[Senate Hearing 112-805]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-805

 
                       TAX REFORM: EXAMINING THE 
                     TAXATION OF BUSINESS ENTITIES

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

                                HEARING

                               before the

                          COMMITTEE ON FINANCE
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                             AUGUST 1, 2012

                               __________

                                     
                                     

            Printed for the use of the Committee on Finance




                  U.S. GOVERNMENT PRINTING OFFICE
82-334                    WASHINGTON : 2012
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office, 
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202ï¿½09512ï¿½091800, or 866ï¿½09512ï¿½091800 (toll-free). E-mail, [email protected].  


                          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

                                  (ii)
?



                            C O N T E N T S

                               __________

                           OPENING STATEMENTS

                                                                   Page
Baucus, Hon. Max, a U.S. Senator from Montana, chairman, 
  Committee on Finance...........................................     1
Hatch, Hon. Orrin G., a U.S. Senator from Utah...................     3

                               WITNESSES

LeFrak, Harrison T., vice chairman, The LeFrak Organization, New 
  York, NY.......................................................     4
Trier, Dana L., adjunct professor in taxation, University of 
  Miami School of Law, and lecturer in law, Columbia University 
  Law School, New York, NY.......................................     6
Warren, Alvin C., Ropes and Gray professor of law, Harvard Law 
  School, Cambridge, MA..........................................     8
de Hosson, Fred C., partner, Baker and McKenzie, Amsterdam, The 
  Netherlands....................................................    10

               ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:
    Opening statement............................................     1
    Prepared statement...........................................    33
de Hosson, Fred C.:
    Testimony....................................................    10
    Prepared statement...........................................    35
Hatch, Hon. Orrin G.:
    Opening statement............................................     3
    Prepared statement...........................................    42
LeFrak, Harrison T.:
    Testimony....................................................     4
    Prepared statement...........................................    44
Trier, Dana L.:
    Testimony....................................................     6
    Prepared statement...........................................    49
Warren, Alvin C.:
    Testimony....................................................     8
    Prepared statement...........................................    69

                             Communications

American Capital, Ltd............................................    81
Carrix, Inc......................................................    86
Center for Fiscal Equity.........................................    90
National Association of Manufacturers (NAM)......................    92
National Association of Publicly Traded Partnerships.............    96
Nichols, Thomas J................................................   103

                                 (iii)


                       TAX REFORM: EXAMINING THE 
                     TAXATION OF BUSINESS ENTITIES

                              ----------                              


                       WEDNESDAY, AUGUST 1, 2012

                                       U.S. Senate,
                                      Committee on Finance,
                                                    Washington, DC.
    The hearing was convened, pursuant to notice, at 10:38 
a.m., in room SD-215, Dirksen Senate Office Building, Hon. Max 
Baucus (chairman of the committee) presiding.
    Present: Senators Conrad, Bingaman, Wyden, Menendez, 
Carper, Cardin, Hatch, Crapo, Cornyn, and Thune.
    Also present: Democratic Staff: Lily Batchelder, Chief Tax 
Counsel; Holly Porter, Tax Counsel; and David Hughes, Senior 
Business and Accounting Advisor. Republican Staff: Chris 
Campbell, Staff Director; and Christopher Hanna, Senior Tax 
Policy Advisor.

   OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR FROM 
            MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

    The Chairman. The hearing will come to order.
    Baseball great Babe Ruth once said, ``Yesterday's home runs 
don't win today's games.''
    The same is true in our modern economy. Businesses have to 
be responsive to the changing landscape around them. Today, 
that landscape offers many different pathways to success. For 
example, that success could come through an IPO, private 
investment, or by forming a pass-through.
    For some businesses, the ultimate success is the IPO. This 
is when, after months or years of hard work, a business debuts 
as a publicly traded company. Once believed to be the best 
route forward for growing a business, IPOs are becoming less 
and less common. In the 20-year period from 1980 to the year 
2000, nearly 300 United States companies went public each year. 
In this past decade, the average fell to 90 companies per year.
    Fewer businesses are filing their taxes as C corporations, 
which are taxed separately from their shareholders. That number 
has been falling at a fairly steady pace for the past 25 years, 
from a high of 2.6 million corporations in 1986 to 1.7 million 
in 2009. But even with fewer IPOs and C corporations, the total 
number of businesses has increased steadily over the past 20 
years.
    Why are more and more businesses avoiding stock markets, 
once seen as the pinnacle of business success? Today, a 
business can obtain the capital they need to grow through a 
variety of sources, including private equity, venture capital, 
and private placements. In addition, many businesses may want 
to avoid the higher taxes that come with listing on an 
established stock exchange.
    Today, 95 percent of all U.S. businesses are structured as 
so-called pass-through entities--95 percent--which are 
partnerships, limited liability firms, sole proprietorships, 
and S corporations.
    Originally used primarily by small businesses, recent 
changes in the law have made it easier for medium and large 
businesses to be taxed as pass-throughs and still retain the 
benefits of limited liability. The pass-through structures give 
businesses unique tax incentives that might discourage 
companies from accessing stock markets. Pass-throughs do not 
pay corporate taxes. Their business income is taxed at 
individual income rates.
    However, C corporations get taxed on income, and then, when 
that money is distributed in dividends to shareholders, it is 
taxed again. While a valuable tool for small businesses, we 
should examine if the use of pass-throughs has disrupted the 
playing field for larger non-public companies and their public 
competitors.
    Ideally, our tax code should cause as few distortions in 
business as possible. Businesses should plan and organize based 
on growth and job creation, not on the code. One of my main 
goals of tax reform is to make the system more competitive, but 
also keep it fair.
    Our hearing this morning will examine the difference 
between corporate and pass-through taxation and whether current 
rules strike the right balance in our diverse economy.
    Today, we will explore various proposals to reform our tax 
system, ranging from the idea of creating one business-level 
tax through some method of integration, to proposals to treat 
large pass-throughs as corporations.
    We will also discuss more tailored changes. That could mean 
simplifying the complex ways the tax code treats different 
pass-throughs or simplifying the audit process of large pass-
through entities.
    Many businesses have urged Congress to enact corporate tax 
reform, arguing that the United States is out of step with 
international rates and methods of taxing foreign income. It is 
important for us to compare how all forms of businesses are 
taxed internationally. We will discuss that today as well.
    Recently, I outlined four goals that must be at the heart 
of any tax reform plan. These are the creation of jobs from 
broad-based growth, competitiveness in world markets, 
innovation, and opportunity.
    Whatever changes we make to the corporate tax code must 
result in a more efficient system. We want businesses focusing 
their energy and their resources on growth and on jobs. I look 
forward to discussing these issues today.
    So let us remember that, for entrepreneurs, the American 
dream is to create an idea, build a business, and then watch as 
the hard work and sacrifice turn to success. Let us remember 
Babe Ruth's words, and remember that ``yesterday's home runs 
won't win today's games.'' And let us build a tax code that 
works for today and, I might add, for tomorrow.*
---------------------------------------------------------------------------
    * For more information, see also, ``Selected Issues Relating to 
Choice of Business Entity,'' Joint Committee on Taxation staff report, 
July 27, 2012 (JCX-66-12), https://www.jct.gov/
publications.html?func=startdown&id=4478.
---------------------------------------------------------------------------
    [The prepared statement of Chairman Baucus appears in the 
appendix.]
    The Chairman. Senator Hatch?

           OPENING STATEMENT OF HON. ORRIN G. HATCH, 
                    A U.S. SENATOR FROM UTAH

    Senator Hatch. Thank you, Mr. Chairman. And I want to thank 
our witnesses for appearing here today. We appreciate the time 
that you are spending and the education that you are bringing 
to us. It is a very good thing.
    There seems to be a lot of interest around this country, 
and really around the world, in corporate tax reform, which is 
understandable given that the top U.S. corporate tax rate of 35 
percent is about 10 percentage points higher than the average 
top corporate tax rate of the OECD countries.
    But corporate tax reform should really be viewed as part of 
business tax reform, which is the subject of our hearing today.
    As is well-known to tax scholars and the business 
community, the earnings of a C corporation are taxed once at 
the corporate level and a second time at the shareholder level, 
if the earnings are distributed in the form of a dividend. As a 
result, the earnings of a corporation may be subject to two 
levels of taxation, a system generally referred to as the 
classical system of taxation.
    For many years, the U.S. Treasury Department, the organized 
tax bar, and other interested parties have advanced a number of 
proposals to integrate the individual and corporate level of 
taxes. Now, it makes no sense today to have two levels of 
taxation of corporate earnings. In fact, I am not sure it ever 
made sense to have two levels of taxation, even in the early 
years of our income tax system.
    Earlier this year, President Obama released his framework 
for business tax reform. One of the really bad ideas in there 
was to double-tax certain pass-through entities. Like all bad 
ideas, this one should be rejected.
    All business income, whether earned by a C corporation, a 
large pass-through entity, or a small business, should be 
subject to a single level of tax, either at the entity level or 
at the owner level.
    A big challenge in moving to a tax system in which all 
business income is subject to a single level of tax, which we 
should do, is that such a system may raise less revenue than 
the current system.
    In 2003, Congress enacted preferential tax treatment for 
dividend income, leading to partial integration of the 
individual and corporate level taxes. Next year, an additional 
tax on capital gains and dividends is scheduled to go into 
effect.
    As part of Obamacare, the Democrats enacted a 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. These amounts are not indexed for inflation at all.
    With the scheduled expiration of the 2001 and 2003 tax cuts 
at the end of this year, capital gains will be subject to a 
23.8-percent tax beginning in 2013, a 59-percent increase from 
current law. Dividend income will be subject to a 43.4-percent 
tax in 2013, a 189-percent increase from current law. The 
result would be a return to the classical system of taxing the 
earnings of the corporation, with all the distortions that 
accompany such a system.
    With the top corporate tax rate of 35 percent, coupled with 
an average 4-percent State corporate tax rate, the U.S. has the 
highest corporate tax rate in the developed world. The top 
corporate tax rate should be reduced by at least 10 percentage 
points, to a maximum of 25 percent, which would bring the U.S. 
in close alignment with other OECD countries.
    The top individual rate should also be substantially 
reduced. And having both the corporate and individual tax rates 
at approximately the same percentage, or percentages, coupled 
with corporate integration, will achieve a large measure of 
parity in the taxation of business income, whether earned by a 
corporation, partnership, limited liability company, or sole 
proprietorship.
    In my opinion, we have a great panel of witnesses, and I 
look forward to hearing what all of you have to say, and we 
really appreciate you, again, for being here.
    Thanks, Mr. Chairman.
    [The prepared statement of Senator Hatch appears in the 
appendix.]
    The Chairman. Thank you very much, Senator. I appreciate 
all your work on this committee.
    Let me introduce the panel. The first witness is Mr. 
Harrison LeFrak. Mr. LeFrak is the vice chairman of the LeFrak 
Organization. We appreciate you being here, Mr. LeFrak. Next is 
Mr. Dana Trier. Mr. Trier is an adjunct professor of taxation 
at both the University of Miami and Columbia Law Schools. Our 
third witness is Mr. Alvin Warren. Mr. Warren is the Ropes and 
Gray professor of law at Harvard Law School. The fourth witness 
is Mr. Fred de Hosson. Mr. de Hosson is the managing partner of 
Baker and McKenzie's Amsterdam office.
    Thank you all very much for coming. This is a very 
important hearing. This subject today goes so much to the heart 
of how we resolve all these conflicts; that is, reduce the top 
corporate rate, get rid of a lot of corporate tax expenditures, 
how it affects pass-throughs on the individual side, and how we 
approach taxing business income roughly as equally as possible, 
irrespective of that business's organization, and recognizing, 
too, we want to be more competitive as a country.
    I think is a very important hearing, and we deeply 
appreciate your time devoted to help us and help resolve this 
problem.
    So why don't you begin, Mr. LeFrak?
    As you know, we urge you to speak about 5 minutes, and 
summarize. Your statements will be automatically put in the 
record. But tell us what you think. Time is short, life is 
short. Let us know.
    Thanks.

