[Joint House and Senate Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 114-51
SMALL BUSINESS, BIG TAXES: ARE TAXES
HOLDING BACK SMALL BUSINESS GROWTH?
=======================================================================
HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
APRIL 15, 2015
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Daniel Coats, Indiana, Chairman Kevin Brady, Texas, Vice Chairman
Mike Lee, Utah Justin Amash, Michigan
Tom Cotton, Arkansas Erik Paulsen, Minnesota
Ben Sasse, Nebraska Richard L. Hanna, New York
Ted Cruz, Texas David Schweikert, Arizona
Bill Cassidy, M.D., Louisiana Glenn Grothman, Wisconsin
Amy Klobuchar, Minnesota Carolyn B. Maloney, New York,
Robert P. Casey, Jr., Pennsylvania Ranking
Martin Heinrich, New Mexico John K. Delaney, Maryland
Gary C. Peters, Michigan Alma S. Adams, Ph.D., North
Carolina
Donald S. Beyer, Jr., Virginia
Viraj M. Mirani, Executive Director
Harry Gural, Democratic Staff Director
C O N T E N T S
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Opening Statements of Members
Hon. Daniel Coats, Chairman, a U.S. Senator from Indiana......... 1
Hon. Carolyn B. Maloney, Ranking Member, a U.S. Representative
from New York.................................................. 2
Witnesses
Mr. Brian Reardon, President, S Corporation Association, and
Principal, Venn Strategies, LLC, Washington, DC................ 5
Mr. Jody Fledderman, President and CEO, Batesville Tool and Die,
Inc., Batesville, IN........................................... 7
Ms. Holly S. Wade, Director of Research and Policy Analysis,
National Federation of Independent Business, Washington, DC.... 9
Mr. Thomas A. Hoghaug, CEO, Signus Medical, LLLC, and CEO,
Lockdown Surgical, Inc, Chanhassen, MN......................... 11
Dr. Martin A. Sullivan, Chief Economist, Tax Analysts, Falls
Church, VA..................................................... 12
Submissions for the Record
Prepared statement of Hon. Daniel Coats.......................... 34
Prepared statement of Hon. Kevin Brady........................... 34
Prepared statement of Hon. Carolyn B. Maloney.................... 35
Chart titled ``Small Businesses Have Added Jobs for 17
Straight Quarters''........................................ 38
Chart titled ``Share of Small Businesses Planning to Increase
Employment Is Near Pre-Recession Average''................. 39
Chart titled ``Share of Small Businesses Listing Taxes as Top
Business Concern Effectively Unchanged Over Time''......... 40
Chart titled ``Only 2/1,000 Estates are Subject to the Estate
Tax''...................................................... 41
Prepared statement of Mr. Brian Reardon.......................... 42
Prepared statement of Mr. Jody Fledderman........................ 51
Prepared statement of Ms. Holly S. Wade.......................... 53
Prepared statement of Mr. Thomas A. Hoghaug...................... 55
Prepared statement of Dr. Martin A. Sullivan..................... 59
Questions for the Record submitted by Senator Mike Lee and
responses from Holly S. Wade................................... 67
SMALL BUSINESS, BIG TAXES: ARE TAXES HOLDING BACK SMALL BUSINESS
GROWTH?
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WEDNESDAY, APRIL 15, 2015
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to call, at 2:31 p.m. in room
G-50 of the Dirksen Senate Office Building, the Honorable
Daniel Coats, Chairman, presiding.
Representatives present: Paulsen, Hanna, Delaney, Maloney,
Brady, Schweikert, Grothman, and Beyer.
Senators Present: Coats, Klobuchar, Lee, Sasse, and
Cassidy.
Staff present: Barry Dexter, Cary Elliott, Connie Foster,
Harry Gural, Colleen Healy, Karin Hope, Jason Kanter, Christina
King, Kristine Michalson, Viraj Mirani, Andrew Nielsen, Barry
Nolan, Robert O'Quinn, Brian Phillips, Leslie Phillips, and
Aaron Smith.
OPENING STATEMENT OF HON. DANIEL COATS, CHAIRMAN, A U.S.
SENATOR FROM INDIANA
Chairman Coats. We want to welcome our witnesses today.
It's no serendipity that this particular hearing has been
scheduled on tax day, April 15th, and we are talking about
taxes. We have some witnesses here who are experts in the field
and have experienced a real-life experience in terms of dealing
with our tax code from the small business owner's standpoint
and so we are looking forward to that testimony.
There are vexing challenges facing us with our tax code
that is burdensome on business, individuals and others and
complex beyond their ability to fully understand it. The small
business owners that I have met throughout Indiana have been
patient, persistent and overcomers. Despite the obstacles that
small businesses face, they are responsible for two-thirds of
the net new private sector jobs created in the United States so
it is important that we listen to you and understand the
challenges that you have.
Our role as legislators should be to ensure that the tax
code is no longer a major obstacle to growth and jobs for these
businesses. Against the headwinds of the slowest recovery since
1960, small business owners have to deal with a tax system that
is hopelessly complex, full of provisions that expire every one
or two years, riddled with special exemptions, deductions and
preferences and filled with new penalties.
The Small Business Administration lists the tax paperwork
as the most costly paperwork burden the Federal Government
imposes on small businesses, adding up to about $1,500.00 per
employee. It is not surprising that 9 out of 10 small business
owners have turned to an outside paid professional to figure
out their taxes as I have to do. Even though I took three tax
courses in law school I can't begin to plow my way through the
complexity of our tax code.
Today we will hear from witnesses who can discuss how tax
policy is affecting the broad landscape of small businesses. We
will also hear two stories of real businesses that will bring
home how taxes affect companies on the ground.
Tax day is a perfect time to commit to not let another
April 15th pass before we finally tackle comprehensive pro-
growth tax reform. And while it is urgent and essential to
lower our corporate rate tax, which is the highest in the
developed world, we must not forget the millions of small
businesses that pay taxes at the individual level and have just
experienced rate increases.
I look forward to hearing from our witnesses about how we
can tear down barriers to growth in our broken tax code and now
I want to recognize Ranking Member Maloney for her statement.
[The prepared statement of Chairman Coats appears in the
Submissions for the Record on page 34.]
[The prepared statement of Vice Chairman Brady appears in
the Submissions for the Record on page 34.]
OPENING STATEMENT OF HON. CAROLYN B. MALONEY, RANKING MEMBER, A
U.S. REPRESENTATIVE FROM NEW YORK
Representative Maloney. I want to thank very much Chairman
Coats and all of our witnesses for being here today. There is
broad agreement that small businesses are the backbone of our
economy, the anchors of our communities and that they have
played an important role in our current recovery.
When President Obama took over from former President Bush
the economy was in a free fall and small businesses were
bearing the brunt of the pain. Over the fourth quarter of 2008
and the first quarter of 2009 small businesses shed more than
three million jobs.
President Obama and Democrats in Congress along with the
Federal Reserve took bold actions to turn things around in the
darkest days of the Great Recession. These actions included a
number of efforts designed specifically to support small
businesses. For example, the Recovery Act cut taxes for small
businesses allowing them to immediately deduct up to $250,000
of investment, carry back losses for 5 years and exclude from
taxation 75% of capital gains from small business investment.
Several small businesses in my district told me that this
initiative alone helped them save their business. Today small
businesses are leading the economic recovery. Small businesses
have added more than 6 million jobs, over 17 straight quarters
of small business job growth which we can see in this Chart
Number 1. You can see where we have been growing with a solid
blue rise of jobs for small businesses.
We have come a long way in the past 6 years. The share of
small businesses planning to add jobs is back near the pre-
recession average as we can see here in this Chart 2. While
this reflects major progress I believe that we need to do much
more to support small business growth.
The Administration's tax reform plan, for example, would
simplify and cut taxes for America's small businesses.
President Obama's revenue proposal includes expanding and
permanently extending increased Section 179 expensing for small
businesses. The proposal would also increase the number of
small businesses that take advantage of simpler cash accounting
rules.
The Administration's approach provides tax cuts for small
businesses in a fiscally responsible way and in the context of
broader business tax reform. By contrast, the Republicans in
the House have passed bills without offsets which would blow
holes in the budget. Some of my Republican colleagues would
have us believe that small businesses are up in arms about
President Obama's proposals. But this chart, based on a survey
and data provided by the NFIB, a very respected organization
and one of our witnesses today, shows that the share of small
businesses listing taxes as their top concern is no greater
today than it was when former President Ronald Reagan left
office, as we see in Chart Number 3.
One of our principal goals today should be to decide what a
small business is for tax purposes. Most of the 95% of
businesses that are organized as pass-throughs are small, but
many are extremely large. Numerous large law firms, accounting
firms, hedge funds and other businesses are pass-throughs. The
tax code treats these large businesses the same as ``mom and
pop'' stores down the street and one of my questions today will
be should we treat them the same?
When designing tax policy, fairness should be a principal
concern. Some large multinationals pay less than small
businesses and some extremely large companies don't pay any
federal income taxes at all. In other words the corner store
likely pays more in federal income taxes than some of our
country's largest corporations. Those who are critical of our
tax system should save some of their outrage for this.
Before taking on tax reform, Republicans have proposed
repealing the estate tax and they plan to vote on it in the
House later today or possibly tomorrow. Let's be clear:
repealing the estate tax would be a major windfall for some of
our most privileged and wealthiest citizens. With the current
exemption of over 5 million per person and 10 million per
couple, the estate tax affects only 2 out of 1,000 estates. In
other words, 99.8% of Americans do not pay any estate tax at
all as we see in Chart 4.
Republicans say they are motivated by a desire to protect
small businesses but that is something of a Trojan horse I
believe. Only about 20 small businesses and small farm estates
owed any estate tax in 2013 according to the Tax Policy Center.
Only 20. Repealing the estate tax is also very expensive. The
Joint Committee on Taxation found that repealing the estate tax
would increase the deficit by $269 billion over 10 years.
1986 was a massive overall and simplification of our tax
code. The minute the ink was dry we began to undo it and trust
me, it wasn't small businesses that were at that tax table. We
must make sure that any tax reform benefits the small firms,
not just the big multinationals gaming the system to further
limit their tax obligations.
Tax reform is hard. That is why there hasn't been a major
rewrite of the code in about 30 years. For it to work it must
be comprehensive and it must be bipartisan. I have always said
the best legislation is always bipartisan and I look forward to
hearing the perspective of our witnesses today on this
important subject. Small businesses create massive amounts of
jobs in our great country. Thank you for coming here today,
thank you for appearing before our Committee.
[The prepared statement of Representative Maloney appears
in the Submissions for the Record on page 35.]
Chairman Coats. Well, thank you Ranking Member Maloney, and
I will now introduce our witnesses. I think we could put on a
pretty good show here if I turned it right over to my colleague
Congressman Brady to talk about estate taxes which the House
will be voting on I think at 4 o'clock or so. So we are going
to try to move through this fairly quickly so our House members
in particular have an opportunity to speak and ask questions.
But with the joint chambers and two parties we have
somewhat of a byzantine balancing act here in terms of making
sure that everybody gets an opportunity in a fair way. Let me
quickly introduce our witnesses.
Brian Reardon is President of the S Corporation Association
and a Principal at Venn Strategies. From 2003 to 2005, Mr.
Reardon was special assistant to the President for economic
policy, working within the President's National Economic
Council. He has also worked on Capitol Hill and for the
National Federation of Independent Business.
Jody Fledderman is President and CEO of Batesville Tool and
Die in Batesville, Indiana, a company that supplies precision
metal stamping components for the automotive and appliance
industries, among others. He is also past Chairman of the
Precision Metalforming Association and serves on the boards of
New Horizons Rehabilitation, the Indiana Manufacturers
Association and the State of Indiana's Chamber of Commerce.
Ms. Holly Wade is the Director of Research and Policy
Analysis for the National Federation of Independent Businesses.
In addition to providing analysis to small businesses on public
policy, she helps produce NFIB's monthly small business
economic trends survey. She also serves on the Department of
Commerce Industry Trade Advisory Committee on Small and
Minority Business.
Martin Sullivan. Dr. Sullivan is Chief Economist for Tax
Analysts, writing frequently in tax publications. Previously he
taught economics at Rutgers University and served as a staff
economist at the U.S. Department of Treasury and later at the
Joint Committee on Taxation. He graduated from Harvard and has
a PhD from Northwestern University.
And finally, our witness from Minnesota who I am going to
let Congressman Paulsen introduce, Senator Klobuchar sent her
regrets she will be arriving late. So Congressman Paulsen I
would love to have you introduce our witness from Minnesota.
Representative Paulsen. Well thank you Mr. Chairman, and it
is my pleasure to welcome Mr. Thomas Hoghaug. He has a long and
accomplished career in the medical device industry and is
currently CEO of both Signus Medical as well as LockDown
Surgical in Chanhassen, Minnesota, which is my home town.
I would like to thank Mr. Hoghaug for his participation in
today's hearing and his willingness to discuss some of the
challenges, the very real challenges medical device tax
presents to his companies and so many others like them in
Minnesota and around the country. I expect, Mr. Chairman, his
testimony will prove very valuable to members of the Committee,
seek ways to ease the tax burden faced by America's small
businesses today.
Chairman Coats. Thank you Congressman. We will go in order
that I just read, starting with you Mr. Reardon and then
followed by Mr. Fledderman and Holly Wade, Mr. Hoghaug and Dr.
Sullivan.
STATEMENT OF MR. BRIAN REARDON, PRESIDENT, S CORPORATION
ASSOCIATION, AND PRINCIPAL, VENN STRATEGIES, LLC, WASHINGTON,
DC
Mr. Reardon. Chairman Coats, Vice-Chairman Mr. Brady and
Ranking Member Maloney I appreciate the opportunity to testify
before the Committee today. The S Corp Association and its'
allies have been active on business tax reform efforts for
about 5 years now and in that time we developed a number of
themes that I would like to emphasize today. They are explained
more fully in my written testimony.
First, if Congress were starting from scratch it would use
S Corp as the model for taxing business income. The basic
principles are that income is taxed once and only once. It is
taxed when the income is earned and regardless of whether the
income is distributed to the shareholders and its taxes at
progressive rights. High income shareholders pay high rates low
income shareholders pay lower rates. That's the correct way to
tax business income.
Second, S Corp's are doing exactly what Congress intended
them to do when they were created 50 years ago. The S Corp was
created to incent private and family-owned businesses and it
has worked. Today there are 4.6 million S Corps and they are in
every community and every industry.
While Congress has acted over the last 50 years on numerous
occasions to improve the rules and to enhance the ability of
families and entrepreneurs to use the S Corp model to structure
their businesses.
Third, you hear lots of talk about the erosion of the
corporate tax base. What you don't hear is that the business
tax base, that is pass-through businesses plus C corporations,
has actually grown over the last 30 years since the 1986 Tax
Reform Act. Prior to 1986 the business tax base was about 9%
almost wholly made up of C corporations, 9% of the GDP. Today
it's 11% of GDP, 6% pass-through, 5% C Corp, so it's grown and
it's grown wholly because of the growth and progress of the
pass-through community.
