[Senate Hearing 114-577]
[From the U.S. Government Publishing Office]








                                                        S. Hrg. 114-577

                     NAVIGATING BUSINESS TAX REFORM

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

                                HEARING

                               before the

                          COMMITTEE ON FINANCE
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 26, 2016

                               __________




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                          COMMITTEE ON FINANCE

                     ORRIN G. HATCH, Utah, Chairman

CHUCK GRASSLEY, Iowa                 RON WYDEN, Oregon
MIKE CRAPO, Idaho                    CHARLES E. SCHUMER, New York
PAT ROBERTS, Kansas                  DEBBIE STABENOW, Michigan
MICHAEL B. ENZI, Wyoming             MARIA CANTWELL, Washington
JOHN CORNYN, Texas                   BILL NELSON, Florida
JOHN THUNE, South Dakota             ROBERT MENENDEZ, New Jersey
RICHARD BURR, North Carolina         THOMAS R. CARPER, Delaware
JOHNNY ISAKSON, Georgia              BENJAMIN L. CARDIN, Maryland
ROB PORTMAN, Ohio                    SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania      MICHAEL F. BENNET, Colorado
DANIEL COATS, Indiana                ROBERT P. CASEY, Jr., Pennsylvania
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina

                     Chris Campbell, Staff Director

              Joshua Sheinkman, Democratic Staff Director

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                            C O N T E N T S

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                           OPENING STATEMENTS

                                                                   Page
Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman, 
  Committee on Finance...........................................     1
Wyden, Hon. Ron, a U.S. Senator from Oregon......................     3
Thune, Hon. John, a U.S. Senator from South Dakota...............     4
Cardin, Hon. Benjamin L., a U.S. Senator from Maryland...........     6

                               WITNESSES

Barthold, Thomas A., Chief of Staff, Joint Committee on Taxation, 
  Washington, DC.................................................     9
Hines, James R., Jr., Ph.D., Richard A. Musgrave collegiate 
  professor of economics and L. Hart Wright collegiate professor 
  of law, University of Michigan, Ann Arbor, MI..................    11
Toder, Eric J., Ph.D., institute fellow, Urban Institute, and co-
  director, Urban-Brookings Tax Policy Center, Washington, DC....    13
Zinman, Sanford E., CPA and owner, Sanford E. Zinman, CPA, PC, 
  Tarrytown, NY..................................................    14
Goschie, Gayle, vice president, Goschie Farms, Inc., Silverton, 
  OR.............................................................    16

               ALPHABETICAL LISTING AND APPENDIX MATERIAL

Barthold, Thomas A.:
    Testimony....................................................     9
    Prepared statement...........................................    35
Cardin, Hon. Benjamin L.:
    Opening statement............................................     6
Goschie, Gayle:
    Testimony....................................................    16
    Prepared statement...........................................    43
Hatch, Hon. Orrin G.:
    Opening statement............................................     1
    Prepared statement with attachments..........................    45
Hines, James R., Jr., Ph.D.:
    Testimony....................................................    11
    Prepared statement...........................................    49
Thune, Hon. John:
    Opening statement............................................     4
Toder, Eric J., Ph.D.:
    Testimony....................................................    13
    Prepared statement...........................................    53
Wyden, Hon. Ron:
    Opening statement............................................     3
    Prepared statement...........................................    66
Zinman, Sanford E.:
    Testimony....................................................    14
    Prepared statement...........................................    66

                             Communications

American Bar Association (ABA)...................................    73
American Council of Life Insurers (ACLI).........................    75
American Farm Bureau Federation..................................    76
American Public Power Association (APPA).........................    77
Cash to Accrual Accounting Stakeholder Coalition.................    80
CRANE Coalition..................................................    83
Financial Executives International (FEI).........................    85
Like-Kind Exchange Stakeholder Coalition.........................    87
National Conference of CPA Practitioners.........................    88
National Multifamily Housing Council (NMHC) and National 
  Apartment 
  Association (NAA)..............................................    92
NRS Inc..........................................................   102