        STATEMENT OF HARRISON T. LeFRAK, VICE CHAIRMAN, 
             THE LeFRAK ORGANIZATION, NEW YORK, NY

    Mr. LeFrak. Good morning, Chairman Baucus, Ranking Member 
Hatch, and members of the committee. My name is Harrison 
LeFrak. I am vice chairman of the LeFrak Organization.
    I appreciate the opportunity to discuss why maintaining the 
current taxation of pass-through entities is essential for the 
continued health and growth of real estate, oil and gas, 
entrepreneurship, and investment in the United States.
    The LeFrak Organization is comprised of three business 
platforms: real estate development, energy exploration, and 
investments--ground floor investments in the companies of 
tomorrow, as well as securities management and ownership.
    The LeFrak Organization was founded in 1901 and owns an 
extensive portfolio of real property concentrated in the New 
York, Los Angeles, South Florida, and London metropolitan 
areas. The LeFrak Organization and its affiliated companies 
have developed and built a majority of their own portfolio. 
Since the 1980s, affiliates of LeFrak Organization have 
developed Newport, the largest new waterfront community in the 
United States. Newport transformed an abandoned rail yard into 
what is now more than 1 percent of the State of New Jersey's 
gross State product. We have recently begun new projects in 
Miami Beach and North Miami, FL.
    Affiliates of our company have originated and drilled a 
significant number of onshore oil and gas wells in the 
continental United States. We have a very exciting shale oil 
project in Nebraska, which, if successful, will be 
transformative to that State. As a domestic explorer and 
producer, we are doing our small part for America's energy 
independence.
    Affiliates of our company have provided and continue to 
provide strategic capital to entrepreneurs and early-stage 
businesses in technology, financial services, and health care. 
We have invested in numerous start-up companies that have 
created hundreds of jobs. Locations of these companies include 
California, South Florida, Michigan, Texas, and New York. In 
addition, the LeFrak Organization has been an investor in fixed 
income and equity securities, currencies, and commodities.
    Partnerships allow our business to establish discrete 
entities for each enterprise. Each project, building, or oil 
field is in its own partnership. The ownership of each project 
or business reflects the objectives, risk tolerance, and 
liquidity needs of various family members and investors.
    In addition, each partnership provides a discrete way to 
measure the success or failure of outcomes and to limit risk on 
a project-by-project basis. Furthermore, our lenders demand 
separate partnerships for each activity that we undertake that 
they are financing. Lenders want a guarantee that the assets 
they are financing are protected and not subject to third-party 
claims arising from unrelated business activities. Lenders 
demand that the assets are compartmentalized, especially in the 
event of bankruptcy.
    We do not use corporations as investment vehicles to 
conduct our business, because the cumulative rate of taxation 
on our enterprises would be confiscatory. The following example 
illustrates why the use of corporations would be inefficient. 
In 2012, our business is conducted in partnership form, and our 
combined effective tax rate is 51.188 percent. That means more 
than half of our income is devoted to taxes.
    In 2012, if our business were conducted in corporate form 
and all profits were paid as a dividend to enable capital to be 
reinvested, the tax rate would be 64.53 percent, and this does 
not take into account the AMT or PEP/Pease.
    In 2013, under present law, if our business were conducted 
in corporate form, our combined effective tax rate would be 
78.45 percent. We are a family enterprise and invest more than 
95 percent of our business income back into our business 
activities, and this tax proposal would be particularly 
onerous. We also rely on our own capital to fund our business 
activities and do not receive $1 of carried interest income.
    If this proposal becomes law, my family will stop drilling, 
stop building, and stop taking risks. As you can see, we would 
have paid 64.53 percent of our business income as tax. That 
would have meant that we would have had to work 7\1/2\ months a 
year to pay our taxes. In 2013, if we were forced into 
corporate taxation, we would have to work 9\1/2\ months to pay 
our taxes. Add that on top of a 55-percent estate tax, and 
there is little incentive for entrepreneurs like ourselves to 
continue to work.
    The LeFrak Organization employs, directly and indirectly, 
more than 3,000 people. Many of them would lose their jobs. We 
are a blue-collar jobs machine everywhere we invest. The only 
jobs that this proposal would create are for tax lawyers and 
accountants, as this proposal would add incredible complexity 
and enormous effort to our annual tax compliance process.
    A lot of complexity would need to be addressed in 
transition. Are current entities grandfathered? How will 
partnerships address changes in economics that were not part of 
the business when they were formed? What would happen if you 
had UPREITs, DownREITs, different complexity in different 
corporate structures?
    Since Ronald Reagan, the policy of this Congress has been 
to eliminate the double taxation of business income. This 
proposal represents a major step backwards from that policy. It 
would create tremendous incentives for people to invest 
offshore, because Canada, the United Kingdom, and Australia, 
all three countries, do not double-tax partnership income in 
the way proposed. This would be highly anticompetitive for the 
United States and, in my opinion, would be very, very negative 
in terms of creating employment and economic activity.
    Thank you. This concludes my testimony. I am very happy to 
answer any questions you may have.
    [The prepared statement of Mr. LeFrak appears in the 
appendix.]
    The Chairman. Thank you, Mr. LeFrak.
    Next, Mr. Trier?

  STATEMENT OF DANA L. TRIER, ADJUNCT PROFESSOR IN TAXATION, 
    UNIVERSITY OF MIAMI SCHOOL OF LAW, AND LECTURER IN LAW, 
          COLUMBIA UNIVERSITY LAW SCHOOL, NEW YORK, NY

    Mr. Trier. Thank you very much, Mr. Chairman, Senator 
Hatch, and members. Let me summarize my testimony as briefly as 
possible, and I assume we will have a robust discussion of 
specific topics.
    First of all, I come at this subject pretty closely to the 
overall philosophy articulated by Senator Hatch. One level of 
tax, as little distortion as possible, the importance of being 
competitive; but on the other hand, of course, we have to raise 
revenue.
    The difficulty is getting from here to there consistent 
with our revenue needs in this very complex situation we live 
in now. In my testimony, I am not going to concentrate on the 
various integration possibilities. Professor Warren is going to 
concentrate on that. But I thought I would add perspective on 
what I consider three big issues and then a couple of smaller 
issues.
    The first big issue is really, in many ways, raised by the 
opening statements. I think that the action-forcing event, the 
gating issue, that may affect everything is where we come to in 
our initial rate of tax for corporate income. And I am very, 
very much of the view that we ought to at least be considering 
seriously, and working at, as you have been working, getting 
that rate down from 35 percent to a lower rate because of 
competitiveness situations.
    Unlike Ranking Member Hatch, however, in my thinking about 
this, I have to think about whether we end up, through our 
various base-broadening work, at a situation where we have a 
maximum rate at the individual level that is somewhat different 
than at the corporate rate after we have accomplished our 
reform.
    So a major part of my written testimony is dealing with 
that prospect and what are the constraints on that.
    To make the long and short of it, I believe that if the 
disparity became too great, we would go back to a world that I 
was very successful in and very familiar with before the Reagan 
revolution, before the 1980s and the 1990s, in which a type of 
tax planning would be involved, involving the accumulated 
earnings tax and all sorts of complexities. So in my mind, it 
is a step backward rather than a step forward.
    So a gating issue for me is whether our base-broadening is 
used to keep the maximum rates reasonably close, not 
necessarily identical, but within 5, 6, 7 percent. So that is 
my first core question. There has been a lot written about 
that, but I myself am skeptical that the system is rational if 
the maximum rates go back to the larger number.
    The second thing is something that you people tend not to 
concentrate on, but I practiced law for 30 years, the last 20 
years around Wall Street, and I live in a world where we are 
not simply talking about subchapter S corporations, 
partnerships, corporations, et cetera. They did not come to 
Dana Trier to do that. They came to do structures that 
involved, in the same structure, a partnership, a subchapter C 
corporation; many times, subchapter S corporations at the top; 
many times, foreign taxpayers, et cetera. And many of them were 
pass-throughs in that setting.
    So the second big question I have is whether we actually 
understand what is happening in that world, a world that I was 
intimately involved in, but did not necessarily understand the 
full effect of. And in that particular regard, I am convinced 
that, as the committee goes forward in its work, and its staffs 
go forward in their work, in particular, we have to pay 
attention to the growing use of blockers and similar entities, 
those that cut off income.
    I am not suggesting that there is something terrible going 
on so much as suggesting that we do not necessarily understand 
exactly what is going on, and we need to wrap our arms around 
it.
    The third point I would suggest, which I do not deal with 
in tremendous detail here but I think is ultimately a big 
question, is whether we are fully capturing the U.S. business 
income that we should be. And I start with prejudices relating 
back to my years in two Republican administrations that are 
similar to those articulated by Senator Hatch today, in that we 
want one tax, et cetera. But a very important aspect of that is 
to get one tax fully, not for it to be escaping into the 
netherworld of foreign taxpayers or perhaps too much escaping 
to the tax-exempt sector.
    So a major emphasis of my own testimony and thought on this 
question is that, while we are bringing the corporate rates 
down, while we are rationalizing and, in many ways, keeping the 
treatment of pass-throughs, are we assuring that basic level of 
tax? And I might say, harkening back to my period in Treasury, 
late 1980s, early 1990s, we had exactly the same question.
    I have been thinking about this question for 30-some years. 
Nothing really changes. Much of it is in the literature that 
Professor Warren talks about: what is that interface?
    So the only other two topics I discuss I do not think are 
big ones; that is, the treatment of the services companies, the 
service organizations, in which we completely have to capture 
one tax, we have to capture this wage income, but I do not 
think we need to talk about treating big service companies as 
corporations subject to the 2-level tax.
    The other issue is something that I have worked with your 
now former staff members and Chairman Baucus on a few years 
ago, which is the treatment of the publicly traded partnership. 
I do not think that is where the real action is in this. I have 
some points I make in my testimony, but I am actually somewhat 
more satisfied with the current situation than one might 
expect.
    So with that, I thank you, and I look forward to talking 
about this later.
    [The prepared statement of Mr. Trier appears in the 
appendix.]
    The Chairman. Thank you, Mr. Trier, very, very much. That 
is fascinating, provocative even.
    Mr. Warren?