Fourth, pass-through businesses employ mostly private
sector workers out there. Every day 55% of private sector
workers get up and they go to work at a pass-through business.
In some states, nearly 7 out of 10 workers work at pass-through
businesses.
Fifth, pass-through businesses pay taxes and they pay lots
of them. There is this theme out there that if you are not
paying the corporate tax you are not paying taxes at a
reasonable rate. That's been something that we have been
concerned about for a long time. Back in 2013 we asked an
economic firm to study how much do businesses pay, and what is
their effective rate by business structure. I think that's the
only time anybody's ever done that kind of study.
And what we found was that S Corps have the highest
effective tax rate, about 32%. Big S Corps, the large ones that
people want to make pay taxes like C Corps they pay an
effective rate of 35% so they are paying lots of taxes right as
they are right now as S Corps.
If you look on this thing you can see the C Corp number is
27%. An important point is that of that 27% dividends makes up
2 percentage points so there is a second layer of tax on C
Corps. Here dividends are represented, capital gains are not,
so you have to add that in. We were unable to calculate the
capital gains rate. But the bottom line is that pass-through
businesses are paying a lot of tax.
Sixth, the tax rates on pass-through businesses just went
up and they went up a lot. This is a result of the fiscal cliff
and the Affordable Care Act taxes. The top rates on pass-
through businesses increased from a marginal rate of 35% to
almost 44%, you can see the components up here. The main rate
went up to 39.6. There's the new Affordable Care Act tax of
3.8% and then the reinstatement of the Pease limitation on
itemized deductions, that's about 1.2%.
When you combine that with state and local taxes, some
pass-through businesses are paying more than 50% marginal rates
on their income.
I mention all of these points to set the table to talk
about tax reform. Back in 2011 the Treasury Department floated
a proposal to broaden the tax base by limiting business
deductions to credits and to use the revenue to lower the
corporate rate.
The challenge for S Corps and other pass-throughs of this
plan is obvious. They use the same deductions and credits but
they pay individual rates not corporate rates. What might this
look like? I think we have a new slide here. Yeah, here it is--
so here's some companies they both have $20 million in revenues
they both use the same deductions and credits. You can see
right now the S Corp or the pass-through is paying the higher
top rate than the C Corporation.
Now if you try to a tax reform and I am not advocating this
but if you go to the next slide and you eliminated those
credits and deductions you can see that under the
Administration's plan the C Corp would get a 25% rate. While
the S Corp is still paying 44.6. That's simply unsustainable.
So pass-through businesses oppose corporate only tax
reform. What do we support? Since 2011 we have advocated the
following three principles for tax reform. One it should be
comprehensive. Two it should lower rates for pass-throughs and
C Corporations alike. And, three, it should reduce or eliminate
the double corporate tax. The double tax on corporations is the
reason U.S. businesses are uncompetitive. We are one of only a
few countries to actually impose a double tax on our corporate
businesses. We should simply get rid of it.
So what are the takeaways? One, S Corporations are the
correct way to tax business income. Two, pass-through
businesses are a significant part of the economy. Three, the
top rates on these employers just went up significantly and 4,
tax reform done right should be comprehensive, it should lower
rates on pass-throughs and C Corps alike and it should reduce
or eliminate the double tax on corporations.
I appreciate the opportunity to testify and I look forward
to answering any questions.
[The prepared statement of Mr. Brian Reardon appears in the
Submissions for the Record on page 42.]
Chairman Coats. Mr. Reardon, thank you very much. I
appreciate you staying close to the five-minute rule that helps
give us time to have a good interaction with the witnesses.
Thank you. Mr. Fledderman, you're on.
STATEMENT OF MR. JODY FLEDDERMAN, PRESIDENT AND CEO, BATESVILLE
TOOL AND DIE, INC., BATESVILLE, IN
Mr. Fledderman. First of all thank you for the opportunity
to testify here today before you. My name is Jody Fledderman,
I'm the President and CEO of Batesville Tool and Die in
Batesville, Indiana. I have been the president of that company
since 1989. We provide metal stamping assemblies mostly for the
automotive industry. I am here to talk to you guys today a
little bit about our business and what the taxes do to us.
We have 395 employees at this facility and we would
actually hire more if we could find enough qualified workers. I
am not a tax expert but I am here to tell my story from a
business owner perspective and how these tax laws are affecting
us. We have a lot of obstacles that we have to deal with as
manufacturers. The single biggest obstacle for us to deal with
right now is the uncertainty in our tax code.
It's very difficult for us to plan the future when we don't
know the rules for today. It feels as if people in Washington
are so insulated from what's going on in these small businesses
that they don't realize not doing something can affect us as
much as doing something. That's why I believe we also need
comprehensive tax reform. Not just to lower our rates to
globally competitive levels, but also to provide stability and
predictability for us.
Washington should develop tax policy that encourages
investment and manufacturing in America, not penalize companies
and their owners for doing business in the U.S. But we need tax
reform for all businesses not just C Corporations. A January
2015 industry survey showed 61% of metalworking companies are
pass-through businesses. Sector-wide 81% of all manufacturing
companies are pass-throughs and pay much higher taxes as you
saw from the previous slides. This means C Corporation only
reform leaves behind 8 out of every 10 manufacturers, mostly
small and medium sized family-owned businesses.
We are one of those millions of manufacturers that
corporate only reform would leave behind. Our company is
structured as an S Corporation. We are a multi-generational
manufacturing business with very strong ties in the community
and we have awarded shares and opportunity for ownership to a
lot of our key employees that are key to our success. Because
of that we are now at 72 shareholders so we are a little
unusual for an S Corporation. We are not a 1 or 2 owner
company.
A main reason most family-owned or tightly held
manufacturers structure themselves as pass-throughs is to make
it easier to transition the business to your family when you
retire. Some of our shareholders are high school students, some
of them are retirees in their 80s, there is no way they could
cover the tax penalties of a sale or buy-back if we were a C
Corp so that is one of the main reasons that the structure of
the S Corporation is so important for us.
The main drawback to being a pass-through structure is the
most obvious. As you saw on the slides before publically most
people believe the top rate is 39.6. In reality we are paying
it at 43.4% for our federal income taxes, when you calculate in
the surcharges and some of the other additions. Now keep in
mind that we have got 72 shareholders and we also have one that
is a fully passive income shareholder which is why we pay the
extra 3.8% tax.
We have to pay that extra tax for everybody so we pay it at
the 43.4% for all of our shareholders and even if that's not
what their tax liability is and then it is up to them to try to
get those refunds on their own. Now because we are not a one or
two owner company that money doesn't come back to the company,
it ends up with our shareholders if they can claim it or if
they had tax attorneys that can do that for them.
We have looked at several different scenarios. Our tax
rates--had our tax rates not increased to 44% we would have had
an additional $500,000 for our manufacturing operations. If
Congress were to lower the effective tax rate to even 28% it
would reduce our tax liability by $700,000 obviously more if
lowered to 25%.
The public perception plays a big role in this. The average
person assumes that the owner takes that $700,000 and puts it
in their pocket when obviously they don't, that's re-invested
back in the business. Profit margins in our industry are
usually less than 3% so all the investment back in the business
comes from any profitability that we are able to generate.
While tax rates receive the most attention, nothing
frustrates us more in manufacturing than the constantly
expiring tax credits and deductions, that's really the biggest
problem for us. We feel like Congress takes too casual of an
approach to the tax extenders, you know that we will get to
them eventually. What Washington doesn't understand I believe
is that we rely on those provisions to plan our investments and
expansion years in advance.
Right now we are mulling the purchase of a $3 million
machine that would probably add 15 to 18 jobs to our business
but it would take 16 months to get that machine in service and
we have no idea if we will be able to use Section 179 or Bonus
Depreciation to apply to that investment.
I'll wrap up here of what happened to us in 2014. I told
the story in Senator Coats' office and I think it is one of the
reasons why I was asked to come here and talk today. We pay the
taxes on behalf of our shareholders every quarter, we make
quarterly estimate payments and by the end of the third quarter
we were paying at our 43 or our nearly 44% and so the week
before Christmas we find out what credits will be extended.
Well we found out that the taxes that we had paid in the
third quarter was already $600,000 more than what our tax was
supposed to be, so that's tax that now we have paid into the
Federal Government that we shouldn't have and that we will end
up coming back to our shareholders in some form or another,
some of it will if our shareholders' tax accountants are savvy
enough to get it back but that's $600,000 that we will never
see back in our business as cash flow.
So in summary the real--my real feeling is that you know
people are never really going to be happy with the tax code no
matter what it is. They're always going to think it is too much
but the real problem is that we can't plan our future. We are
being asked to compete globally and compete with people all
around the world. We already have one of the highest tax codes
of all the countries in the world and then not knowing what the
rules are makes it almost impossible for us to plan a future,
thank you again for your time.
[The prepared statement of Mr. Jody Fledderman appears in
the Submissions for the Record on page 51.]
Chairman Coats. Mr. Fledderman, thank you very much for
your testimony.
Ms. Wade.
STATEMENT OF MS. HOLLY S. WADE, DIRECTOR OF RESEARCH AND POLICY
ANALYSIS, NATIONAL FEDERATION OF INDEPENDENT BUSINESS,
WASHINGTON, DC
Ms. Wade. Good afternoon Chairman Coats, Ranking Member,
Maloney, Members of the Joint Economic Committee. Thank you for
the opportunity to testify today. I am pleased to be here on
behalf of the National Federation of Independent Business as
the Committee discusses small business tax policy and the
economic growth in the small business sector.
The small business economy is slowly emerging from one of
the worst recessions in U.S. history and if I base small
business economic trend survey data it shows the dramatic
change in consumer spending employment, employer's confidence
and business investments throughout the recession and
subsequent recovery.
While some business activities have made significant
improvements over the past 4 years, capital expenditures and
outlook on business conditions and expansion remain at
historically low levels due to economic conditions and the
political climate. The threat of higher taxes whether in the
form of income taxes, the healthcare law, the estate tax,
Section 179 expensing limits or others, create enormous
uncertainty among small business owners worried about the
impact of policy changes on future business costs.
The survey also tracks which problems most affect owners in
operating their small business. From mid-2008 through mid-2012
poor sales was their number one problem as consumer spending
declined sharply, but now taxes is often the number one concern
for small business owners, a problem that moderates the
economic recovery in the small business sector.
The identified small business problems and priorities
survey highlights three main areas of tax policy that are of
great concern to small business owners. With the cost of health
insurance leading as the most severe problem for small business
owners, 5 of the top 10 problems are all tax related. These tax
problems fall into 3 categories, cost, complexity and frequent
changes.
The cost of tax obligations is three-fold. The amount paid
to federal, state and local tax agencies, the cost of hiring a
CPA or a tax advisor to navigate complex tax codes and the
owner's time in providing the required paperwork and/or filing
themselves. Eighty-eight percent of small employers use the tax
preparer and most use one to either insure compliance or
because the requirements are too complex.
Tax related regulations cause the greatest difficulties for
40% of small employers, more than environmental, health and
safety or employee regulated regulations. And compliance costs
are especially problematic because they are 76% higher for
small businesses than for their larger counterparts, costing
them $18 to $19 billion a year or about $74 per hour.
Tax related costs compete with the owner's ability to use
limited profits for primary business activities. Profits are
the main funding mechanism for owners purchasing new equipment,
expanding facilities, hiring and stocking inventory. Tax
related costs pressures are especially problematic for newer
firms that almost solely rely on profits for operation and
expansions costs as they are generally not able to access
traditional vending sources.
But regardless of the firm's age, the tax burdens take a
heavy toll on the owner's ability to operate their business.
One example that encapsulates all three categories of tax
related problems for small business owners is the Affordable
Care Act. The employer mandate, small business tax credit and
the termination of employer reimbursement plans are just a few
of the many tax related costs and complications small business
owners face in complying with the new law.
The ACA though is just one example of how excessive tax
burdens affect small business owners. And the federal tax code
is only one layer of tax obligations owner's face in operating
their business. They must also comply with state and local
taxes adding to the overall compliance burden. Unfortunately
only the owner experiences the cumulative effect of all the
required taxes and regulations placed on their business.
Federal, state and local lawmakers and government agencies
only see them in isolation giving a false perception of their
true impact.
In conclusion small business owners continue to be
accessibly burdened by direct indirect complicated and ever-
changing taxes related to operating their business. Alleviating
the excessive tax burden on small businesses is an essential
component to creating a strong and healthy environment for
owner's to operate and grow their business.
I appreciate the opportunity to present NFIB's views and
data on the effects of tax policy on small business and I look
forward to answering any questions you may have.
[The prepared statement of Ms. Holly S. Wade appears in the
Submissions for the Record on page 53.]
Chairman Coats. Thank you, thank you very much.
Mr. Hoghaug.
STATEMENT OF MR. THOMAS A. HOGHAUG, CEO, SIGNUS MEDICAL, LLC,
AND CEO, LOCKDOWN SURGICAL, INC, CHANHASSEN, MN
Mr. Hoghaug. Chairman Coats, Vice Chairman Brady, Ranking
Member Maloney, Representative Paulsen I thank you for the
opportunity to testify. My name is Thomas Hoghaug I currently
hold the position of CEO for Signus Medical LLC and LockDown
Surgical, Inc. It is an honor for me to be able to address this
Committee today and personally shed some light on an extremely
negative impact the medical device tax has had on both of my
companies and on similar small medical device firms.
The issues and examples I will share are personal examples
that are in no way unique to Signus Medical and LockDown
Surgical, they are common experiences shared by a multitude of
device firms and have been conveyed, confirmed to major
meetings, committees and gatherings of medical device
executives.
Small device firms are primarily responsible for the
majority of innovation and development of better and more cost
effective treatment modalities for patients in the United
States. I have worked in the orthopedic medical device arena
for over 27 years, including as a founder of over 10 companies.
Signus Medical is a master importer developer and
distributor of spinal implants, while LockDown Surgical is an
extremity company focused on joint ligament repair. Both teams
are focused on improving the quality of life and reducing human
suffering. LockDown Surgical was founded in February of 2012
with a single FDA cleared product for shoulder repair. It has
been operating at an annual financial loss and expects to reach
breakeven finally and begin to turn a small, modest profit in
the fourth quarter of this year. It would have been sooner if
it was not for the medical device tax.
With the introduction and the implementation of the
Affordable Care Act's medical device tax, companies have
experienced a multitude of unforeseen and crippling
consequences of the tax including layoffs, non-replacement of
lost employees, disrupted and negative cash flow, curtailing or
elimination of R&D projects, reduced inventory expansion and
effective tax rates which can exceed 100% of profits.
Money that was once used to grow and re-invest in the
expansion of the companies is now sent to the IRS every two
weeks. Another perhaps unforeseen but very significant impact
of the medical device tax is disruption of both of my company's
cash flow. As mentioned earlier payments are made within two
weeks of posting sales, but the collections are running upwards
of 70 days.