 
                     NAVIGATING BUSINESS TAX REFORM

                              ----------                              


                        TUESDAY, APRIL 26, 2016

                                       U.S. Senate,
                                      Committee on Finance,
                                                    Washington, DC.
    The hearing was convened, pursuant to notice, at 9:30 a.m., 
in room SD-215, Dirksen Senate Office Building, Hon. Orrin G. 
Hatch (chairman of the committee) presiding.
    Present: Senators Grassley, Crapo, Thune, Isakson, Portman, 
Coats, Heller, Scott, Wyden, Stabenow, Carper, Cardin, Bennet, 
and Casey.
    Also present: Republican Staff: Tony Coughlan, Tax Counsel; 
Jim Lyons, Tax Counsel; Eric Oman, Senior Policy Advisor for 
Tax and Accounting; and Mark Prater, Deputy Staff Director and 
Chief Tax Counsel. Democratic Staff: Chris Arneson, Tax Policy 
Advisor; and Joshua Sheinkman, Staff Director.

 OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM 
              UTAH, CHAIRMAN, COMMITTEE ON FINANCE

    The Chairman. Good morning. It is a pleasure to welcome 
everyone to today's hearing, which we have entitled 
``Navigating Business Tax Reform.'' I think this title 
accurately describes the challenges we have before us moving 
forward on business tax reform specifically, and on 
comprehensive tax reform more generally.
    In the recent past, identifying and developing certain 
bipartisan policy proposals and moving them through the 
legislative process have proven especially difficult. But I am 
an optimist, and I believe we can and should find common ground 
on a path forward for comprehensive tax reform.
    Of course, as I have said in the past, successful tax 
reform will take a President who truly makes it a priority and 
works closely with Congress to get it over the finish line. 
Currently, I think it is safe to say that we have not met that 
prerequisite with this administration, which most acknowledge 
means that for now we have to wait. But in the interim, this 
committee will continue to lay the foundation and develop pro-
growth proposals for when the appropriate opportunity arises. 
That is why last year, Senator Wyden and I asked members of our 
committee to work on various tax reform working groups to help 
identify issues and develop consensus, if possible, around tax 
policy proposals.
    Today, we will focus our attention on business tax reform 
issues, including topics that were covered in the report issued 
by the bipartisan Business Income Tax Working Group. I want to 
thank the co-chairs of that working group--Senators Thune and 
Cardin--as well as other members of the working group: Senators 
Roberts, Burr, Isakson, Portman, Toomey, Coats, Stabenow, 
Carper, Casey, Warner, Menendez, and Nelson. A lot of time and 
effort went into examining these issues and compiling this 
report. I appreciate everyone's willingness to help advance 
this cause.
    Tom Barthold, the Chief of Staff for the Joint Committee on 
Taxation, is with us today to provide background on business 
tax reform issues and highlight some of the major topics 
reviewed in the working group's report. We appreciate his work, 
and we appreciate him being with us.
    We have a great group of additional witnesses here today as 
well, who will provide important insights and recommendations 
about broad design issues of the business tax system and 
practical on-the-ground issues that are important for us to 
keep in mind as we further develop and refine proposals in the 
business tax space.
    I want to take a minute to discuss one particular business 
tax issue that was discussed in the working group report that I 
believe warrants real consideration by everyone here today: 
corporate integration. In very general terms, corporate 
integration means eliminating double taxation of certain 
corporate business earnings. Under current law, a corporation's 
earnings are taxed once at the entity level and then again at 
the shareholder level when those earnings are distributed to 
the shareholders as dividends.
    In other words, under our system, if a business is 
organized as a C corporation, we tax the earnings of the 
corporation itself and those same earnings when paid out to the 
individual owners of the business. This creates a number of 
inequities and distortions, and my staff and I have been 
working for a few years now to develop a proposal to address 
this problem.
    I was glad to see that the business tax working group 
addressed corporate integration in its report, noting that, 
``Eliminating the double taxation of corporate income would 
reduce or eliminate at least four distortions built into the 
current tax code: one, the incentive to invest in non-corporate 
businesses rather than corporate businesses; two, the incentive 
to finance corporations with debt rather than equity; three, 
the incentive to retain rather than distribute earnings; and 
four, the incentive to distribute earnings in a manner that 
avoids or significantly reduces the second layer of tax.''
    Now, depending on its design, corporate integration could 
have the effect of reducing the effective corporate tax rate 
and help address some of the strong incentives we are seeing 
today for companies to relocate their headquarters outside of 
the United States. It would also have the likely effect of 
making the United States a more attractive place to invest and 
do business.
    Now, I will have much more to say on this topic in the 
coming weeks and months, but I plan to raise this issue in 
general terms here today.
    Once again, I want to welcome our witnesses. I look forward 
to a robust and informative discussion.
    With that, I am glad to turn to Senator Wyden for his 
opening remarks, and then we will hear from the two co-chairs 
of the business tax working group, who will give brief opening 
remarks. We will start with Senator Thune and then Senator 
Cardin after Senator Wyden completes his remarks.
    [The prepared statement of Chairman Hatch appears in the 
appendix.]
    The Chairman. Senator Wyden?

