Mr. HERGER. Thank you, Chairman Camp.
    In 2003, Congress tied capital gains and dividend rates 
together creating parity between gross stocks and dividend-
paying stocks. The Obama administration's latest budget calls 
for untying these two rates and allowing the rate on dividends 
to rise to 43.4 percent, while the top rate on capital gains 
would be 23.8. I would like to get each of your thoughts on 
this proposal. How would a nearly 20 percentage point disparity 
between the capital gains and dividend rates affect investment 
decisions? Mr. Brockway.
    Mr. BROCKWAY. Well, I guess I tend to be a skeptic on all 
of this. The country at times has had vastly different rates 
for capital gains and ordinary income, and also has had times 
where the rates were similar. I don't know that the economy 
performed better in one situation than in the other. So I am 
reluctant to say whether you had a large differential or you 
had the same rate. that it would have a significant impact on 
the overall performance of the economy. I think the overall 
performance of the economy is far too complex to ascribe a 
substantial difference based on the taxation of capital gains 
versus other income.
    Mr. LINDSEY. Just to show you how old I am--I was going to 
do the calculation--I think it was 25 years ago I wrote a paper 
with Professor Bolster at Northeastern University, the chairman 
of the Finance Department Business School there, that looked at 
the effect on the stock market after the reverse story was done 
in 1986. And while I agree that it would have a very complex 
effect on the economy, there is no question it would lead to a 
liquidation of dividend-paying stocks and a reallocation into 
capital-gains-paying stocks.
    Mr. BURMAN. My impression actually is that President 
Obama's budget would tax dividends at a 20 percent rate, but 
the substantive question is about what it would mean to tax 
dividends the same as other income.
    First, I think most economists think that some kind of 
integration would make sense, providing a credit for taxes paid 
to company level. The lower tax rate on dividends and capital 
gains is too much for some stocks, and some companies don't pay 
any tax at all, and too little for others.
    The overall economic effects probably would be smaller than 
you would think. If you actually look at the response to the 
cut in dividend rates in 2003, there was a short-lived surge in 
dividend payments. Basically, companies that intended to pay 
dividends over time sped those up. But the long-term effect, 
according to evidence from research at the Federal Reserve and 
others, was actually pretty modest. So it is not clear that it 
would have a very large overall economic effect.
    Mr. VERRILL. I think the point was made toward public 
equities. If you look in the private space where angels make 
their investments, a miniscule amount of investments use a 
dividend or royalty based model to pay back the investors, so 
ACA has no position on it.
    Mr. STANFILL. And I think I would resort to simplicity, as 
I said in my testimony, taxing all income at the same rate.
    Mr. HERGER. Thank you.
    Chairman CAMP. Thank you.
    Mr. Neal is recognized.
    Mr. NEAL. Thank you, Mr. Chairman.
    Mr. Burman, you recently wrote an op-ed for the New York 
Times titled, ``The Buffett Rule: Right Goal, Wrong Tool.'' In 
the article you argue that instead of enacting the so-called 
Buffett Rule, which has drawn considerable attention in 
Congress, you would require Americans with incomes over $2 
million to pay an income tax rate of at least 30 percent. And 
some of the defects that we are currently arguing over 
certainly have--I think legitimately would allow those to 
dispute tax rates. And, at the same time, Mr. Buffett has 
suggested that, in terms of consequence, he should not be 
paying at a lower rate than his secretary. Do you want to 
elaborate on this point and how Congress in your judgment 
should address the inequity of very wealthy paying at a 
relatively low rate?
    Mr. BURMAN. Sure, thank you for the question.
    My reaction to the Buffett Rule comes from the fact that I 
actually spent a lot of time working on the alternative minimum 
tax, which was originally intended to make sure millionaires, 
people earning over $200,000 in 1969, equivalent to $1 million 
now, paid some tax. It was originally targeted at very high-
income people, it was poorly designed to begin with, it mutated 
and morphed over time, and now I pay it, and I take that really 
personally. I am not a millionaire.
    I don't like alternative taxes. The problem with the AMT in 
the first place was that if there are some loopholes the rich 
people are taking advantage of that are unwarranted, you should 
get rid of the loopholes.
    The reason that Warren Buffett pays a lower tax rate than 
his assistant is that he earns almost all of his income in the 
form of capital gains, and it is taxed at a 15 percent rate. If 
you want to fix that problem, the thing to do would be to tax 
capital gains as ordinary income, or at least at higher rates. 