These payments strip both firms of ready cash which was
previously used for day-to-day operations, payroll, payments to
vendors. Since 2012 our monthly cash flow has been negative due
to the device tax. As of last year I shelved two major R&D
projects because of the device tax.
Instead of investing in innovation we are looking at how we
will simply manage due to the cost of introducing several new
products in 2015 which would under pre-tax condition
expectations return Signus Medical to nominal profitability and
expand LockDown's surgical products into other areas of the
body where there is a very real and significant patient need.
Most difficult for me I had to personally lay-off a number
of team members, specifically to pay this medical device tax. I
am very proud to be actively involved in the medical device
arena. It has historically been a shining star in the U.S.
economy and has boasted some of the highest paying jobs when
compared to all other business sectors and average wages. The
advancements in treatments and improved patient outcomes is
commonly a direct result of the smaller and more nimble device
companies such as Signus Medical and LockDown Surgical who
reinvest profits and resources into the development of new and
lower cost-effective surgical and non-surgical solutions.
Simply put the device tax is destroying our ability to
deliver on the promise to improve patient care. This is
something I will not compromise on. With the inclusion of the
medical device tax in the 2014 operational budgets, both Signus
Medical and LockDown Surgical posted effective tax rates in
excess of 110%. This is not sustainable for any business, large
or small. I feel once again I will be facing employee down-
sizing and further elimination of development projects and thus
new clinical therapies to patients in the United States in
order just to remain in business to pay the device tax.
Money required for re-investing to expand infrastructure
including employees, of inventory and product and R&D project
is no longer available. Again these problems are not unique to
my two companies and are clearly felt across the entire medical
device industry. I do believe however that smaller and start-up
companies are more severely impacted by the device tags given
their inherent size and the inability to spread or defer the
cost over non-device products being sold by larger, more
vertically integrated companies.
In conclusion I would like to thank the Committee members
for this opportunity to testify. I sincerely hope that the
information and personal experiences I shared helped to
enlighten you as to the true negative impact the medical device
taxes have had on the medical device industry as a whole and
smaller and start-up companies in general.
Growth, innovation and new job creation come from small
medical device firms. The medical device tax threatens to kill
off or at the very least curtail this segment of our industry,
thank you.
Chairman Coats. Mr. Hoghaug, thank you very much for your
testimony. And now Dr. Sullivan.
[The prepared statement of Mr. Thomas A. Hoghaug appears in
the Submissions for the Record on page 55.]
STATEMENT OF DR. MARTIN A. SULLIVAN, CHIEF ECONOMIST, TAX
ANALYSTS, FALLS CHURCH, VA
Dr. Sullivan. Chairman Coats, Vice Chairman Brady, Ranking
Member Maloney, Members of the Committee thank you for this
opportunity to testify. Two recent developments have heightened
interest in tax relief for small business. First, in 2012
Congress allowed the top individual rate to rise from 35 to
39.6%. Second, there is concern that Congress will pursue
corporate only tax reform that would cut the corporate rate and
to pay for that lower rate cut, reduce tax deductions and
credits for all businesses.
This would hurt small business that would lose tax breaks
but get no relief from the rate cut. In my remarks today I will
briefly comment on five options for small business tax relief.
Option 1--Congress could reduce the top individual rate to
35% or lower. We should always strive to keep tax rates as low
as possible but the case for lowering the top tax rate should
not pivot on the effect that it would have on small business
but on larger issues such as the need for deficit reduction,
the effective rate cuts on tax fairness and the effect of a
rate cut on the overall economy.
The figure on the screen shows a box. The box represents
all the income affected by a change in the top individual rate.
Only 30% of pass-through income is in this box, only 21% of it
is related to pass-through employers and only 8% is related to
small business employers. The bottom line--most of the benefit
of cutting the top rate would not go to small business.
Option number 2--Congress could cut the top individual rate
but limit that rate cut only to pass-through businesses and
several states have adopted this approach most notably in 2013
Kansas completely exempted all pass-through income. One problem
with this approach is that it opens the door to aggressive tax
avoidance. Secondly, much of the benefit would not go to small
business, but go to large businesses, some of them very large.
Here are the facts. In 2011 there were 15,000 S
Corporations with more than 15 million in sales. They accounted
for 27% of all S Corporation profits. And there were 22,000
partnerships with more than 100 million in assets, they
accounted for 64% of partnership profits. Clearly we should not
equate pass-through business with small business.
Option 3--Congress could limit any rate cuts for pass-
through business to certain industries. Dave Camp's tax reform
provided a 25% rate for manufacturing and construction pass-
through business. This target approach is a lot less expensive,
only about a quarter of the cost of an across-the-board pass-
through tax relief like they had in Kansas. But why should we
pay for some industries over others and why if we want to
create jobs should we exclude labor intensive service and
retail businesses.
Another problem is the complexity. It is hard to figure out
exactly which business lines qualify for these benefits as
demonstrated by our current difficulties with the Section 199
deduction for domestic manufacturing.
Option number 4--Instead of providing back-end tax relief
for small business income, Congress could provide front-end
relief for business costs such as capital spending, wages and
research. This approach has several advantages. It is far
easier to measure qualified costs than it is to isolate income
that is qualified for these benefits.
Second, there is far less opportunity for tax planning and
third, this approach can target activities that promote
economic growth. So for example, if Congress wants to create
jobs it can do this more effectively with a wage credit than
with a cut--a rate cut of equal revenue cost.
Deducting the full cost of capital equipment when purchased
is called expensing. As tax breaks go expensing for small
business is one of the most meritorious. It is an incentive for
capital spending, it's better than a rate cut, it increases
cash flow and it simplifies record-keeping.
Besides a wage credit or expensing, Congress could make the
research credit more attractive to small business by making it
refundable as several states have done.
And Option number 5--Simplification. Of course everybody
wants simpler taxes but simplification is especially important
to small business. Compliance costs per employee are much
higher for small firms than for large firms, yet it is the
economic equivalent of a tax surcharge just for being small.
One particularly promising approach for small business tax
simplification would be the expansion of the cash method of
accounting.
So in conclusion to help small business we should avoid
rate cuts that are poorly targeted, complex and spur costly and
unproductive tax planning. Instead we should provide tax relief
tied directly to investment and employment and most of all we
should simplify.
Simplifications are a sure-fire way to reduce costs for
business, to promote growth with minimal impact on the deficit,
thank you.
[The prepared statement of Dr. Martin A. Sullivan appears
in the Submissions for the Record on page 59.]
Chairman Coats. I want to thank our witnesses for their
testimony and I look forward now to the interaction between the
Members. I want to turn this over now; I'm going to defer my
time. My House colleagues I know have an important vote on
taxes, interestingly enough, coming up at 4 o'clock. So let's
see if we can get as many of them some time here as we can. I
do want to turn to our Ranking Member Mrs. Maloney and then we
will hear from Mr. Brady.
Representative Maloney. I want to thank you all for your
testimony and thank you for being sensitive to our time. One of
the biggest challenges in crafting tax policy for small
businesses is deciding what counts as a small business. Many
Americans when they think of a small business think of a corner
grocery store but clearly small businesses are much more than
that and there are dozens of possible definitions based on
revenues, number of employees, average revenue per employee,
industry classifications or other characteristics.
And defining what a small business is is critical to the
success of our hearing today and I would like to ask Ms. Wade
from the NFIB can you tell me in two or three sentences for the
purpose of tax policy what is a small business, how would you
define it?
Ms. Wade. For NFIB members, most of our members are under
40 employees however they span all industries and all size
groups so for tax policy the policy that would benefit most of
them would be lower rates and simplification and reducing the
changes in the tax code. There isn't a strict definition
because there are many firms that are labor intensive versus
capital intensive so it is a broad spectrum that we represent.
Representative Maloney. Okay, is a global law firm with
dozens of offices around the world a small business Ms. Wade?
Ms. Wade. It depends. It depends what the composition of
the firm here. We have you know, we have manufacturers who
export, we have members who span every industry so tax policy
that can cover most of them would be our choice for pro-growth,
supporting most small businesses.
Representative Maloney. Is a hedge fund with billions in
assets a small business Dr. Sullivan would you say?
Dr. Sullivan. I think it is just common sense that that is
not a small business.
Representative Maloney. What about a global law firm?
Dr. Sullivan. Well as we know they can have thousands and
thousands of partners. They are considered a pass-through
business, they are taxed as a partnership, but they are
certainly not a small firm.
Representative Maloney. Mr. Fledderman you run a successful
tool and die company and you have an I would say a personal
stake in this issue. Do you think, for example, that a global
law firm or a hedge fund should be classified as small
business?
Mr. Fledderman. I don't really know if it should be
classified as a small business.
Representative Maloney. For purposes of the tax code?
Mr. Fledderman. No I don't. I think that manufacturers and
people that make things obviously more on that side since that
is what we do, but that is what really generates the jobs in
this country we all know that and I believe that that's what we
should be concentrating on.
Representative Maloney. Dr. Sullivan could you please tell
me very briefly what is a pass-through? Is a pass-through the
same thing as a small business?
Dr. Sullivan. A pass-through business is one of three
classifications under the tax code, either a sole
proprietorship, a partnership or an S Corporation, they are
called pass-throughs because as all of these folks here know
the income is not taxed at the entity level it is taxed on the
individual level.
However it is not the same thing as a small business. Most
small businesses are pass-throughs but most pass-through not
all pass-throughs are small businesses. There are many very
large pass-through businesses.
Representative Maloney. Should these large entities with
hundreds of millions and even billions of revenue be treated
the same and face the same tax structure as the local
laundromat and the neighborhood deli, Dr. Sullivan?
Dr. Sullivan. It depends. I can use a real live one in
Kansas where the Governor Brownback put in legislation to
exempt all pass-through business from all income tax in Kansas.
It was discussed as a small business tax relief which it was
but it also provided tax relief for the largest businesses in
the state.
Representative Maloney. And are there steps that we could
take to better differentiate in the tax code between
traditional small business employers and huge companies
organized as pass-throughs? What steps would you recommend Dr.
Sullivan since you have written about and studied this?
Dr. Sullivan. Well I think ultimately we are talking about
job creation so I would suggest targeting the tax benefits to
those businesses that have lots of employees rather than just
lots of assets.
Representative Maloney. Thank you my time has expired.
Chairman Coats. Thank you.
Congressman Brady.
Vice Chairman Brady. Thank you Chairman for calling this
important meeting I do have a statement I would like to submit
for the record.
Chairman Coats. We will accept that.
Vice Chairman Brady. The gist of the statement is to lay
out the economic benefits of repealing the estate tax and the
harm it does to our economy and family-owned farms and
businesses, especially a growing group for women and minority-
owned businesses, building wealth for the first time in
America. We think that's a good thing and it also lays out the
need for tax reform, corresponding to the fact that in a recent
poll 80% of Americans believe Congress ought to act now to fix
this broken tax code.
A quick question for you Mrs. Wade and then a tax question
for the others. On the estate tax, we are told that this is
just tax cuts for the wealthy, that your members are the Paris
Hilton's of the world, the robber barons of the Teddy Roosevelt
day, that this doesn't benefit average Americans. But my
understanding from NFIB and other groups is that this death tax
is the number 1 reason family-owned farms and businesses aren't
passed down to the next generation.
It is hurtful to the economy. It harms jobs, it is the
wrong tax, the wrong time or it is the wrong people and studies
show that repealing the estate tax would actually create more
revenue for the Federal Government than keeping the tax in
place. And part of the damage is that the businesses use so
much time, devote so much time and money to planning to survive
the death tax rather than investing in their companies.
So for your member's small businesses, would repealing the
death tax help them spend more money and time on growing their
business and jobs and less time on just doing the tax planning
that they have to do today?
Ms. Wade. Certainly, we've produced a number of studies
looking into succession planning for small business owners and
small employers and how they are trying to work through the
estate planning phase of about 30% are their business. So
looking to pass their business on to family members and while
the estate tax you know affects a number of them, more of them
are spending resources in trying to plan for this, it is that
uncertainty of where their business is headed in the future, it
is the uncertainty of what thresholds the estate tax will be in
the future.
So in our latest survey, tax survey 34% in the last five
years of small business owners have paid for trying to plan for
an estate tax so 35% probably many or fewer will pay this
estate tax but it is a misallocation of resources.
Vice Chairman Brady. That's a good point, the claim is just
a very small number paid the tax. You are saying 1 out of 3 of
your members have to engage in tax planning and to divert
resources from productive investments to avoid or minimize
estate taxes. There is often in tax reform a trade-off between
lowering rates and reducing depreciation or increasing
depreciation so my view is that corporate rates are extremely
important, but so is cost recovery. The ability to fully cover
the cost of those investments is a big driver of main street
jobs. So I wanted to ask the other witnesses today, do you have
any advice to us as we look at this issue of capital cost
recover, and whether it is equally important to rates when it
comes to business growth Mr. Reardon?
Mr. Reardon. I think it's incredibly important. You know
there are a couple of plans out there, including one put
forward by Senator Lee, to allow full expensing and it
effectively shifts the taxation of business income from an
income base to a consumption base approach which I think most
economists agree is the correct way to go. It also has the
benefit of being incredibly simple.
I mean you go out and you buy a piece of equipment and you
write it off. You don't have to keep track of depreciation
schedules, you don't have recapture, you don't have all that so
it benefits on both sides, it reduces the cost of capital and
it increases simplicity.
Vice Chairman Brady. Thank you Mr. Reardon.
Mr. Fledderman.
Mr. Fledderman. Oh yeah I agree 100%. It would be very
beneficial but again I will stress that it's really important
for two things. Number one that we know what the rules will be
and then if this is an expense, it is some type of expense it
is made permanent so many of the pieces of equipment that we
have take months to put into service and when we are informed
that the third week of December what is going to be allowable
we have got a week left to purchase something over Christmas,
again it makes sense.
Vice Chairman Brady. No, thanks for that point, Mr. Hoghaug
and then Dr. Sullivan?
Mr. Hoghaug. No I would agree that estate planning is
something that I used to actually consider and look at for
succession to my children and all. Right now given the medical
device tax it's negative impact and this I am just worried
about being in business in a few years.
Vice Chairman Brady. Having an estate.
Mr. Hoghaug. So you know right now that planning has been
set aside in lieu of planning on the day-to-day business.
Vice Chairman Brady. Thanks, Dr. Sullivan briefly I'm out
of time.
Dr. Sullivan. Sure. Capital expensing and bonus
depreciation are very important and effective incentives for
capital investment, especially for small business because they
give the additional benefit of cash flow. The problem is it is
such a good incentive that it might be better than a rate cut
and so when you are looking at trade-offs when you have limited
budget it makes it very difficult to talk about lowering the
rate and doing a capital recovery at the same time.
Vice Chairman Brady. Thank you sir, thank you again
Chairman.
Chairman Coats. Senator Klobuchar.
Senator Klobuchar. Did you want to let some House members
go first, I understand they have a vote I can wait 20 minutes.
Chairman Coats. I do have some concerns, I have just been
told it has been pushed back a little bit, but if you are
willing to----
Senator Klobuchar. Yes, I just have to leave in 20 minutes,
I'm fine.