STATEMENT OF ALVIN C. WARREN, ROPES AND GRAY PROFESSOR OF LAW, 
               HARVARD LAW SCHOOL, CAMBRIDGE, MA

    Mr. Warren. Chairman Baucus, Ranking Member Hatch, and 
members of the committee, thank you for inviting me to testify 
today on this challenging and important subject. I would like 
to emphasize three points.
    First, the long-standing U.S. taxation of corporate 
entities and their investors is in need of reform to reduce 
economic distortions. Often called a double-tax system, our tax 
law actually sometimes results in corporate income being taxed 
twice, sometimes once, and sometimes not at all.
    These distortions depend crucially on the relationships 
among four different tax rates: the tax rate on corporate 
income; the tax rate on individual business income; the tax 
rate on corporate distributions, such as dividends; and the tax 
rate on capital gains on the sale of corporate shares. 
Depending on the relationships, business decisions about 
whether to incorporate, whether to finance by debt or equity, 
and whether to retain or distribute earnings can be distorted 
in different ways.
    My second point is that these long-standing distortions in 
the taxation of business entities have been exacerbated in 
recent years by two important developments. The first is the 
dramatic rise in the use of pass-through entities, including 
limited liability companies or LLCs, to conduct business in the 
United States. Pass-through business income, which represented 
less than a quarter of all business income in 1980, is now more 
than 70 percent of such income.
    The other recent development that is important for the 
taxation of business entities has been the growth of private 
equity. Historically, in the United States, business owners 
chose to incorporate in order to receive certain non-tax 
advantages, including limited liability and access to public 
capital markets.
    The tax consequences of such incorporation usually included 
the entity-level Federal income tax. But with the rise of LLCs, 
incorporation is no longer necessary to achieve limited 
liability. With the rise of private equity, incorporation is no 
longer necessary to have access to large pools of capital. 
Incorporation is not even necessary for some publicly traded 
partnerships to tap the public capital markets. These changes 
mean that the boundary between taxable corporations and pass-
through entities should be reconsidered.
    My third and final point is that the foregoing challenges 
are made even more difficult for the committee and the Congress 
by the continuing globalization of the economy. American 
companies and investors receive a growing portion of their 
income from abroad. Foreign companies and individuals continue 
to invest in the U.S. economy.
    As a result, proposed changes in the taxation of business 
entities in the U.S. have to be evaluated in the context of a 
variety of investment patterns. For analytical purposes, 
consider a world in which there are just two categories of 
income: U.S. and foreign; just four categories of entities: 
U.S. corporations, U.S. pass-throughs, foreign corporations, 
and foreign pass-throughs; and three categories of equity 
investors: U.S. taxable investors, U.S. exempt investors, and 
foreign investors.
    In that somewhat simplified world, any change in the 
taxation of entities and their investors will have consequences 
for more than 20 different cases that have to be taken into 
account in evaluating any proposed legislation.
    Given these complexities, how should the committee approach 
the issue of entity taxation? My own view is that economic 
production, distributional fairness, and administrative 
simplicity would all be best served by moving further toward 
the goal of taxing all business income once, but only once. To 
the extent possible, the same tax rate should apply, no matter 
how the business is organized or financed.
    The level of that rate is, of course, a separate question 
from how to structure the taxation of entities to advance the 
goal of neutrality.
    Thank you, again, Mr. Chairman, for inviting me to testify 
today. I look forward to responding to any questions the 
committee might have.
    [The prepared statement of Mr. Warren appears in the 
appendix.]
    The Chairman. Thank you very much, Mr. Warren.
    Mr. de Hosson?

