[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
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1. All submissions and supplementary materials must be provided in
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relies on electronic submissions for printing the official hearing
record.
2. Copies of whole documents submitted as exhibit material will not
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3. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental
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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
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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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Alliance for Savings and Investment, statement
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