             OPENING STATEMENT OF HON. RON WYDEN, 
                   A U.S. SENATOR FROM OREGON

    Senator Wyden. Thank you very much, Mr. Chairman. I very 
much look forward to working with you and our colleagues.
    I too want to commend Senator Thune and Senator Cardin for 
their outstanding work. We had just the right people heading 
that part of the working group, and I appreciate it.
    Colleagues, if you own a small business in America today, 
often you go to bed at night believing that you are in danger 
of being ensnared by an outdated, overgrown tax code that 
Americans spend 6.1 billion hours and more than $100 billion 
complying with each year. That tax system is punishing to those 
who do not have a fleet of accountants and the luxury of time 
to plan investments around taxes.
    The American tax code tells small businesses that their 
dollar is worth less compared to sophisticated firms that can 
afford to make the rules work for them. That is why today I 
have released the Cost Recovery Reform and Simplification Act 
of 2016. This proposal is all about making the tax code more 
attractive for the risk-takers who go out and start a small 
business, people who are, more often than ever before, going to 
be minorities or women.
    So this proposal would modernize the tax code and strip 
away much of the unfairness to small business by radically 
simplifying our system of depreciation. For the small, cash-
strapped firms to grow and create jobs, they need to invest in 
basic priorities like a new cash register, an office computer, 
or farm equipment when it makes sense, not when it makes tax 
sense.
    Today, to figure out the tax deductions on these 
investments, a small businessperson has to navigate more than 
100 sets of tax rules. My proposal dumps that headache and lays 
out six categories for depreciation that are far easier for a 
small businessperson to work with.
    Today, you have to do the math as many as three separate 
times under different programs for each and every asset. My 
proposal says one round of math is enough. Small businesses 
should not have to do individual calculations for every car on 
the lot, every computer in the lab, or every machine in the 
shop.
    Today's rules come from yesteryear, from the last century. 
They are stuck in an era of fax machines and VCRs that predates 
the technology boom that has transformed the way in which 
Americans live and work.
    My proposal says our business tax rules should reflect a 
21st-century economy and help our cutting-edge entrepreneurs 
thrive, not hold them back. It makes no sense to cling to an 
outdated system that taxes some high-tech investments, such as 
computer servers and MRI machines, at more than double the rate 
of other investments.
    A start-up should not be told that they are not allowed to 
use a work laptop in a coffee shop or otherwise they are going 
to face a big financial hit on their taxes. And in my view, the 
tax code should not get in the way of public-private 
partnerships that want to build new roads, bridges, and 
highways across the country.
    So my proposal would fix these issues with new rules 
grounded in common sense and a realistic appreciation of how 
our businesses, particularly the small businesses, operate 
today. It is my hope that we are going to be able to look at 
these proposals and more as our committee considers, again, on 
a bipartisan basis, how to bring our tax code up to date.
    So I very much look forward to today's hearing. I am 
especially pleased that Gayle Goschie of Goschie Farms in 
Silverton, OR is with us today. The hundreds of acres of hops 
they grow at Goschie Farms are a big part of what makes Oregon 
beer the best that money can buy. And just for those kind of 
historians in the room, Goschie Farms just celebrated their 
112th hops harvest.
    So speaking for Oregonians and for small businesses, we 
could not have a better witness than Ms. Goschie to represent 
Oregon.
    Mr. Chairman, again, like you, I would like to express our 
appreciation to Senator Thune and Senator Cardin for the 
excellent work that they have done.
    [The prepared statement of Senator Wyden appears in the 
appendix.]
    The Chairman. Thank you, Senator.
    Senator Thune, we will hear your remarks at this time.