           STATEMENT OF FRED C. de HOSSON, PARTNER, 
         BAKER AND McKENZIE, AMSTERDAM, THE NETHERLANDS

    Mr. de Hosson. Thank you. Good morning, Mr. Chairman, 
Ranking Member Hatch, members of the committee.
    I was asked this morning to address the question of, why 
are Western European countries--if we are talking about Western 
European countries, we are talking about the European Union--
why are member states of the European Union making so much less 
use of the so-called pass-through entities? Because that is for 
sure: they make a lot less use of them.
    Of course, they are used by very small businesses, sole 
proprietors, and what have you. Sometimes professionals are, 
more or less, forced to use partnerships. In my profession, for 
instance, bar rules may require that.
    Every now and then, there are tax incentives like 
depreciation facilitation, which would be useful if you could 
take them through the pass-through entity against your other 
source income. Besides that, what you see in Europe is that 
almost all businesses are incorporated, all medium-sized 
businesses are incorporated, and let me explain why that is.
    First of all, there is the legal certainty that 
incorporation offers in many countries, including my country, 
the Netherlands, where there is a lack of legal personality for 
the partnership. A partnership, as such, cannot have legal 
title to assets. Liabilities are a big issue.
    So there are ways around that, but it is, quite frankly, 
very clumsy if you want to run a medium-sized, let alone a 
larger business.
    The second reason why that is is, simply, it is cheaper to 
have a corporation. Tax-wise, it is cheaper. Since 1992, when 
the single market came along, corporate tax rates have come 
down dramatically. Personal income tax rates, on the other 
hand, less so, and some of them went up. The recent trend, as 
we see in France, is to increase the personal income tax rates 
and leave alone the corporate tax rates. I will come back to 
that later.
    You may say that will result, in the use of a corporation, 
in double taxation. At the end of the day, that is not really 
an issue in Europe. We used to have, as you may know, 
imputation systems, but the European court ruled out almost all 
of these imputation systems because they tend to be 
discriminatory. Either they discriminate against foreign source 
income or they discriminate against foreign shareholders, EU 
shareholders, of course.
    So they are basically gone in Europe, and they have been 
replaced by what you call the classical system. But even if we 
have those classical systems in place, we still have much lower 
corporate income tax rates, certainly much lower than the U.S. 
tax rates.
    We still have the deferral of taxation with personal income 
tax until the moment of distribution. And we have, in most 
countries now, special income tax rates for dividends received 
by the shareholders. In other words, tax-wise, it is much 
cheaper to have a corporation than, let us say, a partnership.
    The third reason I would like to point out to you is the 
very different environment wherein European businesses are 
active. It has to do with the big difference between our two 
economies. The U.S. national market is huge. It is $15 trillion 
GDP in 2012.
    So U.S. businesses can grow for a long time by expanding in 
that market. If you have a business in Houston and you want to 
be closer to your customers in Buffalo, it is very easy to set 
up a business, a plant, in Buffalo.
    The EU market, as such, is even bigger. It was $17 trillion 
in 1992. And it developed from a customs union, original 
customs union, a true single market after 1992. That means that 
besides the customs duties, all sorts of regulatory obstacles 
have been removed. We call that harmonization, and that is 
basically done through what we call directives, legislative 
measures coming from the European Union, approved by the member 
states.
    But there are still sizeable differences among the member 
states, and those differences are in the legal systems and in 
the tax systems of the member states. They are not harmonized 
or are not fully harmonized.
    So a business growing--if I have a business in Amsterdam 
and I want to be closer to my customers in Frankfurt, I have to 
operate in a totally different legal and taxing environment, 
and that means, basically, that I have to use a corporation.
    What we have seen in the last few years, last 10 years, 15 
years, is that the disadvantages of partnerships or pass-
through entities simply increased. Legal issues at the national 
level have been compounded by the impact at other member 
states' levels. Tax characterization of a pass-through entity 
in other member states can be a serious headache. Tax treaties 
do not always solve those problems.
    On the other side, if you take a look at the corporate 
taxation in Europe, there is a certain area, a certain trend to 
harmonize, and that goes through various measures, so to say. 
It goes through the corporate directives. We have the parent-
subsidiary directives, which provide for a zero rate on 
intergroup dividend payments. We have the merger directive, 
which allows corporations to reorganize within the common 
market.
    We also have what we call cold harmonization, which means 
that, within that common market, a lot of tax competition is 
going on to attract investments from other member states. 
Capital is mobile. Persons are not mobile in the European 
Union.
    So there is a lot that you see reflected in the corporate 
tax rates. There is a lot of competition to attract corporate 
investments, which results in reduced corporate tax rates. 
Member states are really competing here. But persons, much less 
than in the United States, are not mobile. They stick to their 
region, to their country, and even to their town. So personal 
income tax rates are much easier for governments to raise than 
corporate tax rates.
    You see that even--I mentioned it in my testimony--you see 
even that the tax competition has resulted in the introduction 
across the Union of territorial systems. Even the U.K. has now 
introduced a territorial system of taxation.
    So, in a relative sense, there is almost no improvement for 
cross-border investment through pass-through entities, and 
there have been dramatic improvements for cross-border 
investments through corporations.
    To come to a conclusion, Mr. Chairman, the use of a 
corporation in Europe is cheaper, it is more certain, that is, 
in domestically and especially international contexts, both in 
legal terms and in tax terms.
    That concludes my testimony.
    [The prepared statement of Mr. de Hosson appears in the 
appendix.]
    The Chairman. Thank you, sir, very much.
    Mr. Trier, you indicated some concern about blockers----
    Mr. Trier. Yes.
    The Chairman [continuing]. And potentially leakage with 
respect to tax-exempt entities and perhaps foreign income. 
Could you just explain a little more precisely how business 
income allocable to a tax-exempt or a foreign investor is able 
to set up a blocker or stopper and escape U.S. tax today? How 
would you address that?
    Mr. Trier. Let me go to basics and, in a sense, go back to 
something that Professor Warren said. Today, a tax-exempt or a 
foreign person could not directly invest in an ongoing business 
that is conducted as a pass-through.
    Why? Because it would be viewed as engaged in trade or 
business. And, as we all know from some other controversies, if 
that underlying entity had that business model, you would have 
the unrelated debt financed income rules.
    So, unless the entity that they are ultimately investing in 
is a corporation, a U.S. corporation--and one thing that I 
would disagree, on the margin, with Professor Warren on is that 
there are quite a few emerging enterprise entities that are 
still in C corporations; a very large number are in pass-
through LLCs, but many are still in corporations.
    So, if they are going to invest in something that is a 
pass-through, they are going to set up a blocker corporation 
somewhere in the chain to deal with that setting. And that 
means that the blocker, hopefully, is subject to full U.S. tax. 
That is kind of the deal, if you will, between the tax-exempt 
and the non-tax-exempt sector, that all business income is 
subject to the income at the corporate level, and then the 
dividends or interest that are paid to the tax-exempt are tax-
free.
    What I am worried about is not that the sky is falling, et 
cetera. It is whether we have fully gotten that deal correct. 
And there are big issues, and there are small issues.
    The big issue has been around forever and is one which I 
spent a lot of time on during my Treasury days. Remember those 
were the LBO days, et cetera. One big issue is whether, if the 
tax-
exempt gets its return from the blocker as debt, is there too 
big an interest deduction at the blocker level, in effect 
pulling out income from the corporate sector and into the tax-
exempt sector?
    Professor Halperin, one of Professor Warren's colleagues, 
many years ago persuaded me that that was not a big issue. 
Guess what? I am still thinking about that particular issue.
    So that is one core issue. I refer to that in my second or 
third point. I think, more broadly, you can actually see this 
with people from my milieu. Willard Taylor, who was a Sullivan 
and Cromwell partner while I was a Davis, Polk partner, has 
written an article on blockers.
    We have so many different entities of that kind that I am 
not--I probably have as broad experience as anybody, and 
Willard Taylor also has a broad experience, and we are not sure 
that things are working out correctly.
    So, even if I cannot spot the issue now, I think it has to 
be examined more precisely.
    So, I do not know if that is responsive to your----
    The Chairman. Well, it is. But it also raises another 
question. A great number of entities--and one of the goals here 
is simplicity, so we are spending more time making stuff, not 
making huge tax structures here. And, if the goal is to tax 
business income once, what does that tend you toward?
    Mr. Trier. Well, it is actually a very----
    The Chairman. What changes do we consider here?
    Mr. Trier. Let me respond to that point in two different 
ways.
    One point is that I have largely lived in a completely 
different world than you guys. I have lived in a world that has 
all these entities. And to some extent, what I am saying is, 
you cannot proceed with your work without understanding my 
world.
    I think it partly, also, goes to Professor Warren's point 
and, really, the European experience. To some extent, the 
reason that world is so complex is that we planners are mixing 
and matching so as to only have one level of business income 
and then accommodate all the different parties, whether they be 
the tax-exempt parties, or the foreign parties that are 
investing through tax-exempts, or whether they be other people.
    If we had a world that, through corporate integration, 
through other means, simply itself operated to get that one 
level of tax and then got the interface with the tax-exempts 
and foreign sectors correct, then we would not necessarily have 
this huge proliferation of entities.
    But to be honest with you, I think the world that I come 
from is only going to get more complex. I am really more 
interested that we understand what is happening.
    The Chairman. Does that bother you that the world is going 
to get even more complex? I mean, certainly the world is 
getting more complex, but does it bother you if taxation gets 
even more complex?
    Mr. Trier. I think that for a----
    The Chairman. Why not do something more simple and 
straightforward? People want simplicity.
    Mr. Trier. Well, we are talking about Mr. LeFrak's father, 
who likes to keep the business--I am more in the world of 
simplicity. But listen, we live in an extraordinarily complex 
world, and it is fun, it is dynamic, it is great for a crazy 
guy like me, but I do not know that there is a lot of choice 
about that.
    Of course, everybody understands that part of the reason it 
is so complex is because this is an extraordinarily 
international world. And you go up to a humble law firm like 
Davis, Polk, a third of the people who work there are foreign. 
We are doing work on--they are doing work on this; it is not me 
anymore--they are doing work in many different foreign 
countries. There are going to be many different entities 
involved.
    We have this basic problem that is going on now, which is, 
given the choice, many business entities are going to migrate 
someplace else, potentially, and I am afraid we are going to 
have to deal with that world.
    But rationalizing our own system, I think, would tend to 
make it somewhat less complex. And then, of course, we have to 
deal with a different borderline, the borderline I mentioned in 
my testimony. I come from the industrial Midwest. My father had 
a subchapter S corporation, and my grandfather had a C 
corporation, and we do have to continue to make it possible for 
them.
    It turns out, when you look at the Treasury Department 
analysis, it turned out, I now realize, they thought they were 
small businesses, but they were actually large businesses. But 
we have to make their world relatively----
    The Chairman. Thank you very much.
    Senator Hatch?
    Senator Hatch. Thank you all. I appreciate you all being 
here.
    This question is for the entire panel. As I noted in my 
opening statement, earlier this year, President Obama released 
his skeleton framework for business tax reform. One of the, 
what I consider to be bad ideas, was to double-tax certain 
flow-through entities. What do you think of President Obama's 
proposal to double-tax certain flow-through entities?
    Maybe we should start with you, Mr. LeFrak, and move across 
the table.
    Mr. LeFrak. Senator Hatch, I think that it is actually one 
of the most terrible ideas that I have ever encountered. And, 
if we want to have a jobs funeral in the United States, that 
idea could be one of the opening hymns in a funeral for jobs in 
America.
    Both from an economic point of view and from a tax 
complexity point of view, it is a terrible idea. Between States 
and Federal rates of income, it would put people who work in 
partnerships in a position of working for the government more 
than 9 months a year.
    That is a very, very dramatic incentive-destroying set of 
facts. That is going to reduce employment, reduce capital at-
risk, reduce entrepreneurship, and reduce a tremendous amount 
of the American spirit.
    We do have a witness here who talked a lot about Europe. 
That is a very, very easy and fast way to make America's 
economy as weak and as regulated and as feeble as Europe's has 
been for the last 2 decades.
    From a tax complexity point of view, just to think about 
how that idea might work, would current entities be 
grandfathered? If not, what would happen if there were new 
economics from these taxes that were different from when the 
investors came together?
    Would the determination be based on income, revenue, size 
of assets? Would it apply on an annual basis, where you could 
be in it one year and not in it the next? How would it apply 
when a partnership is owned by another entity such as a REIT? 
What will happen if States do not follow the Internal Revenue 
Code and you have a partnership for States' purposes and a 
corporation for Federal tax purposes?
    In addition, my friends at the left here talked about 
pension funds and State pension funds and whether they should 
be paying their fair share of tax or not. If we had 
partnership-level business taxation in the United States, every 
one of the pension funds and State pension funds, charitable 
and tax-exempt entities, which currently invests in American 
partnerships, would stop investing in American partnerships. 
They would start investing in overseas partnerships and London 
partnerships.
    So this would be a way to take the whole United States 
investment management industry and send it out of the United 
States to another country where partnership taxation does not 
carry with it a separate level of tax.
    Countries like Australia, Canada, and the United Kingdom 
are all jurisdictions which do not have partnership-level 
business taxation, and there are very, very appropriate 
entities for well-
founded, thoughtful fiduciaries to invest their money in in 
those jurisdictions.
    These are not Cayman Islands jurisdictions. These are not 
third world jurisdictions. This is the United Kingdom, 
Australia, and Canada. And, if we want to have our whole 
investment management industry from the United States exported 
to those jurisdictions and those countries, having a separate 
layer of taxation on partnership income would be a fast and 
easy way to make sure that that happened.
    Senator Hatch. Mr. Trier, I am running out of time.
    Mr. Trier. I would just say two quick things. First is 
that, to tell you the honest truth, I had trouble fully 
understanding the series of proposals that were made. It was a 
relatively sketchy document.
    Number two is that conceptually, at a high level, I am not 
averse to there being sort of a single type of entity for 
business enterprises of all kinds. What I am very averse to is 
using that approach to end up or to move in a direction where 