If you think it should be a 30 percent rate, then capital gains 
tax rates should be up close to that. And narrowing the 
difference between ordinary income and capital gains makes that 
more viable as well.
    Mr. NEAL. Just a note based on your discussion of the AMT. 
As you know, I spent a lot of time on this for a long, long 
part of my career, but with some interest. When we get done, as 
we surely will be patching AMT again, we will then have been 
north of $600 billion in patches.
    Mr. BURMAN. Yeah.
    Mr. NEAL. And I think it speaks to the ineffectiveness that 
some of us define common ground on an issue like that that we 
should be able and should have been able to address a long time 
ago.
    Mr. Lindsey, in your testimony, you suggested that limiting 
the favorable tax treatment of debt relative to equity will 
produce a better tax system. We certainly heard a lot about the 
bias in the Code in favor of debt-financed investment relative 
to equity financed investment. Can you explain how you think 
we, in Congress, should limit the favorable tax treatment of 
debt relative to equity?
    Mr. LINDSEY. I am about to make myself very unpopular.
    I think that the conversation----
    Mr. NEAL. You are talking to a group that is not exactly 
held in highest regard by----
    Mr. LINDSEY. I think all of the discussion that is 
happening here, the fact that we have 20,000 pages on capital 
gains, points up to the fact that we have reached the end of 
the road with regard to income as the base of taxation. There 
are a long range of distortions that we have, including an 
unfavorable trade consequence to this country by the fact that 
we use income-based taxation. It is a mistake. We should get 
rid of all of this by moving towards a cash-flow-based 
taxation. All of the questions of neutrality, all of the 
arguments of tax this or that would be solved by doing that, as 
would the difference in the tax treatment of debt and equity; 
and that would be the direction I would urge you to go.
    Mr. NEAL. Thank you, Mr. Chairman.
    Chairman CAMP. Thank you.
    Mr. Johnson is recognized.
    Mr. JOHNSON. Thank you, Mr. Chairman.
    I think an important, but perhaps overlooked issue that we 
should bear in mind, as we look at tax reform, is the role the 
Joint Committee on Taxation plays with respect to its revenue 
estimates which are based on how it analyzes tax changes.
    You may be familiar with the July 21st Wall Street Journal 
editorial, ``Washington's Tax Oracles.'' That editorial calls 
into account JCT's complete revenue myths with respect to the 
2003 capital gains tax cut. Bottom line, instead of costing the 
Government revenue, the capital gains tax cut generated tax 
revenue, significantly higher revenue, I think.
    As we seek to do reform, it is critically important we can 
rely on the revenue estimates from JCT. Given your experience 
with the last major reform effort, as JCT's chief, you no doubt 
can appreciate the importance of getting revenue estimates 
right, Mr. Brockway. And, with that, don't you believe there is 
a need--indeed a need for dynamic impact when it comes to lower 
capital gains taxes? In other words, don't you believe the 2003 
capital gains tax cut can have a positive macroeconomic impact, 
that such a tax cut can also generate greater tax revenues, not 
revenue losses?
    What are your thoughts, please?
    Mr. BROCKWAY. Well, I have no doubt that----
    Chairman CAMP. Is your microphone on?
    Mr. BROCKWAY. Hopefully.
    I have no doubt that changes in the Tax Code can have some 
economic effects. I think it is a political issue, not a 
scientific issue, as to what that economic effect will be. I 
don't think the staffs should be delegated the responsibility 
to decide. If you all think that enacting a certain provision 
is going to expand the size of the economy, then I think you 
should decide to do it.
    I don't think there is consensus on the question of whether 
or not tax reform, whether or not a particular tax cut will 
expand the economy. The fact of matter is the the economy grew 
after the 1982 Act, which was the biggest peacetime tax 
increase in history. That helped turn around a very difficult 
situation. We were in dire economic straits. We also had a big 
tax increase in 1983, and another big tax increase in 1984. 
These are the largest tax increases outside wartime in the 
country's history, and the economy grew.
    So I am not sure what to make of these arguments. I am not 
sure whether the Wall Street Journal is just saying post hoc 
ergo propter hoc, that, yes, the economy expanded in the 1990s 
following a capital gains rate cut. Whether it is because of 
the cut in the tax rate on capital gains, I don't know. Someone 
may know, and the Journal may know.
