[Senate Hearing 112-805]
[From the U.S. Government Publishing Office]
S. Hrg. 112-805
TAX REFORM: EXAMINING THE
TAXATION OF BUSINESS ENTITIES
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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
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82-334 WASHINGTON : 2012
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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
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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.*
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* 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.
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[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
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