             OPENING STATEMENT OF HON. JOHN THUNE, 
                A U.S. SENATOR FROM SOUTH DAKOTA

    Senator Thune. Thank you, Mr. Chairman. I thank you and 
Ranking Member Wyden for the opportunity to make an opening 
statement today and for the opportunity to co-chair the 
Business Income Tax Reform Working Group with Senator Cardin 
last year.
    While undoubtedly there remain significant differences on 
tax reform between the political parties, I believe that our 
working group demonstrated that there is genuine bipartisan 
agreement in a number of areas. The bipartisan report that we 
issued last July underscores that Senators in both parties 
understand the importance of reforming our tax system and are 
willing to think creatively about how we address some of the 
most vexing challenges of business tax reform.
    Our report considered a wide range of issues, from tax 
policies promoting innovation to simplification reforms to 
addressing structural biases in the tax code. However, given 
that my time is limited this morning, I wanted to briefly 
discuss two areas that our report identified as threshold 
issues, meaning that any successful business tax reform effort 
will need to resolve these challenges.
    The Chairman. Senator, may I interrupt you for a moment? I 
have to open up the Senate. I would like you to chair this 
hearing until I get back. Is that all right?
    Senator Thune. Yes, I would be happy to.
    The Chairman. Thank you. I appreciate it.
    Senator Thune [presiding]. Thank you, Mr. Chairman.
    The first of those issues that our working group report 
recognized was that a more competitive U.S. corporate tax rate 
is going to be integral to any effort to modernize our business 
tax system.
    America is losing ground as other nations continue to lower 
their corporate tax rates, highlighted by the fact that the 
U.S. combined State and Federal rate of over 39 percent is the 
highest corporate tax rate in the developed world. This high 
tax rate is not sustainable if we want American companies to 
compete and win in the global economy, and if we want our 
country to continue to be an attractive location for foreign 
investment.
    A number of our major competitors, such as Canada, Japan, 
and the UK, have demonstrated in recent years that lowering the 
corporate tax rate is achievable. Our working group report 
reinforces the notion that while there are differing approaches 
to get there, a lower corporate tax rate remains at the center 
of any bipartisan approach to business tax reform.
    Secondly and just as importantly, our group expressed the 
view that business tax reform needs to be about all businesses, 
both large and small. The reality is that pass-through 
businesses, those businesses taxed at the individual tax rates, 
employ 55 percent of the private-sector workforce and earn more 
than 60 percent of all net business income. If you include sole 
proprietorships, pass-through businesses account for more than 
90 percent of all businesses in America. As such, our report 
found that, and I quote, ``Clearly, business tax reform needs 
to ensure that these businesses are not ignored in an effort to 
reduce the corporate tax rate. Pass-through businesses need to 
benefit from business tax reform for any such effort to be 
considered a success.''
    I believe we need to keep this perspective foremost in mind 
as we move forward. So I would say to members of our committee, 
our colleagues, that our working group found that a modern, 
more efficient system for taxing business income is critical to 
boost economic growth, raise incomes, and increase wages.
    We recognized that achieving meaningful tax reform will 
require difficult decisions on a range of complex issues, and 
it will require leadership both in Congress and from the White 
House. But I believe that we should remain optimistic, because 
with each passing day, tax reform becomes less a question of 
``if '' and more a question of ``when'' and ``how.'' Our 
outdated tax code is, without question, holding America back, 
and the clear recognition of that fact is one of the most 
important elements to come out of last year's working group 
process.
    I want to thank Senator Cardin for his leadership, and for 
the opportunity to work with him, and thank all the members of 
our working group and their staffs for their input and for 
helping us lay the groundwork for our tax reform effort.
    I look forward to hearing from today's witnesses and for a 
continuation of the robust debate over how best to reform our 
business tax system.
    With that, I would recognize the Senator from Maryland, 
Senator Cardin.