Chairman Coats. Well, let's see who would be the next House
member up.
Mr. Hanna.
Representative Hanna. Thank you Chairman. Mr. Hoghaug
people would believe that the medical device tax 2.3% shouldn't
be relevant it doesn't sound like a big number to anybody.
Listening to your statement and incidentally I agree with you
but I would like you to do a little bit deeper dive in
explaining to this community why it is that--and we know it is
on your gross receipts, why it is that that percentage could
have such a tremendously negative impact through ObamaCare on
your bottom line and on your company?
Mr. Hoghaug. Thank you for the question. First of all it's
an excise tax which even though theoretically people say will
be passed on to the consumer. In reality we cannot pass it on,
capitated pricing and hospitals, 70% decrease in actual pricing
since 2008 has completely eliminated the ability to raise
prices.
Secondly it comes out of our weekly or bi-weekly cash flow
and is paid ahead of collections or profitability. Irrespective
of how a company is doing, including being a start-up as one of
my firms is, in the end the Device Tax is not tax deductible.
There are a few opinions out there but there are no IRS
mandates that say where it can or cannot be deducted. Perhaps
at the state and local level but certainly not on the federal,
so if you were to take an 8 million dollar company with roughly
a 6 million dollar profit, $480,000 it is about $248,000 in
tax.
If you were losing money that $248,000 is still owed to the
government irrespective of when you collect it or how you
collect it and it just restricts the day-to-day basic cash flow
for reinvestment in the firm.
Representative Hanna. Thank you very much. Miss Wade you
know government sets all kinds of problems up for small
business. It almost feels--and I'm from New York, one of the
highest taxed states--as if it is a war of attrition. People
think that businesses will stay in business, people and
individuals don't get frustrated, don't quit, don't make enough
money in their lives so that it just becomes marginally not
worth it.
I think you and I know that people do quit, people do give
up and the energy that it takes to create and grow and stick
with a small business through your lifetime regardless of awful
things like inheritance taxes as it may suck the life blood out
of your business just when the next generation needs it the
most. The raw costs, the psychological cost in addition to just
the specific costs, you talked about the 179 deduction and the
fact that Congress--and Mr. Fledderman did also so in a couple
of minutes can you explain to me and I am sure I already agree
with you.
But you notice there is nobody here in defense of this tax
code today. The true meaning of not knowing the direction of
your life, your business, your--this sustenance for your family
in the way Congress handled this this last time, literally in
the last moment and how important and why the 179 deduction is
important.
Ms. Wade. Sure so small businesses one of their major
complaints is uncertainty over government policies and frequent
changes in the tax code and 179 expensing covers both of those
unfortunately so in our survey of small business economic
trends monthly survey we asked a few questions on capital
expenditures.
While capital expenditures are historically low since the
recession the December 2013 when the expensing when it was
going to be lowered from 500,000 to 25,000 we saw a huge spike
in the number of small business owners purchasing capital
expenditures, planning that it would be lowered to 25 and not
retroactive. So these fluctuations in tax policies certainly
affect small business owners and how they conduct their
business and we think it should be better served that they
conduct their business on what's best for their business and
not driven by uncertainties.
Representative Hanna. Do you think all of this causes a
misallocation of resources in many different ways for everyone?
Ms. Wade. Absolutely uncertainty is one of the huge
problems they face.
Representative Hanna. My time is expired, yield back. Thank
you Chairman.
Chairman Coats. Well, thank you for this explanation. To my
colleagues and the witnesses and those watching here, we have
summed it up. As I said, a byzantine system is in place in
terms of who goes when. The rule is that those who are here at
the start of the Committee hearing are listed and then they are
ranked in terms of House, Senate, Republican, Democrat. We try
to be fair to both chambers and to both parties.
Then those who come and go fit in so we almost need to hire
a staffer just to provide me a note which gets revised about
every 3 minutes and then we have the question of votes over in
the House so we are trying. If I overlooked somebody or missed
somebody or they are out of order, I apologize. We are trying
to do the best that we can. The way I have it on the list is
Senator Klobuchar has yielded her time, not yielded, but
deferred her time, to the point where she looks over and tugs
at my sleeve and says I need it now. So you are welcome to do
that, but if we stay with our agreed on procedures it will be
Congressman Paulsen, followed by Senator Lee, followed by
Congressman Delaney, and then we'll go from there if that is
all right with everybody. So Congressman Paulsen, you are on.
Representative Paulsen. Well first of all thank you Mr.
Chairman, and the testimony was very good today. You know we
spent a lot of time in this Committee gathering data over the
last few years about how we are experiencing a growth gap. The
economy is under-performing. It is the slowest economic
recovery ever and wages are flat, small businesses have really
struggled. For the first time in 35 years, more businesses have
failed than have started. On top of that, we have got the
medical device tax and very powerful testimony that we have
heard today.
It is hurting one of our best American success stories. I
think one thing to reflect on is that 80% of medical device
companies are small businesses, 50 employees or less. Sadly
some of the stories that I have heard match the story, Mr.
Hoghaug, that you mentioned of the impact on these device
manufacturers I talked to a company in Texas. They had never
laid off an employee in 22 years, but they laid off 25 people
and then they deferred hiring another 15 people simply because
of the device tax.
I hear other stories all the time in my home State of
Minnesota, and Senator Klobuchar knows and Mr. Hoghaug you
mentioned that in your written testimony and you have kind of
got this a little bit of cash flow issues. In your written
testimony it mentions your effective tax rate as a company at
Signus Medical is nearly 79%. You face one of the highest tax
rates of any industry now in the world.
I mean it is surprising to me that you are still in
business and how can any of us sitting in front of you expect
that you can continue running your business like that. Now the
Congressional Research Service and other supporters of the tax
claim there's no impact on jobs, it's not real. It's not really
happening. As someone who is actually running a small business,
Mr. Hoghaug, and understands what is happening on the ground
how do you respond to those critics?
Mr. Hoghaug. What a great question. In theory most of the
studies that I have seen or read it is all based on the fact
that you can pass on this 2.3% to the actual end user that is
not my experience. We have not been able to--I haven't seen
anything but a decrease in the actual pricing since 2008,
prices are down about 70% thus profits are down. You tack on
the 2.3% on top of that and the cash has to come from somewhere
and as I mentioned in my testimony one of the hardest things
that I ever had to do is walk up and lay off two people for the
sole reason that I had to make my tax payment, not because they
were doing anything wrong, they were exemplary employees but I
had to lay them off otherwise I would be in default and that's
very real and I haven't been able to hire them back because we
are paying 50, 60 days in advance of collecting the actual
money on the sale so you are always playing catch up with the
cash, but the bills always come in on time.
Representative Paulsen. You mentioned also that you
deferred or had to shelve some research and development
products. The surveys we have gotten back from the device
industry says the exact same thing. This is the life blood of
the industry right, I mean, it feeds into the supply chain of
where we have seen all the success.
Can you tell us a little bit about some of the patients
that your devices have helped, and what is the impact of the
device tax now on them?
Mr. Hoghaug. Well I have hundreds of stories of benefiting.
One that actually has stuck with me for many years is a father
bringing in a 16 month old small child who was quadriplegic due
to Down's Syndrome and a congenital defect at the base of the
skull and carrying his small daughter into the neurosurgeon I
worked with in Children's Minneapolis saying please, please
bring my daughter back to me.
And through the course of the surgery an implantation of
our device I was witness to the fact that she could move her
fingers and her legs again and while still has many challenges
ahead she was functional and you know there wasn't a dry eye in
the house. But those are the types of implants and the next
generation implant that could be out there to help more people,
a greater number of patients.
The research and development dollars just aren't there to
take it to the next generation to supply it.
Representative Paulsen. Well, I think that illustrates how
this is really a tax on innovation and as the Chairman knows
coming from a state with a high number of medical device
companies, and Senator Klobuchar knows we need to keep this
industry alive. Thankfully, this is one of those issues that
has gathered bipartisan support for repeal, and I hope that we
will continue to be able to move this issue forward. I yield
back.
Chairman Coats. Thank you.
Senator Lee.
Senator Lee. Thank you Mr. Chairman and thanks to all of
you for your testimony it has been very informative today. Mr.
Reardon in your testimony you mentioned that back in 2003 full
integration of the corporate taxation system came within just a
few votes of becoming law, finally becoming reality and you
made a convincing argument that businesses should choose their
form, their corporate form based on the type of business they
have, the type of business strategy they have rather than
having to game out the tax code.
Can you discuss with us just a few potential ways in which
full integration of business taxation might occur today or ways
in which the tax burden of C Corporations and pass-through
entities might be kept in balance so that the decision of how
to organize a business is driven by business considerations
rather than by the tax code?
Mr. Reardon. Sure, I would be happy to. Thank you. I think
the Committee has discussed a little bit, sort of this dilemma
of that you have big S Corps and you have similar sized C Corps
and they are taxed differently and you know how do you
reconcile that and my argument is that the S Corp is taxed
correctly so you should move the tax code towards that single
layer of tax.
One of the ways to do that is to integrate the corporate
code with the individual code so that if you are paying taxes
at the corporate level then there is no shareholder level tax
or vice versa. If you don't pay tax at the corporate level then
you have a shareholder level tax of an appropriate amount and
then that's the tax that the company pays.
I guess one of the other concerns is that well we can't
quite get there, there's no way to do that. Well we came really
close in 2003.
The President's original proposal was full integration of
the corporate code where if a corporation paid a tax on the
dollar that it made then there would be no subsequent tax,
either as a dividend or when the shareholder sold the stock as
a capital gain. That plan passed the Senate, it came very close
to passing the House. The compromise was that we ended up with
a 15% raid on cap gains and dividends which got us pretty close
to the idea of you know a single layer of tax, certainly much
closer than we have been since World War II.
I think that there is two ways to do it. My understanding
with your plan is that you have if the corporation pays a tax
there is no subsequent shareholder level tax. The challenge
with that is the optics, that it looks like that shareholders
aren't paying taxes when in fact they are carrying the burden
of the tax paid by the business. I think you get around that by
having a notice sent out to the shareholder that this much tax
was paid by the business on their behalf.
The other way to do it would be to allow the corporate to
have a dividend's paid deduction so that the corporation when
they kick out a dividend to the shareholders they don't pay a
tax at the corporate level, but that the shareholder pays that
tax.
I like that because it makes the tax explicit at the
shareholder level. The challenge with that is you know there's
I think 40% of C Corp equity right now is owned by tax exempt
taxpayers, IRA's, trust funds, college funds et cetera so how
you deal with those shareholders is difficult.
Senator Lee. There's probably not an easy fix to that.
Mr. Reardon. There's not an easy fix to that so I think
your solution is probably the most elegant but the bottom line
is that if you want to make U.S. businesses more competitive,
the double tax is the big challenge. Our competitors don't have
double taxes. Most of our countries that we compete with have
integrated their corporate code with their individual codes so
we are an outlier there and we should fix that.
Senator Lee. And once you have double taxation in place
that therefore makes it a lot more difficult to design a fair
tax code, a fair business tax code.
Mr. Reardon. Well I think you have two challenges one it
drives up the cost of capital because you have got the two
layers of tax and that means that you are driving investment
out of the U.S. and into foreign markets and two you have a
huge behavioral issue which is you know one of our members
testified before the House Small Business Committee earlier
today and in his testimony he talked about when they were a C
Corp they didn't want to pay dividends because they didn't want
to face that second layer of tax. But if they have shareholders
who rely on those dividends then what is the point of being the
shareholder of a company where you are not benefiting from the
success of the company?
That endangers the future of the company because the
shareholders say no let's sell the business, let's sell it to
that big C Corp down the street. And so the challenge is that
you know if you are going to you know move the tax code in the
correct way you want to move away from the double tax, you want
to make sure that business income, a single layer is taxes at a
reasonable rate and then that's it and then you get away from
both the cost of capital and the behavior challenges.
Senator Lee. Was this by the way the single biggest
argument that sunk the 2003 plan that would have fixed it, was
it the argument that you are somehow helping----
Mr. Reardon. I think there was opposition by some important
people on the House side but you will have to talk to them I
don't know exactly why they didn't like the idea.
Senator Lee. Okay well said. I see my time has expired,
thank you very much, thank you, Mr. Chairman.
Chairman Coats. Senator Lee, thank you.
Senator Klobuchar.
Senator Klobuchar. Well thank you very much. We are left to
wonder who these important people are but thank you very much.
Mr. Reardon. It might have been the Chairman of the Ways
and Means.
Senator Klobuchar. Oh okay well I wanted to first
acknowledge Mr. Hoghaug thank you so much for being here and
the jobs you create in our State and Representative Paulsen has
already mentioned how difficult this situation is with the
medical device tax. He and I both have been working together to
try to get this repealed along with Senator Hatch and others
and we are hopeful that this may be the year we can get this
done just because of the changing of politics and people
understanding and also a GAO report that came out showing how
difficult it is to assess this tax.
Just one other follow-up I had was just the R&D tax credit
if that's helpful that's something else that expires at the end
of every year and it has been a big frustration and if you find
that helpful Mr. Hoghaug?
Mr. Hoghaug. Well, on the surface it seems to be helpful.
It hasn't due to the length and kind of the uncertainty of the
R&D projects with medical devices not one outstanding being the
FDA--as it changes every year you can't get the entire project
in under the deduction and I don't know if it is going to be
there next year.
So we are planning as if it is not going to be there and
then we just have to look at cash flow and how much you can
afford.
Senator Klobuchar. Exactly and then it doesn't serve its
purpose of creating incentive which is one of the reasons we
would love to see longer term comprehensive reform as well as
international tax reform and I know in this part of this but we
know a little bit about that from having Medtronic and all the
trillions of dollars that are overseas.
I was just talking to Senator Schumer about that if we are
not going to get comprehensive done this year it would be nice
to get that done. Another thing that I have found to be really
helpful to our company's manufacturing companies is something
you mentioned is the section 179 depreciation tax credit
expensing provision and Mr. Fledderman as part of the
comprehensive tax reform do you think we should be looking at
the depreciation tables or some updates?
It is the number one thing that is mentioned to me and I
think it was the head of the Federal Reserve Yellen who also
mentioned that it was a very helpful way if we could make that
longer and clearer and make any improvements to it it's one of
our better tax incentives.
Mr. Fledderman. Yes and thanks for the question. It
definitely would help tremendously especially if we can count
on it. You know I listened to all of this and one of the things
that I think I would like to say is we are talking about the
tax incentives that there are and it seems to me like we really
don't have tax incentives. We have tax rewards for something
you did because we don't know whether we are going to have it.
Senator Klobuchar. Especially when they are retroactive.
Mr. Fledderman. That's right if you know at the beginning
that you are going to have it then it really is an incentive to
do something versus you might get a reward for doing it. It's a
whole different thought process when you are a business owner
when you have to make a decision on an investment or something
like that. You know I am as patriotic as the next guy but I
have got to admit you know when we were getting ready to invest
another 4, 5, 10 million dollars in our business I'm
questioning is this the best place to do it.