    But all I do know is that you will have a very difficult 
time if you put on the staff the responsibility to make it what 
is essentially a political decision. I don't think you want to 
do that. This is something that you all have to decide.
    If you think that what you are doing will expand the 
economy, then say, look, this is what we think it will expand 
the economy by, and staff can produce numbers that are 
consistent with that. I don't think that they are competent--
either JCT or CBO--to make that decision.
    Mr. JOHNSON. Thank you.
    Chairman CAMP. Thank you.
    Mr. Pascrell is recognized.
    Mr. PASCRELL. You have been in the business 40 years, and 
your expertise is the reason why you are here. Are you familiar 
with the report that came out just a few days ago, ``Taxes and 
the Economy: An Economic Analysis of the Top Tax Rates Since 
1945?'' It is put out by the Congressional Research Service, 
Thomas Hungerford, a specialist in public finance. Are you 
familiar with that, sir?
    Mr. STANFILL. No, sir, I am not.
    Mr. PASCRELL. Well, now I would like your opinion on it, 
because this is what it says: ``Advocates of lower tax rates 
argue that reduced rates would increase economic growth, 
increase saving and investment, and boost productivity.'' In 
other words, increase the economic pie. ``Proponents of higher 
tax rates argue that higher tax revenues are necessary for debt 
reduction.'' You have heard that many times. ``The tax rates on 
the rich are too low and violate the Buffett Rule.'' And you 
have heard that today. ``And the higher tax rates on the rich 
would moderate increasing income inequality.'' In other words, 
change how that economic pie is that is distributed. I am not 
afraid of that word.
    But it says this: ``There is not conclusive evidence to 
substantiate a clear relationship between the 65-year steady 
reduction in the top tax rates and economic growth. Analysis of 
such data suggests the reduction in the top tax rate reductions 
appear to be associated with the increasing concentration of 
income at the top of the income distribution. The evidence does 
not suggest, necessarily, a relationship between tax policy 
with regard to the top tax rates and the size of the economic 
pie, but there may be a relationship to how the economic pie is 
sliced.''
    What is your opinion on that?
    Mr. STANFILL. Well, to the extent I remember the question, 
I think I would default to fairness in tax matters. I think 
that in a broader sense what is needed is a Marshall Plan for 
the middle class. I think what we have had is a Marshall Plan 
for the top 1 or 2 percent; and I think, therefore, that 
fairness, as you move through tax reform, has to have an 
important place in your proceedings.
    Mr. PASCRELL. In the comparing of taxing income and taxing 
assets--and there has been a shift over the last 30 or 40 
years--where does the burden fall when that shift took place 
and up until this point in taxing income and assets 
differently? Where is the algebra here in terms of where does 
the major burden fall? On the shoulders of those holding assets 
or those that still depend mainly on income?
    Chairman CAMP. And if you could answer briefly, because we 
are over time.
    Mr. STANFILL. Yes, indeed.
    Well, I am one of those--I am not in--I am one of those 
whose assistant pays a higher rate than I do. So I think the 
burden has fallen on my assistant more heavily than it has 
fallen on me.
    Mr. PASCRELL. Thank you very much.
    Chairman CAMP. Thank you.
    Mr. Reichert is recognized.
    Mr. REICHERT. Thank you, Mr. Chairman.
    Let me ask a question. I want to focus a little bit on jobs 
and how this whole tax discussion affects job creation. So, Dr. 
Burman, in your testimony, you talked about how raising the 
capital gains tax in order to lower the income tax rates could 
help to create jobs in the United States. And I know that some 
of my colleagues would have concerns that raising the capital 
gains rate could discourage investment. Could you tell me and 
the panel here a little more about your theory, and do you have 
any rebuttal for those who worry that raising the capital gains 
rate would discourage investment?
    Mr. BURMAN. Thank you for the question.
    The basic point is that that differential between capital 
gains tax rates and ordinary income rates produces an enormous 
amount of unproductive activity that actually makes the economy 
work more poorly than it would. One argument people make for a 
lower capital gains tax rate is that it encourages 
entrepreneurship. But if you actually look at the incentives to 
start your own business, even if the capital gains are fully 
taxed you have a very strong incentive to invest your own 
labor, your sweat equity into the business. It is kind of like 
an IRA, you save payroll taxes as well as income taxes on the 
contributions of your own labor, and that is a strong 
incentive.