         OPENING STATEMENT OF HON. BENJAMIN L. CARDIN, 
                  A U.S. SENATOR FROM MARYLAND

    Senator Cardin. Well, Senator Thune, thank you, and thank 
you so much for your leadership on the business tax working 
group.
    I also want to join you in thanking Senator Hatch and 
Senator Wyden for their leadership in convening this hearing, 
but also in establishing the working groups.
    Our working group produced a report of 140 pages. I 
particularly want to thank Mr. Barthold and the Joint Committee 
on Taxation for their extraordinary work. I said at the 
conclusion that I learned a lot and I thought that we were 
gaining Senate continuing education credits, though we did not 
have to pay any tuition for them. So it was a great learning 
experience for all of us, and I thank you for that.
    I agree with Senator Thune in that our high tax rate on 
businesses in America is making America uncompetitive. We are 
definitely at a disadvantage in international competition 
because of the high business tax rates, and I think Democrats 
and Republicans agree we have to do something about it.
    The C corporation rate at 35 percent is not competitive, 
compounded by the fact of double taxation, and Senator Thune 
and Senator Hatch and others have brought forward proposals in 
this regard, and the chairman just commented about it. It is an 
area that we certainly need to take a look at so that the 
business entity form does not discriminate against businesses. 
That is clearly an issue that we need to deal with.
    But as Senator Thune pointed out, 90 percent of American 
businesses do not pay the C rate, they pay the individual rate. 
That rate, at 39.6-plus percent, is not competitive. So we need 
to deal with the realities of both the C rate and the 
individual rate in dealing with business taxes in our country.
    Although we want to talk about major tax reform, we should 
not lose sight that during this process, there are so-called 
smaller reform issues that can help a great deal, like S 
corporation reform, that we should do, and we should try to get 
that done as quickly as possible in order to help America's 
businesses.
    The challenges in dealing with the high rates are 
incredible, and I just really want to put this on the table so 
our colleagues understand the challenges we have if we are 
really going to do major reform for business taxes in America.
    First, it is a huge revenue issue in trying to reduce the 
rates under the existing structure. If we use the existing 
structure, for every 1 percentage point reduction in the C 
rate, Joint Tax has estimated that would cost $100 billion over 
10 years. So you can do the math. Most people want to reduce it 
by as much as 10 percentage points. That is $1 trillion. And 
that does not deal with the individual rate.
    As we have talked about, we need to understand that there 
is need for help on the individual rate with business income, 
and that could add anywhere between 60 percent to 80 percent 
more to the cost of any proposal that deals with reducing the 
rates.
    So on the other side, if we say, well, let us do what we 
did in 1986, and that is, let us just spread the burden and 
reduce the rates, that lasted until 1987. So I would suggest, 
politically, I am not sure that is possible for us to leave the 
tax code alone for any significant length of time.
    So I just really want to challenge the committee with 
something which is somewhat counterintuitive. That is that the 
United States, among all the OECD countries, is one of the 
lowest on its reliance on the governmental sector for its 
services. So why should we have the highest marginal rates of 
the OECD countries? We should have the lowest marginal rates of 
the OECD countries.
    The reason, quite frankly, as it was pointed out during our 
study, is that we are the only OECD country that does not have 
a national consumption tax. There have been 150 countries 
globally that use a national consumption tax for part of their 
revenues to finance government.
    So for those reasons and many others, in the last Congress, 
I introduced the Progressive Consumption Tax that would replace 
some of our income tax with a national consumption tax. It 
dramatically simplifies our income tax code, particularly on 
personal income, by starting it at $100,000 of taxable income, 
with the highest rate being 28 percent for that taxable income 
for families over $500,000.
    It would reduce the corporate tax rate to 17 percent, 