Does it really make sense to put that kind of money here
and you don't really know what the return is going to be and I
don't like thinking like that and I don't think that's the way
we want business owners in this country to think.
Senator Klobuchar. Great thank you. Mr. Reardon, many small
businesses in Minnesota actually are ESOPS and I think you know
they provide several tax benefits under the law. Can you talk
about the benefits of ESOPS for small businesses. We sometimes
have tax changes that we are very concerned could affect them
and there are some other issues, we got a ruling today out of
the Department of Labor that we are concerned about on
fiduciary duty but ESOPS actually are exempt from it.
Could you talk about the value of ESOPS?
Mr. Reardon. Yeah that was a real helpful ruling.
Senator Klobuchar. Yes.
Mr. Reardon. The you know, several of our board members are
actually S Corp ESOPS and I think one of the primary values
aside from the fact that when you have an ESOP structure it
changes the whole culture of the business that people take a
much higher level of ownership over both their jobs and sort of
accomplishing the tasks that are within their responsibilities.
But it also eases the transition of business ownership. One
of the biggest challenges for businesses like Mr. Fledderman's
and Mr. McGregor's is how do you transition from one generation
to the next or if there is no other generation what do you do
with that business?
Usually for closely owned businesses, the people who have
the best chance of succeeding with it after the first
generation goes away are the people who are working there and
so that's where an ESOP really comes in handy because it eases
that transition it shifts the ownership to the people who are
best able to keep that business successful and then it creates
a great return and retirement opportunity for them.
Senator Klobuchar. Okay thank you very much.
Chairman Coats. Thank you. Let's see, my list has
Congressman Delaney.
Representative Delaney. Thank you Mr. Chairman and I want
to thank all of our witnesses for being here today. Prior to
coming to Congress I ran a commercial finance company that I
started that across 11 years we financed 5,000 small to mid-
size businesses and made about $30 billion of loans and I can
say every single one of the businesses that I ever financed
always thought that they were paying too much tax.
And they are right about that to some extent because let's
face it you know earnings would be more productively invested
in the business than they are paid to the government but we do
need tax revenues for the government to pay our obligations and
that's our principal responsibility as fiduciaries.
And so when we think about these changes we have to be
smart about them and we have to do things that you know unlike
the medical device tax which I don't like because it's an
excise tax and the reason I think the witness had the problem
with his business is because it was income tax, you would only
pay it if you are actually making money so you wouldn't have
the cash flow problems.
But I think there are two things, the first is that I think
we have to stop with the false choices between small and big
businesses because A it is hard to find those lines and Mr.
Fledderman it sounds like your business does a lot of work for
the auto industry, those are big companies they are your
clients. And so the fact that we have a bad tax system for them
affects you too and I think it's true for most small to mid-
size businesses in this country a lot of their clients at least
of the 5,000 companies I financed a lot of their clients were
big businesses so the fact that we keep their cash overseas
because we have a bad international tax system hurts small
businesses.
The fact that they have all the same problems that you do
hurts small businesses so these false choices because small
businesses employ a lot of people but there is a lot of data
that suggests that it is actually fast growing mid-size
businesses that create all the jobs so I just think it is
important for us not to have this false narrative. We have a
bad tax code and it is hurting all American businesses full
stop and they are all interrelated.
But my question is to you Mr. Reardon, let's assume for a
second because there is a fair amount of momentum at least I
feel to do business only tax reform and I think the reason for
that is that the ideological divide on the individual tax
reform is very wide at this point.
So there is momentum to do business only so let's assume we
are doing that for a second and let's assume that we don't do
what you would like which is to eliminate the double tax and I
understand all the reasons for it but let's assume for a second
we don't do that, how do you--how would you propose that we
deal with all of the unincorporated businesses of which
probably 90% of businesses I don't know what the stats are all
probably incorporated being one of our witnesses here Mr.
Hoghaug you run a C Corp and you run an LLC right so there's
you know these things are somewhat interchangeable.
How do you think we can if we were to eliminate deductions
and lower the rates for C Corps and we were not to do
individual tax reform at the same time, how could we actually
do something to address an incorporated business at the same
time?
Mr. Reardon. Just for the record we have always argued for
comprehensive reform that addresses individual----
Representative Delaney. My hypothetical assumes that.
Mr. Reardon. Plan B is out there which I think it is sort
of encompassed on what Senator Lee has in his plan. There's a
Grant Thornton business equivalency plan out there which would
effectively cap the tax on pass-throughs at whatever the top C
Corporate is so that you would divorce a little bit the
individual rate from the pass-through rate.
Basically treat it like capital gains so when you have
active pass-through income it shows up in the shareholder's
income taxes and then it is treated to a different rate
schedule than their other wage and salary income. I think
that's probably the most fair way to treat the difference
between C Corps and pass-throughs.
Martin has mentioned a number of other options out there,
all of them would benefit certain pass-throughs but the
challenge is that none of them, unlike rates, affect all pass-
throughs the same way and so if you do broader expensing you
are helping companies that have more capital expenditures but
there is lots of S Corps and pass-throughs out there, retail
and others that don't have a lot of capital expenditures so
they won't benefit at all.
So they will still be stuck with that higher rate. We have
explored this as I said for 5 years and we keep coming back to
the rates.
Representative Delaney. What do you think the apples to
apples differential is right now between a C Corp counting its
double tax and a pass-through?
Mr. Reardon. It depends on----
Representative Delaney. Who is paying more and by how much?
I know it's hard but generalize it.
Mr. Reardon. Well the effective rate study that we did
looking at domestic only because once you get into
international it gets really complicated with all the credits
in there. S Corps are at 32%, C Corps were at 27% that does
include dividends but it doesn't include the capital gains rate
so you should probably adjust the C Corp up a little bit. But I
think you know they are sort of in that range where they are at
right now.
Representative Delaney. So if you did the proposal that you
are talking about the spread would probably be similar because
if you lowered the rate?
Mr. Reardon. Yes, I think it would be fairly comparable.
Representative Delaney. Thank you sir.
Chairman Coats. Congressman Beyer.
Representative Beyer. Thank you Mr. Chairman and thanks all
of you for coming and this fascinating--I've been running a
small business for 41 years and very much identify with so much
of what you say the incredible difficulty of accumulating
capital just because of the tax.
So Dr. Sullivan is a Harvard trained economist. We heard
early on and I think Mr. Reardon's presentation about that when
you add up the medical device tax, rather the Affordable Care
Act Tax and the like you get to 44%, 43.4% when you add
Virginia's 5.75% personal state tax you are over 50 and then if
you look at the part that we take out for ourselves for social
security that's another 15.4% so it's you know 65% or something
on the first $107,000 and then drops down.
Is there any theoretical economic research that shows where
that ideal theoretical tax break should be where you start to
get the disincentive of not to work which just doesn't make any
sense to try as hard as it does when you are a small business?
At what point do we say if 53% is perfect or 40% or 60% or
29?
Dr. Sullivan. Well I think there's no magic number out
there. It certainly is subject to a lot of controversy. You
should keep the rates certainly as low as possible. I think the
question that we are talking about is there are a lot of
individuals who are not involved in small business who are
subject to these high tax rates and so when we talk about
lowering the rates it is not just affecting the small business.
If we want to help small business it doesn't make a lot of
sense just to focus on the rates because then you are helping
all individuals who have very high incomes. So if we want to
promote job creation we should give tax breaks to the
individuals who are actually creating jobs. And so I wouldn't
focus so much on the rates as to focus on the job creation part
of the equation.
Representative Beyer. I was impressed with options 4 and 5,
option 4 being the upfront tax benefits like the costing,
expensing and option 5 being you know the tax simplification,
the huge tax burden years ago when Bill Clinton was first
elected President I talked to one of his chief economists about
one of my great frustrations which is I don't mind paying 39.6%
tax on the income I take out of the business, you know to buy
my big house, to pay the country club bills, it drives me crazy
to pay it on the money that I want to leave in the business to
grow more jobs, to expand it.
Is there not an option 7 here or an option 6 that says you
can do the same tax rates on the money that is taken out but a
much, much lower rate on the money that is left to grow the
business and to grow jobs?
Dr. Sullivan. I was just at Harvard last week talking to
the law school professors there and Professor Halperin was
suggesting that there should be tax relief for money that is
kept inside the corporation and so I think there are options
like that that people are interested in.
Representative Beyer. Maybe we can ask our Chair and
Ranking Member if we can pursue that together which would be
excellent, thank you and I'm hoping Mr. Reardon can help us
think about that also.
Mr. Hoghaug, you know one of the arguments made about the
medical device tax was that you were going to sell somebody
more artificial hips and pacemakers and the like that would
offset it. Do you see any uptick in demand from ACA?
Mr. Hoghaug. Great question, no. We have seen zero uptick.
Most of the devices, spine in particular, but I am also
involved with the shoulder and other joints, are diseases of
the aging and elderly. Those people either have insurance or
covered by Medicare so we have seen no appreciable rise at all.
You know a trauma patient that goes in with a broken neck is
going to get treated whether or not they had insurance so those
numbers really haven't changed at all.
Representative Beyer. Would deductibility and alignment of
the cash flow make a meaningful difference for you in the
medical device tax?
Mr. Hoghaug. I just think it's an entirely bad idea to be
taxing in any way this--the innovation. I'm not sure how one
could reconcile that. I mean it seems that the majority of the
House and Senate are in favor of repealing this tax as it
really is a tax on innovation and you know by not being able to
reinvest within the company and on the next new generation
product the patients are suffering.
Representative Beyer. Thank you Mr. Chair.
Chairman Coats. Terrific questions. I mean you got our
attention on those couple of items there. Thank you,
Congressman Schweikert?
Representative Schweikert. Thank you Mr. Chairman. Is it
Congressman Beyer? If you are paying your country club fees,
you belong on this side right? So if I turned to this panel and
said, all right, optimal tax system? And from a personal
perspective, and it would be a good time for the doctor, in a
moment, to share his philosophical vision. What is a tax code
that maximizes economic growth, economic stability but
minimizes decision making directed from the tax code itself;
because I believe as a regulatory policy when it is outside
certain realms but also tax policy we distort price effects, we
distort allocations.
Mr. Reardon, describe to me what the optimal tax code is?
Mr. Reardon. If I were writing the tax code in the current
environment I would shoot for a rate that is sustainable, 28-
30% range and then I would tax all income at that rate. As I
said earlier incorporate or integrate the corporate code so you
can have the 30% rate on C Corps, 30% rate on pass-throughs and
30%----
Representative Schweikert. And you would create
equalization or deal with the differential on the C Corp and
its dividends?
Mr. Reardon. And on the individual rates as well, you know
I disagree sort of a little bit with what Marty is saying about
what rate should be applied to wage and salary income simply
because capital has to come from somewhere and the only way
that you are going to get capital for people to borrow or
invest is for people to be able to earn money and then save it
and then invest it in those enterprises.
Representative Schweikert. Mr. Fledderman does that
accomplish what you need?
Mr. Fledderman. Absolutely I agree 100% I think the
simplification of tax code helps both the business as we can
plan and I think it helps the Federal Government because they
can plan. Right now the government doesn't know what kind of
credits I am going to submit for at the end of the year so they
really don't know what kind of returns are to be necessary. It
would be a lot easier for us to calculate what our tax burden
is going to be and for the government to calculate what the tax
take is going to be.
I'm all for paying my fair share of taxes and a flat tax
would be simplified would make it the same for everybody.
Representative Schweikert. Miss Wade what would be the
optimum tax code?
Ms. Wade. For NFIB members they have told us time and time
again that lowering the rates that's for all demographics of
small businesses, regardless of industry or their growth
potential. Lowering the tax rate but then also permanency of
the Estate tax repeal and 179 expensing so that the frequent
changes in the tax code isn't driving their business decisions.
Representative Schweikert. What is you lowered rates to the
point that you remove things like 179?
Ms. Wade. We've surveyed our members and there is a little
bit of negotiation but it all comes down to what their paying
and bottom line on tax costs.
Representative Schweikert. That's what it is always about
right?
Ms. Wade. Yes.
Mr. Sullivan. It's always about trade-offs. I mean NFIB
members want lower rates and they want expensing but you are
asking the question. If we have to raise a certain amount of
revenue what's the best way to do it.
Representative Schweikert. In the most--my proposition is
based on the concept what maximizes economic growth and
minimizes economic distortion by tax policy.
Mr. Sullivan. And the answer is that under tax reform in
the classic sense we want a single layer of tax on all
businesses and we want rates as low as possible and there is
going to be some very painful loophole closing that is going to
have to take place for that to happen. When I was on staff I
was always lobbied, I'm sure you are lobbied and you are told
that if you take away this tax break it is going to hurt jobs
but ultimately all of those tax breaks are really hurting jobs
and you need to lower the rates and sort of ignore that pattern
about ``oh you are going to kill jobs by taking away my tax
break.''
Representative Schweikert. In a world like you have where
you are putting money into R&D for medical devices what is
optimal for you?
Mr. Hoghaug. Well two-fold once I agree--but I would agree
that a lower flatter tax, corporate tax would certainly induce
re-investment within the company and with R&D. The elimination
of the medical device tax which is punitive on my start-up
company, which has yet to turn a profit and yet it still pays
medical device taxes, so I am actually borrowing money and
financing the tax.
But I would agree just some extension of the R&D tax credit
or something, just something that we could plan for the future.
Representative Schweikert. All right thank you Mr.
Chairman. There is one comment I wanted to make we need to be a
little careful earlier we threw out what if you were an
investment company or a hedge fund or this and that and the
title or the structure we should probably be concerned about
what is the profitability, what's the actual income from it
because there was a time when I ran a fairly large investment
fund and make no money from it but I had a really big title so
we have got to be very careful about stereotyping because it
sort of distorts, you know when we get down to the sort of
what's the actual--that's for the economy and best for the
country that I yield back Mr. Chairman.
Chairman Coats. Well, thank you, Congressman. The Senate
has called a vote so I am going to have to leave shortly, I
would be happy to turn this over to the Ranking Member,
Congresswoman Maloney if you want to continue with some
additional questions or if you have any additional questions.
It seems to me, and I am not trying to categorize
everything into a conclusion here, but what I have heard today
is that tax reform is a necessity if we are going to promote
economic growth for the future.
Comprehensive tax reform seems to be the best way to go.
Piecemeal continues the complexity and some unfairness. Making
it fair is simplifying our tax code, lowering rates to the
extent that we can. Particularly dealing with the question
relative to business income, where is that sweet spot where you
can lower the rate and eliminate the exemptions or the trade-
offs? Because if you want to achieve fairness you want to
achieve simplicity.
It seems to me that to get that fairness, you have to give
that consideration. Is there a level at which you could say
give me that level, that provides the certainty that I need, so
that I know exactly what I am going to have to pay on the
income that I earn and the profits that we achieve and I don't
have to hire attorneys and CPA's to figure out how I qualify
for certain exemptions, certain deductions? I think that's a
challenge that is going to hit all of us here in Congress, and
we are going to have to address the need through comprehensive
tax reform that very question.