    The main thing, and I think what most economists believe, 
although there is obviously some disagreement about how best to 
achieve this, is that, to the extent you can, the tax system 
ought to be relatively neutral. We shouldn't be picking winners 
and losers. We shouldn't be favoring angel investors over other 
kinds of investors who are investing in other kinds of 
activities. When the capital gains tax break favors particular 
kinds of investments over others, it provides a very strong 
incentive for inefficient tax shelters.
    Mr. REICHERT. Anyone on the panel wish to comment further?
    Mr. VERRILL. I will, if you don't mind. I thank you for the 
question.
    Mr. REICHERT. Your name was mentioned.
    Mr. VERRILL. I think the brush is too broad that Mr. Burman 
paints, and I think there is real economic value in efficient 
use of capital and energy and expertise in the angel domain. 
And certainly entrepreneurs put sweat equity into a company. 
They ultimately will generate some tremendous wealth out of 
that in a perfect world and they will give back. They will 
purchase products and services. Those companies will grow. 
Their salaries will become more market-oriented. And I think, 
all-encapsulated, it is a much better economic analysis than 
simply a broad stroke of a brush.
    Mr. REICHERT. Thank you, Mr. Chairman. My time is expired.
    Chairman CAMP. Thank you.
    Mr. Larson is recognized.
    Mr. LARSON. Thank you very much, Mr. Chairman.
    Chairman CAMP. Your microphone.
    Mr. LARSON. Thank you, Mr. Chairman, and I want to thank 
all of the panelists.
    Mr. Lindsey, you said something very intriguing when you 
said this is going to be unpopular for me to say this, but I 
think that our revenue should be more cash-flow based. What did 
you mean by that?
    Mr. LINDSEY. There is a saying on Wall Street that cash is 
a fact and income is an opinion. And right now--and that is--
actually, you know, if you think about the typical business, 
right now, the Securities & Exchange Commission has one 
definition of income. Generally Accepted Accounting Principles 
have another definition of income. The IRS has another 
definition of income for purposes of the corporate income tax. 
They have a different definition of income for purposes of the 
payroll tax and a different definition of income for the income 
tax. So the government is now telling businesses that they need 
to keep five sets of books.
    Well, that can't possibly be a good outcome, and that is 
why I think in the end we are going to have to move away from 
income-based taxation towards a cash-flow-based taxation. And, 
again, I know this is a curse word here, but, ultimately, I 
think Congress is going to be abandoning income taxation and 
moving to value-added-based taxation.
    Mr. LARSON. Would you describe cash-flow-based as 
transaction taxes?
    Mr. LINDSEY. Well, I would call it a net transaction tax, 
yes. So that----
    Mr. LARSON. Right. A net or, you know, a broad transaction 
tax, not transaction on a specific industry.
    Mr. LINDSEY. Correct, and where you would pay tax only on 
the transaction that--in other words, you would get--if I hired 
my colleague here, he would pay a transaction tax.
    Mr. LARSON. How would that differ in many respects to what 
Mr. Stanfill's point--and I would like to see how people would 
have reacted to that when he says, let's let the marketplace 
set it and let's go through--eliminate all of the tax breaks 
that are there, and whether it is royalties, whether it is--how 
would you look at those two intersections and is there an 
intersection or an apex in which that could happen?
    Do you follow what I am saying? Mr. Stanfill's proposal I 
believe at the end was, whether it is wages, dividends, capital 
gains, royalties alike, end the preferences, close the 
loopholes, eliminate most, if not all, and add a dash of 
progressivity. How would you respond to that?
    Mr. LINDSEY. That would actually accomplish what he said.
    Mr. LARSON. Do you agree with that, Mr. Stanfill?
    Mr. STANFILL. I think I do.
    Mr. LARSON. Yeah. Thank you.
    Chairman CAMP. Thank you.
    Dr. Boustany, is recognized.
    Mr. BOUSTANY. Thank you, Mr. Chairman.
    Mr. Brockway, I want to examine the kinds of assets that 
should be treated as capital assets consistent with policy 
rationale for a preferential capital gains rate. In your 
testimony you suggest that the current definition of a capital 
asset in the Tax Code perhaps is not entirely consistent with 
the policy reasons behind a lower capital gains rate. So can 
you elaborate on that some and maybe provide a current example 
of a particular asset or capital asset that we should review in 
this regard?