there is more than one basic layer of tax.
    You could imagine many design approaches to the one layer, 
but to the extent that you are talking about adding to that 
incremental one layer, I think it is a movement in the wrong 
direction rather than a movement in a positive direction.
    Mr. Warren. Just to be very brief, Senator Hatch, I take it 
the motivation for the proposal is that competing parties in a 
particular industry, such as the financial services industry, 
should be taxed similarly so that particular organizational 
forms do not have advantages over other organizational forms in 
the same industry.
    Again, that sounds to me like, in the abstract, a perfectly 
acceptable proposition. This particular proposal, it seems to 
me, cannot be separated from what the rates are and from what 
the single entity taxation method is, as Mr. Trier just said.
    So that if, in fact, the proposal is to reduce corporate 
tax rates and impose double taxation that would actually reduce 
taxes on particular sorts of pass-throughs, that is a very 
different sort of consequence than simply adding on additional 
taxes to certain pass-throughs.
    So for me, analysis of the proposal would depend on exactly 
what the structure is going to be and what the rates are going 
to be.
    Senator Hatch. Mr. de Hosson?
    Mr. de Hosson. A proposal like that is not on the table 
anywhere in Europe, as far as I know. In Europe, the focus is 
much more on the corporations, the difference between 
corporation and partnership taxation, in general, and on how to 
find a rough balance, as it is called, and that is, more or 
less, achieved in many cases.
    There is still, in a general sense, corporate tax. Business 
incorporated is taxed less than a pass-through entity, as I 
said, because of the high personal income tax rates in Europe. 
But still, what the governments seek is an overall balance, 
that is, the combination of personal income tax and corporate 
tax is more or less the same as in the case of direct taxation 
when you operate through a partnership.
    As I said, that is not achieved in practice because, due to 
the tax competition and a lack of mobility of persons, there is 
a big difference between corporate income tax rates and 
personal income tax rates.
    Senator Hatch. Well, thank you. I appreciate all four of 
you testifying. I am particularly happy to have Mr. LeFrak 
here. I am somewhat familiar with the businesses that the 
LeFrak family is in. And I have to say, this has been one of 
the most interesting panels we have had, and I just want to 
compliment all of you.
    Thank you, Mr. Chairman, for your work on this.
    The Chairman. Thank you, Senator.
    Senator Crapo?
    Senator Crapo. Thank you, Mr. Chairman. I would just like 
to ask a quick question of the entire panel.
    There has been a lot of discussion here today about seeking 
to have a single tax level for all business income. Do you all 
agree that that should be an objective of our efforts to reform 
the tax code? Is there anybody who disagrees with that 
objective?
    Mr. Warren. Maybe I could make one comment about it.
    Senator Crapo. Yes.
    Mr. Warren. I agree with the objective, but the pathway 
that is opened once we agree on that is really, what is that 
single level of tax going to be? And the real choice, the 
fundamental choice, that the committee has to think about is, 
are we going to try to tax investors on the income that they 
earn through companies at the same rate as on other income--
that is, one single tax, that is a graduated tax--or are we 
going to have a separate tax on entities that may be unrelated 
to what the individual taxes are?
    So I think buried in the consensus on a single level of 
tax, you may find some disagreement about what that means. Are 
we going to have a unique level of tax for all corporate income 
or is that going to be somehow related to what the individual 
investor's income is?
    Senator Crapo. And what would your thoughts on that be? How 
should that be structured?
    Mr. Warren. My own thoughts on it are related to what I 
think would be most distributionally fair and what I think 
would be the simplest in the end, which is to reduce 
distortions of the tax system so that people will not use the 
tax system to try to organize their affairs differently than 
they otherwise would.
    So I would start with the view that, however you earn your 
investment income, whether it is through a pass-through, 
through a sole proprietorship, or through a company, in the 
end, the same tax rate should apply. If we do not do that, 
people are going to have all sorts of pressure to play all 
sorts of games, to hire Dana Trier----
    Mr. Trier. I will come out of retirement.
    Mr. Warren [continuing]. To do all sorts of things for 
them.
    Senator Crapo. It should be taxed only once?
    Mr. Warren. Absolutely.
    Senator Crapo. What are you saying then--and I invite 
others on the panel to jump in here. What about the distinction 
between capital gains income versus ordinary income? Should 
those kinds of distinctions be maintained?
    Mr. LeFrak. I think you need to maintain that distinction, 
Senator, because we have this thing in this country called 
inflation, and, if we had $1 in the late 1960s when the country 
still had its currency pegged to gold, the asset was worth, in 
dollars' terms, what it was constantly worth in dollars' terms.
    Since we have had this constant inflation of, not only the 
U.S. dollar, but fiat money throughout the world, the asset 
might not have had any change in its character, in its value 
whatsoever. It is the fact that the currency has had a big 
change in its value.
    So what is pernicious about capital gains taxation is that 
one may not have had any accession to wealth whatsoever, which 
is what the income tax, in theory, is supposed to capture. But 
one may have a difference in the value of U.S. dollars of one's 
asset, not because the asset has changed in value, but because 
the U.S. dollar, the measuring scale, has changed in its value.
    And one of the most important reasons to have a lower 
capital gains rate is because it is not indexed for inflation. 
So, if an asset was purchased in 1970 in 1970 dollars, sold in 
year 2012 in year-2012 dollars, it may not have appreciated in 
any way whatsoever. It may be that it is just worth more 
dollars because the value of the dollar has gone down over that 
40-year period.
    So one very important reason why the capital gains rate 
must be lower than the ordinary income rate is that it must be 
lower unless you are going to index for inflation the tax basis 
of assets. And without that indexation for inflation of the tax 
basis of assets, a lower rate is quite essential, because 
otherwise you are just taxing people for doing a transaction. 
You are not taxing their accession to wealth.
    Senator Crapo. Does anybody else want to weigh in on that? 
Yes?
    Mr. Warren. Just two comments. First of all, we have 
capital gains assets, some of which are shares of corporate 
stock.
    Part of the reason, historically, for the concession in the 
rates on capital gains or shares of corporate stock is the 
double-tax system. So, if you moved away from the double-tax 
system, then you might want to rethink that particular result.
    Secondly, if inflation--inflation is, obviously, a problem. 
If inflation is the rationale for the benefit of a lower rate 
for capital gains, then you might want to rethink what the 
requirements are to get the lower rate.
    If inflation is really the problem, probably you do not 
need to have a lower rate after investment of 6 months or a 
year. Maybe the benefit should depend on how long you have held 
the asset, which we have had in the past in our system.
    So, whatever the rationale is for preferential treatment 
for capital gains, you should think about how that matches up 
with the actual requirements to get the lower rate today.
    Senator Crapo. Thank you.
    Mr. Trier?
    Mr. Trier. I do not know if you have much time. And let me 
sort of add to his point. I was going to make the point that if 
we were not perfect in our integration system, the capital 
gains rate is having the effect of mitigating the second level 
of tax and, therefore, decreasing distortions.
    If you look at a rough-justice guy like myself, one of the 
places I start is, I actually like our current rates. In an 
imperfect world, I like having the 15, and I can live with 20--
probably you could not live with 20--percent rate on the 
dividends and a similar rate on the corporation as sort of a 
rough, modified integration.
    The other point I would make is that, as I have come to 
think about it, this is a long story, because I have thought 
about the capital gains quite a bit. I emphasize, in my own 
thinking, a third concept, and that is the concept of lock-in. 
To me, one of the basic reasons for that capital gains 
preference, wherever we set it--I might set it at a higher 
level of rate than you would--but I know that moving from one 
asset to another in an efficient way is deterred if there is a 
full 40-percent tax on the appreciation. And, therefore, at 
some level, I still believe there is a reason for a capital 
gains preference to ease that movement from one business asset 
to another.
    Senator Crapo. Thank you. My time has expired, but I 
appreciate those answers. They were very helpful.
    The Chairman. Thank you, Senator.
    Senator Wyden?
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Chairman, I am very glad you are holding this hearing. 
I think, as you and I have talked about, the question of 
taxation on the business side is absolutely crucial to doing 
tax reform right.
    I am looking forward to working with you and Senator Hatch.
    Here is my sense of where we are, for the four of you, and 
I am going to ask one question, and just go down the row.
    There was a recent study by the accounting firm Ernst and 
Young, and they found that, a few years ago, pass-throughs, 
which of course are companies where the owners, investors, and 
partners pay individual income taxes on the business income--
which make up 95 percent of American businesses and employ 54 
percent of U.S. workers. And essentially, in this analysis, 
Ernst and Young found that reforming the code for corporations 
alone, for just corporations--and, as you know, there are some 
in Washington who are advocating that--would, in effect, raise 
income taxes for millions of these small pass-through 
businesses, whether they are organized as sole proprietorships, 
partnerships, or something else for tax purposes.
    So the question that I would like to ask, and I am asking 
it because I think, if you look back at 1986, the resolution of 
this business issue was absolutely key to job creation. And the 
Bureau of Labor Statistics, in the 2 years after the 1986 bill, 
said the country created 6.3 million new jobs.
    Nobody can claim that every one of those jobs was due to 
tax reform, but getting the climate set right as it relates to 
job creation is key, and particularly for creating jobs in this 
country.
    So my question for all of you is, given that Ernst and 
Young study and the prevalence of these pass-through entities, 
doesn't tax reform have to be comprehensive--covering both 
individual and business taxpayers--in order to provide real tax 
relief to the overwhelming majority of Americans?
    Let us just go right down the row, and we can start with 
you, Mr. de Hosson.
    Mr. de Hosson. Thank you, Senator. Very briefly, because I 
can only comment from a European point of view and give you my 
initial views on that, I think that, indeed, it must be 
comprehensive. You cannot leave alone a part of the business 
the way business is carried on.
    Restructuring the other side of it, there will be an effect 
from one side to another. It, I would expect, is inevitable. 
You have to--coming from a European background and my 
experience there--it has to be comprehensive. Yes.
    Senator Wyden. Very good.
    Mr. Warren?
    Mr. Warren. I agree that tax reform would have to be 
comprehensive, in part because the effects of our current 
system depend on the interaction of those four rates that I 
talked about before.
    But I would go even further than you did to say that tax 
reform--business tax reform, since we are talking about tax 
reform with entities and investors--also implicates other kinds 
of investors like tax-exempt investors, charitable endowments, 
and pension plans.
    Imagine a proposal that would, say, let us dramatically 
reduce the corporate tax rate and make it up by increasing the 
top individual rate on dividends. That would have a certain 
distribution, as you suggested, between individuals and the 
companies.
    It would also have very strong positive effects for 
investors who happened to be exempt, because they would benefit 
from the reduction at the corporate level and would not bear 
any of the burden.
    So I would say even they have to be brought into the mix, 
and that is also true of foreign investors. So I think, 
absolutely, you have to think about all of these possible 
combinations.
    Senator Wyden. Thank you.
    Mr. Trier?
    Mr. Trier. What you have just said is obviously one of the 
core points I discuss in my testimony. And the way I think of 
it a little bit is, by use of the base-broadening revenue--and 
I would not be comfortable, for reasons I go into in my 
testimony, with a world that would use the base broadening to 
sock it to me, so to speak, while you lowered and reformed and 
made more rational the 
corporate-level rates applicable to public corporations, but on 
the other hand, you reintroduced a significant disparity 
between that pass-through world, the individual world.
    It may very well be that, at the end, we have to live with 
some disparity, but I think we have to look at the process 
jointly or we have not accomplished much in neutrality.
    Senator Wyden. Mr. LeFrak? Last word for my round.
    Mr. LeFrak. Everybody would agree that comprehensive tax 
reform at the corporate and individual level is important. 
However, I would want to caution you about 1986 in one respect.
    In 1986, tax reform did wreck the real estate industry in 
the United States, which was one of the major reasons why we 
had an S&L crisis. And, given that we are in a position of 
financial and job fragility in the United States right now, 
where our financial sector and our job sector are both hurting, 
I think that all types of tax reforms have be very, very 
considered and measured, and 1986-style reforms might, in some 
way, be playing with matches in this environment.
    Senator Wyden. My time has expired. I would only say I 
think, yes, this is a very different time in terms of real 
estate and housing than you had in the 1980s. And, as you know, 
Senator Packwood was one of the key architects of tax reform, 
from my home State.
    I just think one of the big challenges is, as you look at 
this question, business, if you do not bring in all sides--and, 
as you know, there are a lot of groups here in Washington right 
now that are advocating corporate only, and a number of you 
expressed it--I think you are not going to get relief to the 
overwhelming majority of Americans, and that was the linchpin 
in 1986. The overwhelming majority of Americans, all the people 
who work hard and play by the rules, got real tax relief, and I 
just want to make sure we get that done.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator.
    Senator Cardin?
    Senator Cardin. Thank you, Mr. Chairman. Let me thank you 
for the hearing, and thank our witnesses.
    I agree with much of what has been said. I come to this 
hearing agreeing with a lot of what Senator Hatch said about 
the concern of eliminating or restricting pass-through 
entities. I have been working to strengthen the ability of 
pass-through entities for two major reasons.
    One, I do believe we have double taxation, and that is 
wrong. And, if you can set up business entities that can take 
advantage of one level of tax, I think it is the right thing to 
do. And secondly, it has encouraged the type of economic 
activities that many of you have talked about.
    In my own State of Maryland, these entities have been 
responsible for a lot of our real estate and economic 
expansions. So I am reluctant to want to put the pass-through 
entities at a disadvantage.
    I understand a lot of the discussions that have taken 
place, but I think Senator Wyden, in his questions, really 
raised a fundamental issue. I hear a lot about trying to spread 
the tax burden on the corporate side in order to get a lower 
corporate rate.
    On the other side, we have to have more revenue in order to 
balance the budget. So you have to find revenue someplace. And, 
if it is not going to come out of the corporate sector taxation 
directly, then the individual taxes are going to have to yield 
more revenue. So I think it is unlikely that you can reduce the 
corporate tax rate and, at the same time, have a relatively 
similar marginal top rate on the individual side. I just think 
it is going to be difficult to get to those lower levels.
    So I guess I want to try to isolate this a little bit. If 
the price for a lower corporate tax, in and of itself, without 
other tax reform, is to eliminate the pass-through entities, is 
that a good deal or not? And there would be other things that 