We have talked about the right level as you have gone
through this I don't think we need to report that. And then
locking in certainty seems to be the key component of getting a
pro-growth dynamic economic tax code. We talked about what I
would think are two confiscatory, egregious taxes and one is
the medical device tax, which I think our witness here from
Minnesota knows, and I have experienced the same thing in
Indiana. We are a medical device state also.
I have seen and heard from those who own the companies who
have not yet, but have potentially innovated breakthroughs that
can substantially improve health and save lives, but simply
aren't going to be able to get there or pursue their technology
or their innovation because they are forced to pay tax on their
sales, an excise tax and not on their profits.
They are not making a profit, they have to borrow money to
pay the tax or they lay-off people. We have had companies that
have planned expansion, planned new hiring and canceled as a
result of this tax. It's egregious to take this type,--
particularly this type of innovative industry that has so much
promise for future health benefits to slap on an excise tax.
And it was all based on the fact that you would have a surge of
business from the Affordable Care Act, which you have indicated
has not been the case. And that's true with many of our smaller
companies in particular.
And then the estate tax. I know the House will be voting on
this. I am not sure if the Senate has the votes to address
this. But in many instances, not in every because there is some
inherited money passed down, clearly, but this is money that
has been earned, money that has been taxed. And then you get to
do it all over again--almost half of everything that you have
saved, and give it back to the government the second time.
I think it's been a very constructive hearing. I thank our
witnesses for being here, with some terrific questions that
have been asked, and some very good answers that have been
given. I think this will play an important role in terms of how
we determine how we move forward with achieving the goal I
think we all want to have and that is taking a very complex,
out of whack, desperately needed, tax code reform piece and
make it sensible. Accomplishment here is relative to what is
necessary for us to get our economy not hindered by the
complexity and the unfairness of this particular code. And so
thanks to all of our witnesses, thanks to my colleagues here.
With that, this meeting is adjourned.
(Whereupon the meeting adjourned at 4:06 p.m.)
SUBMISSIONS FOR THE RECORD
Prepared Statement of Hon. Dan Coats, Chairman,
Joint Economic Committee
It is fitting that on Tax Day, April 15, we are examining one of
the most vexing challenges for small business--our burdensome and
incomprehensible tax code.
A quote by an unknown source represents the entrepreneurial spirit
I have witnessed representing Hoosiers in Washington: ``Small business
isn't for the faint of heart. It's for the brave, the patient and the
persistent. It's for the overcomer.''
The small business owners I have met are brave, patient, and
persistent. They are indeed overcomers. Despite the obstacles small
businesses face, they are responsible for two-thirds of the net new
private-sector jobs created in the United States. Our role as
legislators should be to ensure that the tax code is no longer a major
obstacle to growth and jobs for these businesses.
Against the headwinds of the slowest recovery since 1960, small
business owners have to deal with a tax system that is hopelessly
complex, full of provisions that expire every one or two years, riddled
with special exemptions, deductions, and preferences, and filled with
new penalties.
The Small Business Administration lists tax paperwork as the most
costly paperwork burden the Federal Government imposes on small
businesses at $74 per hour or $1,500 per employee. It is not surprising
that nine out of 10 small business owners have to turn to an outside
paid professional to figure out their taxes.
Today we will hear from witnesses who can discuss how tax policy is
affecting the broad landscape of small businesses. We will also hear
two stories of real businesses that will bring home how taxes affect
companies on the ground.
We hear these stories every day:
Stories of complexity. I can sympathize with business
owners because I took two tax law courses in law school and am still
baffled by the tax code.
Stories of uncertainty, like the farm family unable to
replace outdated equipment because they are unsure whether small
business expensing or bonus deprecation will be in effect for the year,
and at what level.
Stories of manufacturers hit with higher tax bills
because the top individual tax rate rose, but without extra cash in the
business to pay the tax.
Stories of small businesses struggling under the weight
of ObamaCare's taxes and mandates, wondering if they can afford to add
more workers or whether they should move employees to part-time status.
Stories of medical device makers, like one in Warsaw,
Indiana, that develops orthopedic implants for children and had to
shelve two important projects because of the medical device tax.
And stories of family-owned businesses with land,
buildings, equipment or inventory but without cash to pay the estate
tax, worried the business won't survive to the next generation.
Tax Day is a perfect time to commit to not let another April 15
pass before we finally tackle comprehensive, pro-growth tax reform. And
while it is urgent and essential to lower our corporate tax rate, which
is the highest in the developed world, we must not forget the millions
of small businesses that pay taxes at the individual level and have
just experienced rate increases of their own.
I look forward to hearing from our witnesses about how we can tear
down barriers to growth in our broken tax code.
__________
Prepared Statement of Hon. Kevin Brady, Vice Chairman,
Joint Economic Committee
Chairman Coats, Ranking Member Maloney, Members, and Distinguished
Witnesses:
Even though the United States has technically been in a recovery
for more than five-and-half years, our economy remains stuck in second
gear. Last year, our economy grew by 2.4 percent--that is barely above
the average annual growth .rate of 2.3 percent for this entire
disappointing recovery.
In this recovery, the rate of new business formation has lagged.
New and expanding small businesses have historically accounted for a
large share of new jobs during expansions. Regrettably, this fountain
of job creation has slowed significantly during this recovery compared
with past recoveries.
Our broken U.S. tax code is a major cause for this weak recovery:
Our tax code is too costly, complex and unfair--but
mostly unfair. Especially to hardworking taxpayers, small businesses
and America's economy.
A national survey by Texas-based polling firm Baselice &
Associates shows 80 percent of voters support Congress ``acting now to
fix the tax code by making it fairer, flatter and simpler.'' Eighty-six
percent of Republicans support reform, followed by 79 percent of
Democrats and 76 percent of independent voters.
Americans agree: We need a simpler, fairer tax code
that's built for growth and makes our economy healthier. It should
close loopholes and limit deductions to lower tax rates for everybody.
Small businesses shouldn't pay higher tax rates than big businesses,
and real reform should stop encouraging companies to shift jobs
overseas.
I believe a 21st century tax code shouldn't raise taxes
to bail out Washington's spending problem. It should limit spending,
rein in the IRS and strengthen America's economy to begin paying down
our national debt.
Today, I want to focus on a particular challenge confronting
farmers, ranchers, and small business owners--the death tax. All too
often, families must sell their farms, ranches, and small businesses to
pay Uncle Sam's death tax. One fifth-generation Texas ranch I know-
which started back in the 1800s--had to sell 2/3 of that historic land
to pay the death tax. That's just wrong.
What is worse--if you can imagine it--is that the death tax is
especially destructive for women- and minority owned small businesses.
They're the fastest growing sector of small businesses and start-ups in
this country.
Bob Johnson, the founder of BET television, observed the death tax
``continues to pose a serious threat to the likelihood that present-day
African American-owned businesses can be preserved as part of a
family's long-term legacy.''
President Obama insists that the death tax is necessary to remedy
income inequality. Yet, that just isn't so. Former Vice Chairman of the
Federal Reserve Board Alan Blinder found that only two percent of
income inequality can be explained by inherited wealth.
The death tax motivates the wealthy to reduce their savings and
increase their consumption spending now rather than pass their wealth
on to the next generation. The death tax actually increases the
consumption gap between the wealthy and the poor in America. Moreover,
the death tax leaves all Americans poorer as the productive investment
in new buildings, equipment, and intellectual property--which those
savings would have funded--does not occur and the jobs that such
investment would have generated are not created.
This reminds me of President Reagan's aphorism about our friends'
knowing so much that isn't so.
Democrats claim that ``special use valuation'' is an alternative
way to exempt farms, ranches, and small businesses from the death tax.
We've tried these gimmicks before. They don't work. They just throw
additional burdens and complexity on family businesses and tie them up
in red tape for years after death.
Enough with the gimmicks and complicated workarounds. They don't
work. Right now, our country is facing a $1.5 trillion Growth Gap
compared with an average recovery since 1960. That means we're missing
5.5 million private-sector jobs. The average family of four is missing
almost a thousand dollars a month. Our recovery is so bad, we're going
to need 7.4 percent growth in real GDP each and every quarter just to
catch up to the average recovery by the time President Obama leaves the
White House.
We need American entrepreneurs and family businesses to close that
gap. They're the backbone, the engine of our economy. But the death tax
has robbed them of $1.1 trillion in capital stock. The Tax Foundation
estimated that in 2005 the death tax cost American taxpayers $88.2
million and 2.3 million hours of effort just in compliance. Imagine if
all of that could have been invested in new jobs and business
opportunities. I don't think I need to stress to anyone here how
desperately we need that.
The Treasury collected $19.5 billion in estate and gift taxes over
the last 12 months. In contrast, the Treasury spends $9.9 billion per
day. The death tax generates less than two days of federal spending.
This week, the House of Representatives will vote to repeal the
death tax once and for all. I hope the Senate will join the House and
approve this truly progressive legislation and send it to President
Obama.
I look forward to today's discussion with our witnesses.
__________
Prepared Statement of Carolyn B. Maloney, Ranking Member,
Joint Economic Committee
Thank you Chairman Coats for holding today's hearing. I also want
to thank all of the witnesses for being here today.
There is broad agreement that small businesses are the backbone of
the economy, the anchors of our communities, and that they have played
an important role in the current recovery.
actions by democrats
When President Obama took over from George W. Bush, the economy was
in free fall and small businesses were bearing the brunt of the pain.
Over the fourth quarter of 2008 and the first quarter of 2009, small
businesses shed more than three million jobs.
President Obama and Democrats in Congress, along with the Federal
Reserve, took bold action to turn things around in the darkest days of
the Great Recession. These actions included a number of efforts to
support small businesses.
For example, the Recovery Act cut taxes for small businesses,
allowing them to immediately deduct up to $250,000 of investment, carry
back losses for five years, and exclude from taxation 75% of capital
gains from small business investment.
small business job growth
Today, small businesses are leading the economic recovery. Small
businesses have added more than six million jobs over 17 straight
quarters of small business job growth (see chart #1).
We have come a long ways in the past six years. The share of small
businesses planning to add jobs is back near its pre-recession average
(see chart #2).
While this reflects major progress, I believe we need to do more to
support small business growth.
The Administration's tax reform plan, for example, would simplify
and cut taxes for America's small businesses. President Obama's revenue
proposal includes expanding and permanently extending increased section
179 expensing for small businesses. The proposal would also increase
the number of small businesses that can take advantage of simpler cash
accounting rules.
The Administration's approach provides tax cuts for small
businesses in a fiscally responsible way and in the context of broader
business tax reform. By contrast, the Republicans in the House have
passed bills without offsets--which would blow massive holes in the
budget.
small business attitudes
Some of my Republican colleagues would have us believe that small
businesses are up in arms about the Obama Administration's policies.
But this chart--based on survey data provided by the NFIB, one of our
witnesses today--shows that the share of small businesses listing taxes
as their top concern is no greater today than when Ronald Reagan left
office (see chart # 3).
Ronald Reagan!
some ``small'' businesses are quite large
One of our principal goals today should be to decide what a small
business is for tax purposes.
While most of the 95 percent of businesses that are organized as
pass-throughs are small--many are extremely large. Numerous large law
firms, accounting firms, hedge funds and other businesses are pass-
throughs.
The tax code treats these large businesses the same as ``mom and
pop'' stores down the street. But, should it?
When designing tax policy, fairness should be a principal concern.
Some large multinationals pay less than small businesses and some
extremely large companies don't pay any federal income taxes at all.
In other words, the corner store likely pays more in federal income
taxes than some of our country's largest corporations. Those who are
critical of our tax system should save some of their outrage for this.
estate tax
Before taking on tax reform, Republicans have proposed repealing
the estate tax and they plan to vote on it in the House later today or
tomorrow.
Let's be clear: repealing the estate tax would be a major windfall
for the wealthiest Americans. With the current exemption amounts of
over $5 million per person and more than $10 million per couple, the
estate tax affects only two out of 1,000 estates. In other words, 99.8
percent of Americans do not pay any estate tax (see chart #4).
Republicans say they are motivated by a desire to protect small
businesses. But that's something of a Trojan horse. Only about 20 small
business and small farm estates owed any estate tax in 2013, according
to the Tax Policy Center. Twenty!
Repealing the estate tax is also very expensive. The Joint
Committee on Taxation found that repealing the estate tax would
increase the deficit by $269 billion over 10 years.
need for bipartisan tax reform
1986 was a massive overhaul and simplification of the tax code. The
minute the ink was dry, work began to undo it. And trust me, it wasn't
small businesses at the table.
We must make sure that any tax reform benefits the small firms, not
just the big multinationals gaming the system to further limit their
tax obligations.
Tax reform is hard. That's why there hasn't been a major rewrite of
the code in about 30 years. For it to work, it must be comprehensive
and it must be bipartisan. There is no other path forward.
I look forward to hearing the perspective of our witnesses this
afternoon. Thank you for appearing before the Committee.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Prepared Statement of Jody Fledderman, President & CEO,
Batesville Tool & Die
Thank you for the opportunity to testify before you today about the
impact of taxes on small and medium- sized manufacturing businesses. My
name is Jody Fledderman; I have been President and CEO of Batesville
Tool and Die in Batesville, Indiana since 1989. For over 30 years,
Batesville Tool & Die has been providing quality metal stamping and
stamping assemblies for our automotive, appliance, industrial and other
industry customers. We currently have 395 employees and would hire more
if we could find qualified workers.
In addition, I was the 2014 Chairman of the Precision Metalforming
Association and serve on Board of Directors for both the Indiana
Manufacturers Association and the Indiana Chamber of Commerce. I think
my positions on state and national boards and running my own business,
provide me a unique perspective of the challenges facing manufacturers
in Indiana and across the country.
The single greatest obstacle to growing my business in the long
term is the uncertainty surrounding our tax code. How can Congress
expect us to plan when we do not know what the rates will be in the
future?
How can lawmakers carelessly continue putting off their
responsibilities until the last hour? Too often it feels as if people
in Washington are so insulated from the real world they do not
recognize their inaction has significant consequences for families and
businesses throughout the country. It is very difficult to plan for the
future when you don't even know the rules for today.
I truly believe our economy would have recovered more quickly if
businesses felt comfortable that Washington would set the rules and
stop meddling for a while. This is why we need comprehensive tax
reform. Not just to lower our rates to globally competitive levels but
also to provide stability and predictability in the Internal Revenue
Code. Washington should develop tax policy that encourages investment
and manufacturing in America--not penalize companies and their owners
for doing business.
tax reform for all businesses
A January 2015 industry survey by the Precision Metalforming
Association and National Tooling and Machining Association showed that
61% of companies are structured as a pass-through business, often
paying income taxes at the higher individual rates. Sector-wide, 81% of
all manufacturing companies are structured as pass-throughs, meaning C-
Corporation only reform would leave behind eight in ten manufacturers,
most small and medium-sized family-owned businesses. We are one of
those millions of manufacturers Corporate-only reform would leave
behind.