    Mr. BROCKWAY. Well, I mean, obviously----
    Chairman CAMP. Your microphone, please.
    Mr. BROCKWAY. You all have had a fair amount of discussion 
about carried interests, so I am not going to be able to say 
anything here that is going to educate you further on that 
subject matter. But, obviously, you are considering as what is 
the appropriate rate there--does income from gains on carried 
interests deserve taxation at capital gains rates or ordinary 
income rates?
    But let me give you a simple example, land. There is a 
finite amount of land in the United States, more or less. I 
guess that we created some more with the fill from the 
excavation to build this visitors center, but, as a general 
proposition, there is a finite amount of land. So whatever you 
do with the capital gains rate there is going to be that amount 
of land. The fact of the matter is, however, that you have a 
preferential rate for transactions in land.
    So it is not about economic growth. It is not about jobs or 
anything else. It is just you happen to have the preferential 
rate because you invested in land.
    I am not saying it is good or bad. I am just saying, stand 
back, ask yourself, why do we think it is important to have 
this difference in treatment and does it make sense in that 
context?
    And I can look at a question that I think has been picked 
up in the testimony already, if you are concerned about the 
double tax on corporate investments, which I think is something 
serious to think about, perhaps the appropriate way to think 
about that is integration of the individual and corporate tax 
regimes. The plain fact of the matter is that I make my living 
by the fact that corporations do not effectively pay tax at a 
35 percent rate. You have to separate between what the Code 
says is the top marginal rate and what actually happens before 
determining whether there is a double tax and how it should 
best be addressed.
    Another thing you can think about is what Professor Burman 
has been discussing about the benefits of deferring 
realization. At some level, you may want to think about 
expanding the existing marking-to-market and loss 
capitalization regimes. You have to think about something in 
that regard if you are going to expand the ability to deduct 
current losses on capital assets. You have to think seriously 
about capitalizing loss regimes so you don't get a substantial 
amount of arbitrage.
    The staff can do a lot of thinking technically about your 
question and make some proposals. I am not saying that, for 
example, that taxing gains on farmland at ordinary income rates 
is going to be particularly popular. It is just something to 
think about. You are not going to get more farmland, whatever 
you do with the capital gains rate.
    Mr. BOUSTANY. Thank you.
    I see my time is expired. Thank you, Mr. Chairman.
    Chairman CAMP. Thank you.
    Mr. Rangel is recognized.
    Mr. RANGEL. Thank you so much.
    I know we are concentrating really on capital gains, but 
having experienced the 1986 tax reform and thinking at that 
time that it was partisan and it was rough, I had no idea that 
the Congress could really get to the stage that we are today, 
where even allowing the President to be able to adjust the debt 
ceiling became a partisan issue.
    Having said that, I was talking to Senator Wyden to say 
that before we concentrate on this we have to get some sense of 
civility that the parties really want to talk. And I assume 
that all of you are wishing, if you don't believe, that after 
the election there will be a better sense of responsibility 
that Republicans and Democrats have to the economy and to the 
country.
    Having said that, I don't think we will ever get away from 
the fact that everyone wants reform as long as it doesn't 
adversely affect them; and the question of a mortgage and 
charitable contributions and local and State taxes would remain 
an issue. But can anyone tell me before my time runs out 
exactly why religious institutions are exempt from taxes on 
income that they receive? I mean, we just accept it, but does 
anyone just--it shouldn't be something you have to----
    No? Because I had thought it was because they provided the 
glue in terms of moral responsibility, that gap between 
capitalism that should work to make money and that bridge 
between government that should provide for the poor and the 
vulnerable. And they play absolutely no role in the budget that 
we are dealing with today as the institution. They play no role 
as relates to peace and war. They play no role as to which 
countries we bomb. Their voices are not heard except perhaps on 
same-sex marriage. But I assume none of you believe that we 
would ever contemplate of even considering taxing religious 
institutions. That is correct, right?
    Having said that, do you think that there is an area that 
we could go into local and State taxes and have that not 
deductible? Is that one of these third rails that we could get 
over if we were talking to each other?
    Mr. Burman, you remember in 1986 the problem we had with 
that. At least I do.