would have to be eliminated.
    I think that the rate that people are talking about is 25 
percent to get there. And I know, Senator Crapo, you were 
involved in some of these issues. You have to look at 
eliminating all of the tax expenditures and credits. At least 
80 percent, I think, was the number that was given. So it would 
involve eliminating a lot of tax benefits and, also, answering 
questions like, what we do with depreciation and maybe the 
domestic manufacturing deduction in section 199, maybe interest 
deductions, things like that.
    But, if we could just isolate those two changes. If we were 
to get a lower corporate rate, and the price of that was the 
elimination of these pass-through entities--and we have a lot 
of different types, and some are not called pass-through 
entities as such, but they are taxed at one level rather than 
two--bringing that into the corporate rate, is that a good deal 
or not, if we do not get beyond that? Who is brave enough to 
take on that question?
    Mr. Trier. Much of what you said is really what I have been 
thinking about. I am, in honesty, skeptical that we can get to 
a 25-percent across-the-board rate and, therein, a pass-through 
effect.
    I like the way the pass-throughs work. So, in my view of 
the world, what I think is going to become necessary as you 
proceed is sort of a very delicate balancing of possible minor 
distortions, but with the objective that we have business 
income at all levels, pass-through or not, subject to a 
relatively modest burden. And so the last thing I would want is 
for pass-throughs to be brought into the corporate world and 
then have a huge individual tax rate.
    In my testimony, I use the example of 40 and 28 percent. I 
do not think that is a forward movement. And where I may be 
more concerned is, we have to keep the world that is inhabited 
by the LeFrak Organization, et cetera, relatively close to the 
corporate world. It does not have to be identical, but, like 
what Senator Wyden was articulating, I do not think we can look 
at this as only something that is occurring in the corporate 
world and we take it out of the hide of the pass-through world, 
or tax poor individuals, like myself, from New York City.
    Senator Cardin. I think I would be very reluctant to give 
up the pass-throughs in what might end up being the tax policy 
of this country.
    Mr. LeFrak. I would just want to add a couple of things 
because, like New York, Maryland is a State with a high State 
income tax. That has been written about recently.
    When you have the----
    Senator Cardin. I think you have higher taxes than we do, 
but we will----
    Mr. LeFrak. I think we do. So I think we are almost 12 
percent, New York City, but Maryland is pretty high. But when 
you are paying in the corporation and then you are paying at 
the individual level again, you are now paying very, very high 
marginal rates of taxation to the point where people in 
Maryland who would be forced into corporate form would be 
working more days of the year for the government than for 
themselves or for their capital or for their families or for 
their futures.
    And to take domestic American partnerships, which are here 
creating jobs in America and employing Americans, working for 
Americans, and to put them under the knife to make 
multinational corporations, put them in a different situation, 
I think that you have to decide where is the locus of the 
business activity that is represented by these partnerships and 
where is the locus of the business activity represented by 
these multinational corporations. And I think you have to take 
a home team-type of approach.
    If multinational technology companies are opening up 
offices in Ireland and they are complaining about the rate of 
corporate tax in the United States, whereas Maryland real 
estate people are opening up businesses in Maryland, employing 
construction workers in Maryland, and putting people to work in 
Maryland, that should be a very, very different set of tax 
facts that this committee would approach, in my opinion.
    Senator Cardin. And I would just add one other thought to 
that, and I will yield back my time.
    From the European example, one of the risk factors, if we 
eliminate pass-throughs, even if we have lower corporate rates, 
is, with the individual income taxes being what they are in our 
country, including local--and I think you were making a good 
point about the State and local taxes--you run the risk of 
using the corporate structure as a shelter through deferral, 
therefore, avoiding taxation. It does not get us the revenues 
that we expected to get, creating a problem.
    So I appreciate particularly what Senator Wyden said about 
comprehensive reform. We are all for that. But we have to be 
realistic as to what is likely to happen here, and we have to 
be very careful if we are going to go to double taxation as the 
solution to our problems.
    I, for one, am very concerned about movement away from or 
making it more difficult for pass-throughs.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator.
    I am just curious if any of you know the relative taxation 
of businesses in Europe, with European businesses compared with 
American businesses, irrespective of the form of taxation, just 
the burden. Is it comparable, or is there a difference?
    Mr. de Hosson. I am sorry?
    The Chairman. Is it comparable, or is there a difference? 
The burden of business taxation of European companies versus 
American.
    Mr. de Hosson. Well, it is difficult to say, because we are 
not only discussing here rates, but also the tax base. The 
rates, if you are talking effective taxation, my guess is that, 
in most European countries, the burden will be lower on the 
corporate entities and such than in----
    The Chairman. I know it is hard; I am generalizing. All 
businesses in Europe, just the burden, taxation burden on 
businesses in Europe compared with the U.S.
    Mr. de Hosson. I guess it is lower. That is because----
    The Chairman. Lower in Europe.
    Mr. de Hosson. It is lower in Europe because, let us not 
forget, our basic revenue-raiser is the VAT.
    Mr. Warren. If I could just add one comment.
    The Chairman. Yes.
    Mr. Warren. As you say, Mr. Chairman, it is very difficult 
to generalize. But I think probably, overall, at the business 
level, it is lower, but at the investor level, it is higher, 
because personal tax rates are higher. And we have to think 
about both together.
    Mr. Trier. Individual rates are higher in general. It is 
not just the investors, but it could be a lawyer or something.
    The Chairman. Right. Now, is that a concept that the three 
of you think we should pursue, tax the individuals a little 
more, tax the businesses a little less?
    Mr. Warren. That is beyond our pay grade.
    The Chairman. No, no, no. Our goal is competitiveness.
    Mr. Trier. As I have emphasized, I am not averse--let us 
use numbers. Let us say we ended up at 28 corporate level or 30 
percent corporate level or entity-level business taxation, and 
there was an incremental 5 or 6 percent that, despite Senator 
Hatch's best efforts, despite Senator Crapo's best efforts, 
that little disparity remained, I think we have still done 
something positive.
    But, if the result was that we took everything and went to 
40 or 45 or 50 and--as somebody who lives in New York City and, 
by the way, checked out Maryland, the State tax, just in case; 
you have to take into account the State burden--I think that 
what ends up happening is, you have too much un-economic 
planning between whether you are using the entity that has the 
lower rate, you are doing something in a pass-through, doing 
something in a corporation. So I just do not think it is right 
to go in that direction.
    The Chairman. Let me ask Professor Warren to amplify on an 
earlier answer. He was asked, I think by Senator Crapo, all of 
you were, the degree to which you tend to agree with the 
concept that business income should be taxed similarly, 
irrespective of its form.
    And you, Professor Warren, said, yes, we agree in 
principle, but when you start digging down into it, how that is 
accomplished, there are different paths, different approaches.
    Could you elucidate a little more on a couple or three of 
those different paths and different alternatives that might 
make a little more sense compared with some others?
    Mr. Warren. Sure. Just to take sort of two polar extremes. 
Everybody is familiar with withholding on your salary. We could 
make the corporate income tax essentially a withholding 
mechanism. Corporations would pay taxes, but when shareholders 
got dividends, they would receive a tax credit for their 
corporate tax paid with respect to that dividend.
    That is essentially the system that the European countries 
had that Mr. de Hosson talked about. That is no longer possible 
in Europe because of the European treaties, which do not apply 
to us. So it would be perfectly possible here.
    That would mean that your income that was earned through 
corporate solution would be taxed ultimately at your individual 
rates, because, when you get the dividend, you pay your rate 
and you get a credit for what the corporation paid for.
    The alternative is to say, we just will not tax individuals 
at all. We will have a flat rate at the company level. We will 
collect it always.
    The Chairman. Flat corporate rate.
    Mr. Warren. Flat corporate rate, or whatever entities we 
are applying the rate to.
    Mr. Trier. We will not tax individuals on business income. 
Right?
    Mr. Warren. We will not tax individuals on business income. 
Right.
    The Chairman. Just tax the business.
    Mr. Warren. We will just tax the business at some rate. And 
the Treasury Department once proposed a so-called comprehensive 
business income tax that would do that. And in 2003, the 
administration proposed exemption for dividends at the 
shareholder rate.
    So those are two different pathways. They are very 
different. The first one would apply your usual graduated rate 
ultimately to your income, and the second one would single out, 
for a particular rate, business income.
    The Chairman. Do you lean toward one of the two more than 
the other?
    Mr. Warren. My own personal view would be to lean toward 
the first, again, on the grounds of simplicity. If people are 
subject to more than one tax rate, their own individual rate on 
things that are not earned through businesses and a different 
rate on things that are earned through businesses, that is just 
going to compound game-playing, people trying to transform one 
form of income into another. That would be my reasoning.
    The Chairman. My time has expired. But very briefly, Mr. 
Trier, is that a concept that you find outrageous, or is that 
something you can handle?
    Mr. Trier. No, no, no.
    The Chairman. There may be something to it?
    Mr. Trier. I generally agree with what he has said. I want 
to say this, even though it is a long story, it kind of is 
responsive to Senator Hatch's questions earlier.
    I find myself in somewhat more sympathy with the taxing it 
once at the entity level as opposed to the approach of 
Professor Warren. But reasonable people can disagree and et 
cetera.
    The devil is in the details and, therefore, to go back to 
this treatment of pass-throughs--and the proposal is sketchy, 
whatever you call that structural thing that the administration 
put out--I am not, in principal, against there being sort of a 
uniform entity tax level.
    The devil in the details is whether you end up with full 
tax, a relatively significant--I say 35 percent or 30 percent--
rate at the entity level and then this significant additional 
layer of tax that is imposed somewhere along the line on that 
business income.
    I think that that reintroduces the distortions and moves us 
toward a double burden of tax in a way that is just not where 
we should be going. It is not where we should be thinking about 
it.
    The Chairman. My time has expired. But this concept that 
the form of income is irrelevant, whether it is cap gains, 
dividends, corporation income, or other business income--you 
add it all up, and it would be one tax.
    Mr. Trier. One tax or barely more than one.
    Mr. Warren. If I could just make one interjection, Mr. 
Chairman.
    Doing it at the company level is a little harder today than 
it was in the past because of international competition, where, 
because European rates are so much lower and so on, if you went 
down that pathway, you might find yourself more constrained in 
terms of what you can do. It is just a different consideration.
    The Chairman. Right. It raises lots of questions. But my 
time has expired.
    Senator Hatch?
    Senator Hatch. Many countries have a territorial system as 
well, which we do not have, which I think is tremendously 
disadvantageous to us. You can go on and on about the 
differences, it seems to me.
    This question would be for you, Professor Warren. In your 
testimony, you note that Treasury, in 1992, introduced a 
comprehensive business income tax prototype that would apply to 
all business entities, whether formed as a corporation, 
partnership, or limited liability company.
    Now you advocated, as I recall, in 1993 and continue to 
advocate today, I believe, for a shareholder credit for 
corporate taxes paid. Now, would you recommend one regime in 
which an entity-level tax is imposed on all business entities 
and then a shareholder credit is used to eliminate the double 
tax on earnings, or would you establish, say, two regimes in 
which a dividing line is created between taxable entities and 
pass-through entities and limit the shareholder credit system 
to the taxable entities?
    Mr. Warren. Obviously, the fewer distinctions we can have, 
the simpler our system would be. On the other hand, I certainly 
think about small businesses, which we may not want to ask to 
go through the complexity of having a withholding at the entity 
level.
    So my instinct would be, if we were going down this 
pathway, to try to transform the corporate tax into some sort 
of withholding tax. My instinct would be to limit that to all 
business entities that were large--obviously, there would be a 
question as to what that means--and to let smaller entities 
continue with the pass-through.
    But I think that is an important and difficult design 
question that you raise, Senator.
    Senator Hatch. Thank you. Well, we would like to have your 
best thinking on it beyond what you say here today.
    I have other questions, but I think Senator Carper is here.
    The Chairman. Senator Carper?
    Senator Carper. Thanks, Mr. Chairman. And welcome.
    I apologize for not being here. We are trying to pass some 
cybersecurity legislation to safeguard our country and help us 
on our national security and on our economic security, and I 
have been over on the floor working on that.
    We appreciate you and your comments and your willingness to 
respond to our questions.
    One of the main reasons we hear that tax reform has again 
become necessary is the proliferation of new tax breaks added, 
some of them since 1986, some of them more recently than that, 
to the tax code. We do it every year, as you know.
    Also, one of the other reasons is because of the increased 
use of some of the existing tax expenditures by taxpayers. I am 
told by the chairman of the Budget Committee that, if we add up 
the cost of these tax expenditures, the total of them over the 
next 10 years is about $15 trillion, which I believe is more 
than we are expected to appropriate over the next 10 years.
    So we figured out a new way to move money out of the 
Treasury, not by appropriating money, but through the tax code. 
But some of the tax incentives for individuals and for 
companies, I think, are sound policy. Most would say that that 
is a good idea, we should do more of that.
    With that in mind, the tax treatment of debt versus equity 
is something that I feel needs to be examined and needs to be 
examined closely. Particularly, we are discussing whether or 
not to better integrate the corporate code and the individual 
tax code.
    I would just like to ask each of you, it may take a minute, 
to directly and frankly tell me and others who are here today 
which type of integration system you think would be more 
effective. Are there any that reduce any bias in favor of debt 
that are in the current tax code?
    And I do not care who goes first. Start with the youngest.
    Mr. LeFrak. Just completely offhand, I think that if one 
would be concerned about people receiving interest payments and 
inappropriately not paying tax on the receipt of those interest 
payments, then we should have a withholding tax on interest 
income.
    If one decides that the recipient of that interest income 
is worthy of receiving that income without paying taxes, credit 
back the withholding. And if one finds that the recipient of 
that interest income should be paying tax on the receipt of 
that interest income, then keep the withholding.
    If one buys Swiss government bonds, for example, the Swiss 
government--even though they pay a meager rate of interest, 
which is now negative--they actually withhold interest and they 
keep it to themselves, and if you are a worthy owner of those 
government bonds, you can apply to receive that interest back.
    So I think one idea that came out of this discussion with 