Batesville Tool and Die is structured as an S-Corporation. As a
multi-generational manufacturing company with strong ties to the
community, over the years our company has awarded shares to certain
employees and family members. Maybe we've been overly generous in the
past, but we now have 72 shareholders. We are not your typical
manufacturing pass-through, which in our industry tends to average 3-5
shareholders. However, being a pass-through allows us to reward
employees with shares in the company without the penalty of double
taxation that a C-Corporation structure brings.
The main reason most family-owned or tightly held manufacturers
structure themselves as pass-throughs is so they can keep the company
within the family. Underscoring this point is that many in our industry
are nearing their retirement and planning to pass the business along to
the third or fourth generation of manufacturers. If our company was a
C-Corporation, when I'm set to retire, the tax penalties just on my
portion alone would mean I'd have to plan years ahead how to cover the
dividend tax rate - even if I knew what it was ahead of time.
Unfortunately, I'm still a ways away from retiring, but think what
would happen to these 72 small shareholders if we sold the company--
some of them are retirees in their eighties while others are high
school students. How would they come up with the resources to pay the
income and dividend taxes were we structured as a C-Corporation?
While there are many benefits to our pass-through structure, the
main drawback is the most obvious--Congress raised our rates a few
years ago. While publicly most believe the top rate is 39.6%, in
reality we pay roughly 43.4% in federal income taxes when you calculate
the surcharges and other additions. Keep in mind we have 72
shareholders, with one drawing fully passive income. This means we are
withholding 43.4% from all of their taxes and leaving it up to the
individual shareholder to seek a refund if their overall income levels
do not reach the highest brackets. More importantly, that is money
taken out of the business to pay taxes on their behalf and even if the
individual receives a refund, the company will never see any of that
money again--valuable resources we could have used to invest in the
business.
As Washington contemplates tax reform, I asked our CFO to explore
how various scenarios affect our company. Based on current tax law and
after deductions and credits, Batesville Tool and Die paid roughly $1.6
million in taxes. Had the individual tax rate not increased to 39.6%,
we would have paid $1.1 million in taxes using the same figures. If the
rate is reduced to 28% and the key investment provisions are kept in
place, our tax liability drops to $928,000, freeing up $700,000 to
invest in the business, more if lowered to 25%.
This is where public perception plays a big role. The average
person and politician would assume the owners pocket that $700,000. In
reality, that is not the way small and medium-sized manufacturers
operate. In the metalworking industry, our profit margins are typically
1-3%. The cost of manufacturing in America is not cheap and we use
every resource available to make ourselves more globally competitive
through investing in new technologies and hiring skilled workers.
Furthermore, what many people do not know is most small business
owners have to personally guarantee loans for the company when buying
equipment that can cost in the millions. The fewer resources our
lenders see in the business, combined with the higher personal tax
liability for each shareholder, often leads to increased borrowing
rates and stricter terms. Small and medium-sized manufacturing
businesses rarely self-finance, and with a 1-3% profit margin we are
not the most attractive borrower in the best of circumstances.
tax credits and deductions used by manufacturers
Every manufacturing business is different and each company serves a
variety of industries which have varying needs requiring specialty
equipment. Some of our equipment can cost $2-10 million, much of which
we could not afford without Bonus Depreciation. For others the R&D Tax
Credit is worth hundreds of thousands as opposed to general deductions.
While traveling the country as Chairman of the PMA last year, I
heard from countless manufacturers that they are holding back
investments because they do not know whether Congress will extend
critical tax provisions. The recent association survey of our industry
showed that 91% of metalworking manufacturers claimed Section 179
Equipment Expensing in 2014. An equally impressive 89% used Bonus
Depreciation while roughly half claimed the R&D Tax Credit. This
January, Congress allowed the R&D credit to lapse for the sixteenth
time, Bonus Depreciation to expire, and 179 to revert to $25,000,
rendering it completely useless for manufacturers like us.
To our company, the R&D and Bonus are by far the most important. We
claimed $544,000 in R&D and while that was among a peak year for us, we
see this provision as one of the few in our tax code that actually
incentivizes manufacturing in America. I know many smaller companies
shy away from the R&D as not being worth their time to defend in an
audit. Some will say they cannot substantiate the $20,000 in expenses
to claim $40,000 in R&D credits. But at Batesville, our exposure to the
R&D is significant, so I guess we will just have to keep the faith in
Congress that you will extend or make permanent the R&D, I just ask
that you don't wait until the eleventh hour this time.
Bonus Depreciation really is a game changer for manufacturers who
invest heavily in equipment and talented people to run them. Had
Congress not extended Bonus Depreciation in December of last year,
countless manufacturers in the metalworking industry would have faced
an average $400,000 tax liability due in 2015. The typical small
manufacturer does not have that kind of cash on hand and would
eliminate 2015 purchases and hiring to pay the added tax liability.
However, before Congress pats themselves on the back for a job well
done, extending expired provisions in November and December each year
clearly stunts economic growth. Machines in our industry take eight
weeks to eighteen months to place into service. This makes it
impossible for the average manufacturer to benefit from Bonus
Depreciation or Section 179 Equipment Expensing extended on December 11
with only three weeks to finance, purchase, and place into service
machinery weighing several thousand tons.
The other real world impact of Congressional inaction was witnessed
firsthand at Batesville Tool and Die last year. Due to the uncertainty
over whether Congress would extend the R&D, Bonus and other key tax
provisions, we overpaid our quarterly estimates to account for a
potential massive tax liability if the provisions remained expired for
2014. This meant we overpaid our taxes by $580,303 because lawmakers
waited until a lame duck Congressional session before acting. While our
employees and other shareholders benefit from this structure, it causes
significant challenges for the business when we have to overpay based
on which tax credits and provisions Congress keeps in place.
As a pass-through, we pay the taxes for our shareholders quarterly
based on estimates of revenue and existing tax law. This meant that
last year we withheld roughly 44% from each shareholder for income
taxes and overpaid on their behalf based on not knowing which tax
provisions Congress would put in place for the taxable year. The
individual shareholders will receive a refund for the overpayments on
their personal tax returns, but they will never give that money back to
the business who overpaid on their behalf. This means, the company will
never see that $580,000 again. With over half a million dollars I could
hire seven or eight new employees or purchase a new machine that would
have also required new workers. Instead, we sent that money to
Washington, who will just turn it around and give to it the
individuals, while the small business is left footing the bill.
Comprehensive tax reform would immediately fix this problem. Our
company would know the rules at the beginning of the year and withhold
or pay the appropriate estimate. But the current system is like
shooting a moving target, but never giving you a chance to lock on.
Absent comprehensive tax reform, we need Congress to make permanent
these investment provisions or at least extend them for a significant
number of years. As I mentioned earlier, some of our equipment takes
eighteen months or longer to place into service and our planning
process is often two to ten years as we anticipate future growth.
The Alternative Minimum Tax, or AMT, is another issue which
receives attention from politicians when discussing tax reform. The
reach of the AMT is much broader than just affecting the ``middle
class.'' When a business is captured under the AMT, they cannot claim
the Research and Development Tax Credit, which would be available to
them and is so popular among lawmakers. In addition, an AMT captured
business could not benefit from the politically popular $1,000 credit
for hiring the long-term unemployed. Again, this is why we need
comprehensive reform, the Internal Revenue Code is riddled with
outdated and conflicting provisions stifling U.S. companies and
deterring foreign investment.
conclusion
In towns such as Batesville, Indiana with a population of 6,500,
the community needs employers like us but we need a partner in
Washington that sets the rules and sticks with them. Manufacturers of
all sizes need time to plan. We may not be a billion-dollar company but
businesses in our industry routinely spend millions each year to remain
competitive. Virtually every other industrialized nation has a tax code
that fosters innovation and encourages investment. It is time the U.S.
Government caught up to the rest of the world the way its manufacturers
have.
Thank you for the opportunity to testify before you today on this
important issue.
__________
Prepared Statement of Ms. Holly Wade, Director of Research and Policy
Analysis, National Federation of Independent Business
Good morning Chairman Coats, Vice Chairwoman Maloney and members of
the Joint Economic Committee. Thank you for the opportunity to testify
today. I am pleased to be here on behalf of the National Federation of
Independent Business (NFIB) as the Committee discusses small business,
tax policy and economic growth in the small-business sector. NFIB is
the nation's leading small business advocacy organization representing
over 350,000 small-business owners across the country. NFIB represents
businesses in most industries and of various sizes, with about 80
percent under 40 employees.
The small business economy is slowly emerging from one of the worst
recessions in U.S. history. NFIB's monthly Small Business Economic
Trends (SBET) survey data shows the dramatic change in consumer
spending, employment, owner's confidence and business investments
throughout the recession and subsequent recovery.\1\ While some
business activities have made significant improvement over the past
four years, capital expenditures and outlook on business conditions and
expansion remain at historically low levels due to economic conditions
and the political climate. The threat of higher taxes whether in the
form of income taxes, the healthcare law, the estate tax, section 179
expensing limits, or others creates enormous uncertainty among small-
business owners worried about the impact of policy changes on future
business costs.
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\1\ Dunkelberg, William C., and Holly Wade, NFIB Small Business
Economic Trends, NFIB Research Foundation, series.
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The SBET survey also tracks which problems most affect owners in
operating their small businesses. From mid-2008 through mid-2012,
``poor sales'' was their number one problem as consumer spending
declined sharply. But now ``taxes'' is often the number one concern for
small-business owners, a problem that moderates the economic recovery
in the small-business sector.
The NFIB Small Business Problems and Priorities survey highlights
three main areas of tax policy that are of great concern to small-
business owners.\2\ The survey is of a random sample of NFIB members
asking them to evaluate 75 potential small-business problems and assess
the severity of each. The problems are then ranked by their mean score.
With the ``Cost of Health Insurance'' leading as the most severe
problem for small-business owners, five of the top 10 problems are all
tax-related. These tax problems fall into three categories: cost,
complexity and frequent changes.
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\2\ Wade, Holly, Small Business Problems and Priorities, NFIB
Research Foundation, 2012.
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The cost of tax obligations is threefold; the amount paid to
federal, state and local tax agencies, the cost of hiring a CPA or tax
advisor to navigate complex tax codes, and the owner's time in
providing the required paperwork and/or filing themselves. Eighty-eight
percent of small employers use a tax preparer, and most use one to
either ensure compliance or because the requirements are too complex.
Tax-related regulations cause the greatest difficulties for 40 percent
of small employers, more than environmental, health and safety, or
employee-related regulations.\3\ And compliance costs are especially
problematic for small-business owners as they are 67 percent higher for
small businesses than for their larger counterparts, costing them $18-
19 billion per year, or about $74 per hour.\4\
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\3\ Dennis, William J., Tax Complexity and the IRS, NFIB Research
Foundation, Volume 6, Issue 6, 2006.
\4\ https://www.sba.gov/sites/default/files/advocacy/rs343.pdf
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Tax-related costs compete with owners' ability to use limited
profits for primary business activities. Profits are the main funding
mechanism for owners purchasing new equipment, expanding facilities,
hiring and stocking inventory. Tax-related cost pressures are
especially problematic for newer firms that almost solely rely on
profits for operation and expansion costs as they are generally not
able to access traditional lending sources. Banks almost exclusively
lend to more established firms, not new ones due to higher failure
rates. But regardless of the firm's age, tax burdens take a heavy toll
on owners' ability to operate their businesses.
One example that encapsulates all three categories of tax-related
problems for small-business owners is the Affordable Care Act (ACA).
The employer mandate, small-business tax credit, and the termination of
employer reimbursements are just a few of the many tax-related costs
and complications small-business owners face in complying with the new
law.
The cost of health insurance is the most critical issue facing
small-business owners. It is the main reason owners do not offer
employer-sponsored health insurance and the main reason owners
discontinue providing the benefit.\5\ But the employer mandate does not
take into consideration the cost issue as it requires all employers
with 50 or more full time equivalents to offer health insurance or pay
a tax for not offering.
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\5\ Dennis, William J., Small Business's Introduction to the
Affordable Care Act Part II, NFIB Research Foundation, December 2014.
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The employer mandate pressures offering firms to continue
regardless of profitability and penalizes firms for not offering,
regardless of their financial situation. Firms with high employee
turnover, seasonal employment and lower profit margins are less likely
to offer health insurance. But now, those with 50 or more full time
equivalents must absorb an additional tax for not offering, offer
increasingly expensive health insurance, or limit employment--all less
than optimal options.
The employer mandate also contributes to increased tax complexity
due to the often ambiguous and complicated aggregation rules associated
with calculating the number of full time equivalent employees. The
paperwork associated in calculating employee hours as they relate to
the mandate reduces the most valuable asset of the owner, his or her
time. And the aggregation rules will be most difficult for owners with
seasonal employees, high employee turnover or own more than one
employer firm. The IRS estimates that it will take over 4 hours to fill
out the required forms, acknowledging that these estimates will vary
due to individual circumstances. For firms with more complicated
employment structures, the time commitment required will likely be far
greater.\6\
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\6\ http://www.irs.gov/pub/irs-pdf/i109495c.pdf
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Small-business owners have also encountered repeated delays and
confusion over the ACA's small-business health insurance tax credit and
financial reimbursement options. The tax credit is a targeted approach
to help curb health insurance costs for offering small employers and is
intended to provide an incentive for those that do not, to start
offering. However, the tax credit is largely ineffective on both fronts
as its design is exceedingly restrictive, complicated, and only offers
temporary relief to a larger small business cost problem. The tax
credit now serves as a windfall for the few who qualify and take the
time, or pay an accountant, to file for it. The IRS estimates that it
will take over 15 hours to understand, complete and submit the
appropriate forms.\7\ The paperwork costs involved in filing for the
tax credit will likely yield little benefit at the end of the day.
These problems are not an uncommon fate for many tax credits including
those trying to increase hiring and car sales. Generally these types of
incentives only benefit those already committed to the activity and are
willing fill out the required paperwork or pay someone to do it for
them.
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\7\ http://www.irs.gov/pub/irs-pdf/i8941.pdf
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Another ACA tax burden that falls into the frequent changes
category is the termination of employer reimbursements for individually
purchased health insurance plans by their employees. A recent NFIB
survey found that about 18 percent of small employers offered this
benefit last year and are now in violation of the law. NFIB continues
to receive calls from owners, generally after having talked to their
CPA or insurance agent, confused about the new rules prohibiting the
practice and the subsequent harsh tax penalties. It is very likely many
small employers are still not aware of this change in policy and will
be notified of its termination in the form of a letter from the IRS
requiring payment of excessive penalties.
The ACA is just one example of how excessive tax burdens affect
small-business owners. And the federal tax code is only one layer of
tax obligations owners face in operating their business. They must also
comply with state and local taxes adding to the overall compliance
burden. Unfortunately, only the owner experiences the cumulative effect
of all the required taxes and regulations places on their business.
Federal, state and local lawmakers and government agencies only see
them in isolation, giving a false perception of their true impact. But
it's the responsibility of the business owner to manage them all while
trying to operate a profitable, successful business.