    Mr. BROCKWAY. I think the question about religious 
institutions generally is a policy issue. I don't really think 
it is something that is an economic issue that tax experts can 
speak to.
    Mr. RANGEL. I don't understand. I would assume there is 
trillions of dollars out there if we looked at it as a tax 
issue. I know politically----
    Mr. BROCKWAY. But, Mr. Rangel, I think they generally 
operate as charitable institutions. They are nonprofit, and 
they are performing services but not raising net profit by the 
time you look through their books. To the extent they are 
running businesses, profit-making businesses, I think they are 
already brought into the system.
    On the State and local tax issue, that obviously was a 
critical part of the 1986 discussion, and the bill almost 
cratered precisely over that issue. It comes down in good part 
to being a regional issue. At the end of the day when people 
understand the way that you are thinking about paying for the 
rate cuts is eliminating the deduction for State and local 
income tax, they may think that is a good idea if they live in 
Texas, Florida, or Oregon but not if they live in one of the 
other States that has a higher rate.
    Chairman CAMP. We really are out of time now.
    Mr. RANGEL. We are? I am over?
    Chairman CAMP. You have gone over.
    Mr. RANGEL. Well, okay, Mr. Chairman. Thank you for your 
great contribution in clarifying the religious institution 
issue. I leave a better person. Thank you.
    Chairman CAMP. Thank you.
    Mr. Marchant is recognized.
    Mr. MARCHANT. Thank you, Mr. Chairman.
    For Mr. Lindsey and Brockway, I have been spending my time 
at home with two groups of investors lately, business owners, 
and seniors. When you talk about the tax reform of 1986 and 
talk about the realignment of capital gains rates and dividend 
rates, in 1986, after the reform, there was a significant 
realignment of interest and liquidation in the real estate 
industry; and I wonder if in fact we could approach that 
subject in this tax reform in the time that we are living in 
now, where we have already had a significant amount of 
liquidation and realignment in the real estate industry. I 
think that would be something we have got to talk about.
    Secondly, in 1986, there were options besides dividends for 
those that needed income, and there were less people in 1986 
that depended on income. There were fewer seniors. So if you 
have a significant liquidation and realignment, if you raised 
the dividend rate now, there are no alternatives for income. 
They are not the same alternatives for income that existed in 
1986. I think you could probably get 8 or 10 percent on a long-
term CD.
    So if that significant realignment and liquidation takes 
place, then does it, in fact, actually result in an increased 
tax revenue or does it have a very--does it have a flat effect 
or does have it a negative effect on it?
    And the last thing is that the investors that I talked to 
say at 15 percent they do not spend any time or money on tax 
avoidance exchanges, et cetera. They do the deal, they pay the 
tax, and they go on down the road. They say that there is a 
rate at which they will return to the old behavior of avoiding 
the tax, doing tax free exchanges. And, in fact, if we raise 
that too high, where would the sweet spot be where you would 
not in fact have a decrease in tax revenues?
    I know that is a long question.
    Mr. BROCKWAY. Well, certainly after the 1986 Act, if I were 
dealing with real estate investors, I would go under an assumed 
name. So I am not arguing that it didn't have an adverse impact 
on that industry.
    But I think where it most significantly had an impact was 
that a substantial part of the financing of real estate was in 
the form of tax shelter arrangements that had created a bubble 
in some real estate prices at that time, but it was because of 
the effective negative tax on real estate investment that was 
in place.
    So, yes, when you change things, there is going to be a 
discontinuity, a disruption in the marketplace, and that is 
inevitable whatever change you make, because the market will 
adjust to whatever current law is. And that is unfortunate, but 
sometimes you just simply have to break a few eggs, if you 
will. How big it would be in this situation, I am not sure.
    For the issue about the elderly who are dependent upon 
dividend income, if your concern is that elderly lower middle 
income taxpayers may be subject to increased tax on their 
retirement income, you can still have comprehensive tax reform 
and meet the design constraints if you provide preferences for 
up to a certain dollar amount. Now I am not advocating that as 
a theoretical matter of tax policy, but if that is what your 
economic and social concerns are, which are very valid, then 
think of those alternatives as well, I guess I would say.
    Chairman CAMP. All right. Thank you. Your time is expired.
    Mr. Reed is recognized.