the three erudite tax professionals--whose tax erudition 
exceeds my knowledge by many years and many volumes of books--
what I would say is, think about a withholding tax on interest 
payments to make sure that the person receiving that interest 
payment is appropriately being taxed on that payment.
    Senator Carper. All right. Thank you.
    Please, others?
    Mr. de Hosson. Maybe in general, in Europe, here in the 
States, there has been a lot of discussion about debt-to-equity 
ratios, earnings strippings, what have you. Almost all 
countries have that now in place.
    An interesting discussion is that the bias is reduced by 
allowing the deduction of undeemed return on equity. That is 
what Belgium has done, and there is some serious discussion 
about that in my country.
    Senator Carper. Thank you.
    Mr. Warren. Just picking up on what Mr. LeFrak said, if we 
had a withholding tax on interest, that would be an exact 
parallel to having a shareholder credit form of integration, 
because the shareholder credit performs exactly the same 
function as the withholding tax.
    My direct answer to your question would be that the 
shareholder credit form of integration would be the most direct 
way of eliminating the distinction.
    I would caution the committee against another pathway, 
which is, since interest is deductible, some would say, why do 
we not just make dividends deductible, which would eliminate 
the corporate tax when the dividend was paid?
    The problem with that is that that would eliminate the 
corporate tax for certain kinds of recipients who themselves 
are not taxable. And so that is why I would prefer the 
shareholder credit approach.
    Senator Carper. Thank you, sir.
    Mr. Trier. I will say briefly that I think it comes--I 
agree with what Professor Warren just said about the deduction 
system, unless you somehow made them taxable on that at their 
entity level. There is a recent article in Tax Lawyer to that 
effect. So it has been going on for 20 years, whether the base 
place you get taxed at once is at the entity level or whether 
it is through the credit system.
    The point that I would make that makes things a little bit 
more complex here is that the integration systems, which I 
think Professor Warren and I would agree come down to two basic 
versions, do not fully address debt and equity.
    They address debt/equity distinctions of the type that we 
are accustomed to talking about, the stuff that I did on Wall 
Street for 20 years, designing things to get debt treatment 
where maybe it was really equity. There is still the interface 
with those non-taxed parties that you have to deal with.
    Therefore, you have to--maybe you deal with it exactly as 
you have it today, but you still have some remaining disparity 
between equity and debt if you simply keep the basic deal that 
we have with foreign taxpayers and U.S. taxpayers today.
    I do not know whether Professor Warren agrees with me or 
not.
    Mr. Warren. I agree with you.
    Senator Carper. Terrific. Thank you all very, very much. 
Thank you.
    The Chairman. Thank you, Senator.
    I think it was Wayne Gretsky, when asked why he was such a 
great hockey player, said, ``You don't skate to where the puck 
is, you skate to where the puck is going to be.'' Just like the 
Babe Ruth quote.
    We are thinking ahead about where this country is going to 
be from a business perspective 5, 8, 10, 15, 20 years from now, 
to the degree that one can.
    The trend is, we have more high-tech and services and so 
forth, and more globalization. So, as we address this question, 
what are the couple of things we might be thinking about, from 
your perspective, to make sure we are making changes that make 
sense, not just for today, but kind of planning ahead a little 
bit, or can we?
    Mr. Warren. I think we can do the best we can, and I think 
the committee is absolutely to be commended for having this 
series of hearings on these kind of fundamental issues so that 
the committee will be ready to think about fundamental reform 
when it becomes politically possible or germane.
    I guess my advice, for what it would be worth, is to 
continue down the pathway that the committee is on, which is to 
try to think about ways to rationalize the taxation of American 
business income through different business entities, whatever 
those entities may be, to reduce the tax incentives to 
structure investment in different ways.
    Mr. Trier. I would add to it. It is, of course, exactly 
what is making our job so hard, that the overall level and 
rationalization that we come up with has to be consonant with 
what is going on in the world. And this, as mentioned by you at 
the inception, this whole effort on business entity taxation is 
very, very linked to the international--whether it is 
territorial or other--system.
    So I actually think I know where we are going. I think that 
things have played out in a way that we tend to know what this 
modern world looks like now, and I think we have to come away 
with a balanced system that is relatively rationalized, that, 
nevertheless, permits us to continue to be the best place in 
the world.
    The Chairman. Some commentators think our country is a 
little too heavily involved in consumption, maybe biased toward 
housing looking toward the future, with not enough investment 
in education, enough investment in infrastructure, to help make 
us competitive with other countries worldwide.
    So, as we reform the code, I can support, not just how to 
integrate and so forth and how much rates can be lowered 
compared to the base-broadening, et cetera, and all that. But 
it is an opportunity to kind of look and see the degree to 
which the code can have any effect, help encourage our country 
to be economically stronger through more investment in some of 
the basics--education, infrastructure, entrepreneurship, and so 
forth--so our kids and our grandkids have a better shot than 
they otherwise might.
    Do any of you have any thoughts on that subject?
    Mr. Warren. I would say one thing, Mr. Chairman--and I 
completely agree with your comments. And that would be, as you 
think about, as several of the members have said, how to pay 
for some of these proposals----
    The Chairman. That is right. That is a big question.
    Mr. Warren [continuing]. One of the parts of the code that 
I would urge you not to attack is the incentives we give for 
research and development, which are fundamental for the future 
of the country, and I think have been influential in that 
regard. Part of the outstanding part of our economy today is 
that so much has been developed in the past in basic research 
and development.
    The Chairman. I agree with that.
    My time has expired.
    Senator Hatch?
    Senator Hatch. Let me just say that I agree with you, 
Professor Warren. I think both of us do. The R&D tax credit is 
an approach that I would like to make permanent.
    The Chairman. We both do.
    Mr. Trier. It turns out you guys are not in charge anyway.
    The Chairman. Well, it is a snare and a delusion. 
[Laugher.]
    Senator Hatch. Our problem is that we have really one of 
the stupidest budget processes that I have ever seen in my 
life, and you might want to give some thought to that too, to 
help us down here.
    But I particularly have enjoyed this panel very, very much. 
We have a top businessman, we have top tax experts, we have a 
top European tax expert. I mean, it does not get any better 
than that.
    So I am grateful to all of you. Thank you for being here.
    The Chairman. And I also thank you very much. You have 
taken a lot of trouble to draft your testimony, come to 
Washington, DC. We deeply appreciate your help. This is, as I 
said at the outset, a subject we think is very important and 
somewhat at the heart of tax reform.
    We will be talking to you more, I am quite certain of that.
    Senator Carper?
    Senator Carper. This is not a question that I am going to 
ask you to respond to here.
    Sitting behind me is Chris Pendergrass, my tax counsel. He 
has done a lot of work. He reached out to a lot of folks and 
asked for comment on this and input on the R&D tax credit, and 
it is universally supported--almost universally supported, as 
you know.
    The question is, is it perfect? Probably not. Can it be 
made better? It probably could, and we have an opportunity here 
to ask that question and try to answer it.
    I am going to submit a question along those lines in 
writing and ask that you would respond. If we are going to make 
some changes that can make it more effective for us going 
forward, what changes would you suggest? If you could get that 
question and respond to it, I very much appreciate it.
    Thanks for joining us today.
    The Chairman. And I am sure you all know this, but the many 
high-technology companies, they say, lower the top corporate 
rate. They say they are willing to get rid of all these tax 
expenditures, just get rid of them, get rid of depreciation, 
get rid of the R&D tax credit, get rid of the section 199 
deduction, get rid of them all. That is what they say, and I am 
not too sure how many actually believe that.
    But the top, larger U.S. tech companies just say, get the 
rate down to 26 percent, something like that, we do not care 
about any of the rest of that stuff. And that is for a larger 
company in the high-tech world. That might not be as true in 
some other companies.
    But I agree with the point of Professor Warren about R&D. I 
think there should be incentives for research and development 
in the United States.
    Mr. LeFrak. I would like to, in response to that comment, 
just state that this is the United States Senate, and this body 
is charged with the well-being of people in the United States, 
and companies that have chosen to incorporate in the United 
States are very, very different from domestic businesses. And 
thinking about how one balances the equities of taxation, I 
think that it is a very important thought going forward. We 
need to think about what incidence of taxation are we imposing 
on companies that are incorporated in the United States versus 
domestic American businesses that are entirely within the 
United States.
    The Chairman. Correct. That is a very good point.
    Mr. LeFrak. And I think that that is a very, very important 
point as it relates to this concept of taxation of 
partnerships, because we are getting into this tension of 
businesses which hover over the United States, which are 
incorporated here, potentially, wanting to have their taxes 
reduced and wanting to have domestic American partnerships pay 
the price for businesses that are not fully domestic and fully 
American.
    I just think that that is a very, very important point that 
we have to make, and I would just like to bring that out on the 
table in case anyone was too polite to bring it up.
    The Chairman. I am glad you brought it up. Thank you.
    Senator Menendez? We are joined now by the Senator from New 
Jersey. Thanks, Senator.
    Senator Menendez. Thank you, Mr. Chairman. I am glad to be 
able to get here before the hearing closed. I was chairing my 
own hearing on housing, but I wanted to get here.
    I appreciate the testimony the panel has given, 
particularly the written testimony that I read, and I want to 
welcome Mr. LeFrak to the hearing.
    The LeFrak family has really transformed the Hudson 
waterfront, which was abandoned railroad yards, legacies of 
failures of the past, many of the sites contaminated, lying 
fallow without creating any ratable economic opportunity or 
housing.
    The vision of Mr. LeFrak's grandfather, followed on by his 
father and his family, transformed the whole Hudson waterfront, 
in which now--and I would welcome the chairman and the ranking 
member to come visit anytime--you would see an incredible 
vibrant community of housing, real estate, commerce, commercial 
real estate, parks, a real vibrant sense of community, an 
enormous ratable base, and an unlocking of economic 
opportunity.
    I wanted particularly to come here and recognize that. And 
I see that, in your testimony, you very strongly oppose taxing 
large partnerships as corporations. In fact, you state that 
your family would stop building and stop taking risks if such a 
proposal became law.
    I am wondering, in the context of having set the framework 
of what has been unlocked in the case of the Jersey City 
waterfront, among others, do you think that if the tax policy 
were different, that those investments would have been made, 
the ones that your family made and transformed that waterfront 
on?
    Mr. LeFrak. Currently, we pay a rate of taxation that 
exceeds 50 percent. So it is not as if we are not willing to do 
business and take risks and pay a heavy tax burden. A 50-
percent-plus tax burden is, in my opinion, a very heavy tax 
burden. And globally, our European tax expert would tell you 
that it is among the top of the world.
    Having said that, if our tax burden were a 75-percent-plus 
tax burden, where we would be working 9.5 months for the 
government before we started working for ourselves, which would 
put us kind of until mid-September as, let us say, a government 
program and then a private enterprise between mid-September and 
the end of every calendar year, I think we would seriously 
consider whether we should be taking risks at that time, 
whether it was worth spending time at work or whether we should 
just be coming down to Washington and enjoying our Nation's 
monuments, parks, and other cultural activities that we as 
taxpayers have been fortunate enough to fund.
    Senator Hatch. You can only take so much of that, you know. 
[Laughter.] But we get your point.
    Senator Menendez. The other question I have is maybe not 
the focus of the hearing, but I certainly want to use your 
expertise on it. When we were talking about the treatment of 
family partnerships and carried interest as it relates to real 
estate, where there was a huge concern of the consequences of 
the changes that were being proposed in that, I would like to 
get a sense from you what would have been the consequences in 
your own experience had that become the law at the time.
    Mr. LeFrak. Well, the law, as written, created a tax burden 
for real estate family partnerships. That was the same tax 
burden for real estate partnerships where the capital was being 
promoted against investors.
    What was particularly troublesome about that legislation to 
my family's enterprise was that my family's enterprise, which 
does not receive $1 of carried interest from any investor 
whatsoever, was being taxed under that legislation as if it 
were a business that raised money from investors and as if it 
received a carried interest from those investors.
    So I am not in the world of carried interest, and I do not 
get carried interest, but I was going to be carried out by 
carried interest. [Laughter.] And I was particularly troubled 
that the revenue score of that bill reflected all of the family 
businesses, like ourselves, which would have been carried out 
with carried interest, even if we did not receive $1 of carried 
interest on any type of investment or any type of partnership 
that we participated in.
    So that was really where my trouble with that legislation 
arose, and I was happy to communicate it to you at the time, 
and I will be happy to communicate that to you at any time in 
the future, sir.
    Senator Menendez. I am sure you will.
    One final question, if I may, Mr. Chairman.
    Mr. Trier, you wrote, ``I am deeply skeptical that we can 
achieve, consistent with fiscal responsibility, the more 
ambitious goals that have been publicly announced,'' and you 
note a 25-percent corporate tax rate as an example.
    In your opinion, is it realistic for a tax reform package, 
done in a revenue-neutral manner, to achieve a 25-percent 
corporate tax rate? And what do you think of the significant 
issues surrounding whether or not that is achievable?
    Mr. Trier. We discussed some of them before you came. But I 
am, in fact, skeptical that we can achieve a 25, 28, something 
like that, percent rate at both--let us say 25. I am very 
skeptical that we can achieve that rate, consistent with the 
political mission that we have, in a manner that is relatively 
neutral across the public corporation world, the world that Mr. 
LeFrak inhabits, and the world that I have done a lot of work 
in, which is the closely held business.
    The burden in my testimony is that the thing that I really 
do not want to see is having us finance 25, 28, name your 
number, for the larger multinational enterprises in a manner 
where we are, in effect, subjecting other sectors of the 
economy to 38 or 40 or too high a rate. So the key to me is 
that, as this process goes forward, there is relative balance 
in how we approach the system.
    Now, this sounds a little bit like a Republican approach to 
the whole system. I am not so concerned that there be absolute 
parity between the rates across the board, but I would think it 
would be unfortunate if we would finance getting to that 25 
percent on the backs of the non-corporate and non-public 
sectors of the economy.
    Senator Menendez. Thank you, Mr. Chairman.
    The Chairman. Thanks, all of you, very much. I appreciate 
your time.
    The hearing is adjourned.
    [Whereupon, at 12:30 p.m., the hearing was concluded.]