In conclusion, small-business owners continue to be excessively
burdened by direct, indirect, complicated and ever changing taxes
related to operating their business. Alleviating the excessive tax
burden on small businesses is an essential component in creating a
strong, healthy environment for owners to operate and grow their
business. I appreciate the opportunity to present NFIB's views and data
on the effects of tax policies on small businesses. I look forward to
answering any questions you might have.
__________
Prepared Statement of Thomas A. Hoghaug, CEO, Signus Medical, LLC, and
CEO, LockDown Surgical, Inc.
Chairman Coats, Vice-Chairman Brady, Ranking Member Maloney,
Senator Klobuchar and Representative Paulsen, I would like to thank you
for this opportunity to testify. My name is Thomas Hoghaug and I
currently hold the position of CEO for Signus Medical, LLC, and
LockDown Surgical, Inc. It is an honor for me to be able to address
this committee today and potentially shed some light on the extremely
negative impact the Medical Device Tax has had on both of my companies
and on similar small medical device firms. The issues and examples I
will share are personal examples that are in no way unique to Signus
Medical and LockDown Surgical. They are common experiences shared by a
multitude of smaller device firms and have been conveyed and confirmed
to me during meetings, committees and gatherings of medical device
executives. Small device firms are primarily responsible for the
majority of innovation and development of better and more cost
effective treatment modalities for patient care in the U.S.
I have worked in the orthopedic medical device arena for over 27
years with extensive experience in both international and domestic
product sales and distribution. Over the course of my career I have
founded seven (7) medical device companies, the largest being
California based Alphatec Inc., and assisted others in achieving
critical sales mass in order to go public. The most notable being
Minneapolis based Spine-Tech Inc. which is considered to be the most
successful IPO and ultimate acquisition target in the orthopedic
industry. In 2002, I acquired sole ownership of Signus Medical, LLC, a
master importer, developer and distributor of spinal implants. In June
of 2014 I accepted the concurrent position of CEO of LockDown Surgical
Inc; an extremity company focused on joint ligament repair. LockDown
Surgical was founded in February of 2012 with a single FDA cleared
product for shoulder repair. It has been operating at an annual
financial loss and expects to reach breakeven and finally begin to turn
a modest profit in the fourth quarter of this year. It wound have been
sooner if it were not for the device tax.
Since the economic disaster of 2008, the spinal implant industry
has been one of the hardest hit in terms of downward pricing pressure,
FDA clearance delays and regulatory scrutiny. We have seen end user
pricing drop in excess of 70% , while the burden of compliance and
reporting has increased dramatically. Signus Medical has managed to
weather these storms but not without a negative impact on its top line
sales and net profit.
With the introduction and implementation of the Affordable Care
Act's Medical Device Tax, companies have experienced a multitude of
unforeseen and crippling consequences of the tax including: layoffs,
non-replacement of lost employees, disrupted or negative cash-flow,
curtailing or elimination of R & D projects, reduced inventory
expansion and effective tax rates which can exceed 100% of profit.
Money that was once used to grow and reinvest in the expansion of the
companies is now sent to the IRS every two (2) weeks. The AdvaMed
response to the November 3, 2014 Congressional Research Service reports
that these payments are in fact used in the Nation's general revenue
stream and not used for healthcare reform under the ACA as was
promised.
From the time of our first device tax payments the impact was felt
immediately. We are required to pay the 2.3% tax on all invoiced sales
approximately every two (2) weeks. This tax is assessed on all device
sales billed within the previous two (2) weeks irrespective of profit,
profitability, cash-flow or collections. At present, our collections
average about 72 days from the date of surgery yet we are compelled to
pay the IRS within 14 days or less. As a result, we are fronting the
tax payment nearly 50 days in advance of actually collecting payment
for our implanted devices. Representing two small device companies as I
do, I was forced to lay off several employees in order to cover the
initial shortfall and when several more key support personnel were lost
through the course of normal job advancement, I no longer have the
investment capital to re-hire those positions. Both Signus Medical and
LockDown Surgical are privately held businesses with very close-knit
groups of employees. One of the hardest tasks I have ever had to
perform in my 27 year career is to personally layoff employees who have
performed their jobs admirably, have families and homes of their own,
employer paid healthcare, financial obligations and commitments based
upon the strong wages and benefits we were able to provide. Solely and
for no other reason but to pay for the Medical Device Tax. To date we
have experienced a nearly 25% reduction in our staff and I see no near
or long term opportunity to replace them while this tax is in effect. I
have had to implement a wage freeze since 2012 as the device tax cut
into the profits and ultimately took more than 100% of both company's
profits in 2014.
The payment terms and concept of what is essentially a 2.3% excise
tax was, in my opinion, ill-conceived. The tax is on gross sales,
cannot be passed on to consumers, is non-deductible and does not take
into consideration the profitability or financial status of the
company. In respect to LockDown Surgical, being a startup company, we
have had to actually finance the device tax in addition to financing
all of the initial costs associated with setting up and rolling out a
new company and product. Investors look at the negative impact of the
device tax; see how it pushes out the point of breakeven by literally
years and are extremely hesitant to invest capital knowing much of it
will be siphoned off to pay for a tax instead of used to grow and
develop a company and new treatment therapies. No other industry is
burdened with this government imposed barrier to market. Make no
mistake it is a very real impediment to investment as was highlighted
by a number of surveys conducted by LifeScience Alley, the Medical
Device Manufacturers Association (MDMA) and AdvaMed. While presenting
to Minnesota Governor Mark Dayton's Economic Round Table Forum in 2013,
I expressed real alarm that the then effective tax rate on Signus
Medical due to the device tax was 82%. Governor Dayton's financial
advisor addressed my concerns by asking me, ``Why on earth would you
want to be in any business with such a high tax rate? I would never be
in one.'' My response after the incredulous shock of that comment was
that I have been in the spinal market since 2001. Our company has made
commitments to providing the best treatment options to surgeons and
patient care, providing our employees and their families with well-
paying jobs and benefits. This company is my investment in my own
future as well. Prior to 2012, the corporate playing field was
essentially even and all companies just had to deal with some of the
highest corporate tax rates in the world. I certainly didn't chose to
self- impose this excise tax on my companies.
To help put this in perspective, our CFO provided me with some very
basic accounting examples of the impact of the tax. I am by no means a
tax expert, but as CEO I am legally liable for all financial reporting
and tax submissions. As such, I can certainly navigate through
corporate Profit and Loss Statements and can clearly assess the impact
the Medical Device Tax has on corporate bottom lines. In former times,
pre device tax, a small company with $8,000,000 in sales and an average
6% pre-tax income would show a modest $480,000 pre-tax profit. Using
the National average state corporate tax rate of 8.5% or $40,800
combined with the Federal Tax Rate of 35% on the adjusted taxable
income or $153,720 it would result in a total of $194,520 in taxes
paid; the Net Income After Tax would be $285,480 which could be used to
expand the business, service debt or develop new products. That
represented a 40.5% effective tax rate. Now, add in the 2.3% Medical
Device Tax on gross sales of $184,000 and the total taxes paid on the
same revenue dollars jumps to $378,520 resulting in a Net Income After
Tax of $101,480 or in other words a 78.9% effective tax rate, which is
a 94.6% increase in taxes and far less capital to reinvest.
Next, extend this same scenario to a startup or loss company and
the effects are even more dramatic. A pre-device tax company with the
same $8.000,000 in sales and a modest -2% loss of -$160,000 would only
be subject to the average 1.5% of various State minimum taxes of
$2,400. Total Net Loss After Tax would be a -$162,400. With the
addition of the Medical Device Tax, this startup or loss company is
liable for the same $184,000 as the profitable company; its total tax
liability is now $186,400 thus resulting in a Net -$346,400 loss. This
loss, including the device tax, has to be financed somehow and pushes
out breakeven and profitability. There is no return on investment when
one is financing a government tax and fewer investors are willing to
take on this financial burden. Furthermore, the Device Tax loss is not
deductible and is therefore lost to any kind of recovery forever. The
following page contains a simplistic visual example of the deleterious
effect of this tax.
Another perhaps unforeseen but very significant impact of the
Medical Device Tax is disruption of both of my companies' cash-flow. As
mentioned earlier, payments are made within 2 weeks of posting sales
but collections are running upwards of 70 days. These payments strip
both firms of ready cash which was previously used for day to day
operations, payroll and payments to vendors. Since 2012, our monthly
cash-flow has been negative due to the tax and we have slowly used up
all cash reserves and creative reductions of inventory to now find
ourselves in arrears with suppliers. Banks and investors are clearly
aware of the effects of this tax and are reluctant to extend lines of
credit or further loans citing no desire to finance government taxes.
As of last year, I shelved two major R&D projects because I could not
guarantee that cash, which at one time was budgeted and deemed
available, would in truth actually be available. Instead, we are
looking at how we will simply manage through the cost of introducing
several new products in 2015 which would, under pre-device tax
conditions and expectations, return Signus Medical to nominal
profitability and expand LockDown Surgical products into other areas of
the body where there is a very real and significant patient need.
I am very proud to be actively involved in the medical device
arena. It has historically been a shining star in the US economy and
has supported some of the highest paying jobs when compared to all
other business sectors and average wages. The advancements in treatment
and improved patient outcomes is commonly a direct result of smaller
and more nimble device companies, such as Signus Medical and LockDown
Surgical, reinvesting profits and resources into the development of new
and more cost effective surgical and non-surgical solutions. What many
are unaware of, however, is the very high physical cost of supporting
each and every case performed on a daily basis across this huge nation
of ours. Using spinal surgery as an example, Signus Medical must supply
the hospital and surgeon sufficient implants and redundant backup
inventory to address every potential size and possible complication one
might face in surgery. Literally dozens of implants, like shoes in a
shoe store, must be provided in order to actually implant and sell only
one device and the cost of this inventory is born by the company.
Hospitals no longer purchase or stock specialty instruments and
implants so they must be shipped in and tracked for every single case.
The FDA and HIPAA compliance burden for the location of each and every
implant, their corresponding lot numbers, all associated instrument
sets and ultimately which implants are used is staggering for a company
of any size. The costs associated with increasing even one surgical
customer are so significant that it may take many months to upwards of
a year just to recoup the investment of the supporting implants and
instrumentation. We at Signus have become a model of ``Just In Time''
shipping and inventory control in order to work around the much needed
expansion capital which has been used instead to pay the device tax.
Efficiency alone has its limits and I have been faced with the
unenviable choice of slowing or turning down business to ensure patient
safety. Patients, their safety and surgical outcomes are a priority
shared by all medical device companies. This is something I will not
and cannot compromise on.
With the inclusion of the Medical Device Tax into the 2014
operational budgets, both Signus Medical and LockDown Surgical posted
effective tax rates in excess of 110%. This is not sustainable for any
business, large or small. I fear once again I will be facing employee
downsizing and further elimination of development projects and thus new
clinical therapies to patients in the United States in order to just
remain in business and pay the device tax. Even as the business
improves, so do the pre-payment of device taxes and it is extremely
difficult to actually ever catch up. Money required for reinvesting in
expanded infrastructure including employees, new inventory and
promising R&D projects is no longer available. Again, these problems
are not unique to my two companies and are clearly felt across the
entire medical device industry. I do believe however that smaller and
startup companies are more severely impacted by the device tax given
their inherent size and inability to spread or defer to cost over non-
device products being sold by larger and more vertically integrated
companies.
In conclusion I would like to thank Chairman Coats, Vice-Chairman
Brady, Ranking Member Maloney, Senator Klobuchar and Representative
Paulsen for this opportunity to testify before this committee. I
sincerely hope that the information and personal experiences I have
shared help to enlighten you as to the true negative impact the ACA's
Medical Device Tax has had on the Medical Device Industry as a whole
and smaller and startup companies like Signus Medical LLC, and LockDown
Surgical Inc in particular. Growth, innovation and new job creation
come from small medical device firms. The Medical Device Tax threatens
to kill off or at the very least considerably curtail this segment of
our industry.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Questions for the Record Submitted by Senator Mike Lee and Responses
from Holly Wade, Director of Research and Policy Analysis, National
Federation of Independent Business, Washington, DC
What is the empirical evidence on how small, young, and growing
businesses contribute to employment and to the economy generally?
Overall, the small business economy (those firm under 500
employees) contribute to almost half of private,non-farm,GDP,about half
of private sector employment and 63 percent of net new private-sector
jobs.\1\
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\1\ Small Business Administration, Office of Advocacy, Frequently
Asked Questions, March 2014.
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However, a growing amount of attention on job creation has focused
on the type of small business that most contributes to net new jobs per
year. And important research has found that while small businesses are
the engine of job creation, it is specifically new and young businesses
that drive the process.\2\ The latest research shows that while new
firms only account for roughlypercent of all jobs, these
start-ups generate about 20 percent of gross job creation and the vast
majority of net new jobs. The highly dynamic nature of new, young firms
is an essential component to the economy as a whole, as employment in
mature small and large firms tends to be more constant. However, that
is not to discount the contribution of more mature firms. Most workers
are employed in mature firms, those older than 5 years.
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\2\ Haltiwanger, John, Ron S. Jarmin, and Javier Miranda, ``Who
Creates Jobs? Small vs. Large vs. Young,'' The Review of Economics and
Statistics, May 2013.
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But one area of significant concern is the decline of net new firms
and associated job creation. Census data shows that new firms accounted
for about 16 percent of total firms in the late 1970s. However, that
share had declined to 8 percent in 2011. And jobs created by those new
firms are also on the decline. Therefore, a supportive pro-business
environment is crucial in both attracting start-ups and maintaining a
supportive and competitive environment for mature firm to be
profitable.
How does the tax burden and tax complexity adversely and
disproportionately impact small, young, and growing businesses?
NFIB's Small Business Problems and Priorities survey ranks the
severity of 75 potential business issues. The survey is a random sample
of NFIB members. While the headline result are of all respondents, we
also looked at the severity of issues by the firm's age. ``Federal
Taxes on Business Income'' ranked 5th for those businesses open less
than 3 years and was ranked 6th for the overall population. Twenty-nine
percent of this group found the problem a ``critical'' issue in
operating their business. And ``State Taxes on Business Income'' while
ranking lOth for the overall population, ranked 4th for the youngest
category with 26 percent finding it a critical issue.
Other studies have found that regulatory cost burdens also
disproportionately harm small firms and tax compliance certainly falls
into this category.\3\ Tax compliance costs are three times higher per
employee for small firms than their larger counterparts, or about
$1,600 per employee compared to just over $500, respectively. While
most small employers hire an accountant for tax purposes,\4\ the
associated costs and paperwork burden are a challenge for small
business owners.
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\3\ Crain, W. Mark & Crain, Nicole (2010). The Impact of Regulatory
Costs on Small Firms. Washington, DC: U.S. Small Business
Administration, Office of Advocacy.
\4\ Dennis, William J., Tax Complexity and the IRS, Volume 6, Issue
6, NFIB Research Foundation, 2006.
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