    Mr. REED. Thank you, Mr. Chairman.
    Mr. Brockway, I want to continue on that conversation. 
Because I try to ask as many practical questions, being a new 
member here.
    I know we spend a lot of time on numbers and rates and 
everything else and how it impacts investors and the theory. 
But when I go back to my family farm or when I go back to my 
senior citizen, I want to learn from your experience in 1986 
when the capital gains rate went up and the impacts it had on 
the markets and those sectors in particular. Is there anything 
you could tell me, having lived that experience, that you could 
give me, as going through the upcoming experience, some 
guidance as to how to lessen the impact on those folks, 
especially the family farmers and the seniors that you were 
just referencing?
    Because, to me, it would seem like there is a potential 
threat here. And a lot of these guys, especially my family 
farmers, they are planning their retirements. A lot of that is 
based on the sale of their inventory, their family farms, and 
that tax bill that is going to be potentially in there. And if 
people are talking about raising the rates to some of the rates 
that I hear being thrown around this town, I am very concerned 
about that.
    So is there a way to transition through that in a practical 
way or is that just not something we can expect to achieve?
    Mr. BROCKWAY. Well, again, it is a matter of what trade-
offs you want to accept, and you can provide benefits up to 
certain income levels if you wish to. If you do move the rate 
of capital gains taxation to, let's say, 25, 30 percent, 
somewhere in that range, it is obviously going to have a 
negative impact on someone who has had a farm for a long time 
in their family and all of a sudden has this very large amount 
of income after 30, 40 years of holding the farm. And they 
thought that revenue was going to be for their retirement, and 
it turns out a lot of it is going to taxes.
    So it is a very difficult problem. I am not sure what you 
do about it at the end of the day. For most investors, for real 
estate investors, for example, their problem was so much the 
capital gains rate increase in 1986; it was the limitations the 
Act put on passive losses. For family farmers, I think a very 
major tax concern has always been the estate tax treatment. It 
is a similar problem for them where there is potentially a very 
large tax being imposed.
    But I do think you have to accept that if you raise the 
rate for capital gains, unless you make some special exception 
that goes against the theme of comprehensive tax reform, you 
will have a difficult problem for certain people.
    I don't think the financial markets minded changing capital 
gains rates at all--nor do I think it was a major burden for 
the real estate markets. I don't think that affected them at 
all, as best as I can tell. But in situations like that of the 
family farm, it may have been significant. In any event, the 
lower rate on capital gains only lasted 5 years, so it 
obviously was of significant concern to some people and you 
will get feedback if you raise the rate. There is no doubt 
about it.
    Mr. REED. Thank you. My time is expired. I yield back.
    Chairman CAMP. Thank you.
    And for our final question, Mr. Smith is recognized.
    Mr. SMITH. In the interest of time, it won't take long.
    I was wondering if you could reflect a little bit in terms 
of investor behavior within the 1031 like-kind exchange and the 
impact that that has had? Anyone on the panel.
    Mr. BROCKWAY. Well, taxpayers certainly use those 
provisions to be able to reinvest in other assets. Whether it 
is in real estate or in autos or leases or whatever else, all 
sorts of businesses use the like-kind provisions because the 
alternative is that they would be required to take a slug of 
their capital away and not reinvest it in their businesses. 
Deferring that tax, at least in terms of immediate cash flow, 
is the same position as not having a tax on that income. So it 
certainly is beneficial to the business. But, again, you have 
to have this choice. If that tax isn't being paid, then where 
is the tax coming from?
    Mr. BURMAN. That is a good example of how taxation of 
capital gains along with other provisions in the Code can 
produce inefficient behavior. I think the idea behind 1031 was 
you trade one kind of business for another and defer the gain. 
But my understanding, which is fairly limited, is that there is 
a whole industry devoted to chains of exchanges that are all 
tax free and go way beyond the original intent of the 
legislation.
    So it does mitigate the sort of cash-flow burden that is 
created by taxation of gain on sale, but it would make sense 
for Congress to think about whether 1031 exchanges are actually 
encouraging a lot of really economically inefficient behavior.
    Mr. SMITH. Thank you. I yield back.
    Chairman CAMP. Thank you.
    I see Mr. Tiberi has arrived. You are recognized.
    Mr. TIBERI. Thank you, Mr. Chairman.
    One question to all of you, if you would try to answer it. 