                            A P P E N D I X

              Additional Material Submitted for the Record

                              ----------                              




[GRAPHIC] [TIFF OMITTED] T2334.002

[GRAPHIC] [TIFF OMITTED] T2334.003



[GRAPHIC] [TIFF OMITTED] T2334.005

[GRAPHIC] [TIFF OMITTED] T2334.006

[GRAPHIC] [TIFF OMITTED] T2334.007

[GRAPHIC] [TIFF OMITTED] T2334.008

[GRAPHIC] [TIFF OMITTED] T2334.009

[GRAPHIC] [TIFF OMITTED] T2334.010

[GRAPHIC] [TIFF OMITTED] T2334.011

[GRAPHIC] [TIFF OMITTED] T2334.012

[GRAPHIC] [TIFF OMITTED] T2334.013

[GRAPHIC] [TIFF OMITTED] T2334.014

[GRAPHIC] [TIFF OMITTED] T2334.015

[GRAPHIC] [TIFF OMITTED] T2334.016

[GRAPHIC] [TIFF OMITTED] T2334.017

[GRAPHIC] [TIFF OMITTED] T2334.018

[GRAPHIC] [TIFF OMITTED] T2334.019

[GRAPHIC] [TIFF OMITTED] T2334.020

[GRAPHIC] [TIFF OMITTED] T2334.021

[GRAPHIC] [TIFF OMITTED] T2334.022

[GRAPHIC] [TIFF OMITTED] T2334.023

[GRAPHIC] [TIFF OMITTED] T2334.024

[GRAPHIC] [TIFF OMITTED] T2334.025

[GRAPHIC] [TIFF OMITTED] T2334.026

[GRAPHIC] [TIFF OMITTED] T2334.027

[GRAPHIC] [TIFF OMITTED] T2334.028

[GRAPHIC] [TIFF OMITTED] T2334.029

[GRAPHIC] [TIFF OMITTED] T2334.030

[GRAPHIC] [TIFF OMITTED] T2334.031

[GRAPHIC] [TIFF OMITTED] T2334.032

[GRAPHIC] [TIFF OMITTED] T2334.033

[GRAPHIC] [TIFF OMITTED] T2334.034

[GRAPHIC] [TIFF OMITTED] T2334.035

[GRAPHIC] [TIFF OMITTED] T2334.036

[GRAPHIC] [TIFF OMITTED] T2334.037

[GRAPHIC] [TIFF OMITTED] T2334.038

[GRAPHIC] [TIFF OMITTED] T2334.039

[GRAPHIC] [TIFF OMITTED] T2334.040

[GRAPHIC] [TIFF OMITTED] T2334.041

[GRAPHIC] [TIFF OMITTED] T2334.042

[GRAPHIC] [TIFF OMITTED] T2334.043

[GRAPHIC] [TIFF OMITTED] T2334.044

[GRAPHIC] [TIFF OMITTED] T2334.045

[GRAPHIC] [TIFF OMITTED] T2334.046

[GRAPHIC] [TIFF OMITTED] T2334.047

                             Communications

                              ----------                              




[GRAPHIC] [TIFF OMITTED] T2334.049

[GRAPHIC] [TIFF OMITTED] T2334.050

[GRAPHIC] [TIFF OMITTED] T2334.051

[GRAPHIC] [TIFF OMITTED] T2334.052

[GRAPHIC] [TIFF OMITTED] T2334.053

[GRAPHIC] [TIFF OMITTED] T2334.054

[GRAPHIC] [TIFF OMITTED] T2334.055

[GRAPHIC] [TIFF OMITTED] T2334.056

[GRAPHIC] [TIFF OMITTED] T2334.057

[GRAPHIC] [TIFF OMITTED] T2334.058

[GRAPHIC] [TIFF OMITTED] T2334.059

[GRAPHIC] [TIFF OMITTED] T2334.060

[GRAPHIC] [TIFF OMITTED] T2334.061

[GRAPHIC] [TIFF OMITTED] T2334.062

[GRAPHIC] [TIFF OMITTED] T2334.063

[GRAPHIC] [TIFF OMITTED] T2334.064

[GRAPHIC] [TIFF OMITTED] T2334.065

[GRAPHIC] [TIFF OMITTED] T2334.066

[GRAPHIC] [TIFF OMITTED] T2334.067

[GRAPHIC] [TIFF OMITTED] T2334.068

[GRAPHIC] [TIFF OMITTED] T2334.069

[GRAPHIC] [TIFF OMITTED] T2334.070

[GRAPHIC] [TIFF OMITTED] T2334.071

[GRAPHIC] [TIFF OMITTED] T2334.072



[GRAPHIC] [TIFF OMITTED] T2334.074

[GRAPHIC] [TIFF OMITTED] T2334.075

[GRAPHIC] [TIFF OMITTED] T2334.076

[GRAPHIC] [TIFF OMITTED] T2334.077

[GRAPHIC] [TIFF OMITTED] T2334.078




                                   