And it revolves around the short-term impact of raising capital 
gains rates. In July, the Wall Street Journal published an 
article that was entitled: Get Ready for the New Investment 
Tax, in which the author described how taxpayers were beginning 
to react to the 3.8 percent tax that is going to go into effect 
in January of next year.
    One analyst predicted that investors would likely apply--or 
reapply, shift assets into investments that would not be taxed 
at that 3.8 percent tax like the municipal bonds, for instance. 
Others said that they were--another analyst predicted investors 
would accelerate their investments into other options.
    Anecdotally, I can tell you of a family in Columbus, Ohio, 
in my district that has been in the real estate investment 
field for two generations now, going on the third generation, 
and their tax lawyer has told them that they need to get out of 
that business and begin getting out of it quickly, which they 
are.
    So my question to all of you is, what would be the impact 
for taxpayers if we did the same with respect to capital gains? 
Would we see the same sort of reaction on the street from 
investors who would say, I am going to do this because of that?
    Mr. BURMAN. I actually did an article in 1986 where I 
looked at the response of capital gains to the increase in tax 
rates that took effect in 1987, and it would actually be very 
good for the Treasury in the short term. There was a huge surge 
in realizations at the end of 1986, total realizations doubled. 
Realizations on corporate stock, which are the ones that are 
easiest to get rid of, actually increased much faster and there 
was a huge short-term boost in revenues.
    Whether this would actually cause investors to massively 
move out of capital gains assets into others is more 
questionable. If you actually look at the data, there didn't 
seem to be a huge amount of change in the ownership of assets.
    The other thing is whether it has an effect on markets 
overall. Certainly on the stock market the effect would be 
pretty minimal, because even if individual investors decided 
that they wanted to hold less corporate stock, institutional 
investors, pension funds would just pick up the slack.
    Mr. TIBERI. Can we hear from everybody else?
    Mr. VERRILL. Yeah, I will go quickly.
    We don't have the luxury of immediately exiting a public 
stock in order to change the means on which we might be taxed. 
A fellow board member of mine, when asked this precise 
question, said my asset allocation will shift from early-stage 
companies to tax-favored investments, such as municipal bonds. 
For those companies that I do invest in, I will look towards 
safer later-stage companies, further exacerbating the funding 
gap for small companies.
    So I don't have a statistically significant response for 
you, but I suspect if I did take a poll of the 7,000 angel 
investors that represent the ACA, you would have a pretty 
representative sample that would find very significant change 
in their behavior.
    Mr. TIBERI. Thank you.
    Next?
    Mr. STANFILL. I think in my case I would sell a public 
security, which we funded as a venture capital firm, and use 
the proceeds to do more angel investing.
    Mr. TIBERI. The last two.
    Mr. STANFILL. I think I would refer you to Allen Sinai's 
work on this. He estimates that if the cliff were about to go 
over it would result in a 19.8 percent decline in the S&P, and 
I thought it was carefully done. I don't know that it described 
any one number, but it was a carefully done analysis.
    Mr. TIBERI. Thank you.
    Last?
    Mr. BROCKWAY. I don't have a view on what would happen. In 
1986 I am pretty comfortable that there wasn't any drastic 
result from that change. I think everybody thinks the economy 
performed reasonably well after that Act.
    If you simply allow current law to go back to where it was 
in the 1990s, I have no idea what would happen. Obviously, in 
the 1990s, the economy worked well. So my instinct is it is not 
the end of the world, but I am not an economist.
    Mr. TIBERI. All right. Thank you.
    Chairman CAMP. Thank you all very much. I appreciate your 
participation in this hearing and your testimony.
    Senator Baucus, would you like to make any closing remarks?
    Senator BAUCUS. No, just thank you very much. This is one 
of many steps we all are going to take.
    Chairman CAMP. Thank you. Thank you very much. This hearing 
is now adjourned.
    [Whereupon, at 12:03 p.m., the committees were adjourned]
    [Questions For The Record follow:]

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    [Submissions For The Record follow:]
             Alliance for Savings and Investment, statement

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          American Council for Capital Formation 1, statement

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          American Council for Capital Formation 2, statement

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                  Center for Fiscal Equity, statement

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                  Edison Electric Institute, statement

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                Investment Company Institute, statement

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                   US Chamber of Commerce, statement

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