giving us a significantly lower corporate tax rate, and would 
establish a national consumption tax at 10 percent using the 
credit invoice system, which we think is the most efficient way 
to do it.
    It is progressive, starting the income tax at $100,000, and 
the Earned Income Tax Credit and the Child Tax Credit are 
actually cashed out in order to keep it progressive. It is 
revenue-neutral, and it contains a circuit-breaker in the event 
the Joint Tax numbers are not exactly accurate and we produce 
more revenue than expected--there would be a trigger mechanism 
to return those excess taxes to the taxpayers.
    The result is, we would have, on average, about a 5 
percentage point lower average on all of our taxes, income and 
consumption, than the OECD countries, giving us a competitive 
advantage rather than a competitive disadvantage on 
international issues.
    Mr. Chairman, I just really want to make this point. I 
think this committee needs to be in the leadership on tax 
reform. I think we can be in the leadership on tax reform. I 
think with the work that was done by the working groups, we 
have become, I think, more understanding of the challenges we 
have, and I would just urge us to work together so America, in 
fact, can have a tax code that is a lot easier and simpler and 
more efficient on capital and growth than our current tax code.
    Senator Thune. Thank you, Senator Cardin.
    I am just going to take a couple of minutes here and 
introduce our panel of five witnesses today.
    First, we are going to hear from Mr. Tom Barthold, who, as 
mentioned earlier, is the Chief of Staff for the Joint 
Committee on Taxation. Tom is no stranger here and really 
should not need much of an introduction. He has worked for the 
Joint Committee staff since 1987, when he started as a staff 
economist. He then worked his way up the ladder to become 
Senior Economist, Deputy Chief of Staff, and Acting Chief of 
Staff, before being named in his current position in May of 
2009.
    Prior to his work here in Washington, Tom was a member of 
the economics faculty of Dartmouth College. Tom received his 
bachelor's degree from Northwestern University and later 
received his doctorate in economics from Harvard University 
and, I would add, is indispensible in terms of the work that we 
were doing on the working groups, providing insight and counsel 
as we went through that process.
    So, good having you here, Tom.
    The second witness will be Dr. James Hines, the Musgrave 
professor of economics and Wright collegiate professor of law 
at the University of Michigan. Dr. Hines also currently serves 
as the research director of the Office of Tax Policy Research 
at the University of Michigan.
    He is a research associate of the National Bureau of 
Economic Research, research director of the International Tax 
Policy Forum, former co-editor of the Journal of Economic 
Perspectives, and once, long ago, was an economist in the U.S. 
Department of Commerce.
    Dr. Hines has held visiting appointments at Columbia 
University, the London School of Economics, the University of 
California-Berkeley, and Harvard Law School. He graduated with 
a B.A. and M.A. from Yale University and a Ph.D. from Harvard, 
all in economics.
    Third, we will hear from Dr. Eric Toder, an institute 
fellow at the Urban Institute and co-director of the Urban-
Brookings Tax Policy Center. Dr. Toder's recent work includes 
papers on what the U.S. can learn from other countries' 
territorial tax systems, issues in designing a carbon tax, 
corporate tax reform, net benefits of payroll tax expenditures, 
and many other issues.
    Dr. Toder previously held a number of positions in tax 
policy offices in the U.S. Government and overseas, including 
service as the Deputy Assistant Secretary for Tax Analysis at 
the U.S. Treasury Department, Director of Research at the IRS, 
Deputy Assistant Director for Tax Analysis at the Congressional 
Budget Office, and consultant to the New Zealand treasury. Dr. 
Toder received his Ph.D. in economics from the University of 
Rochester.
    Our fourth witness will be Sanford Zinman, president of 
Sanford E. Zinman, CPA, PC in New York. Mr. Zinman is licensed 
in New York, Florida, and Connecticut, and has worked in public 
accounting for more than 30 years. His diversified clientele 
includes architectural firms, attorneys, authors, child care 
providers, construction and real estate developers, insurance 
professionals, interior designers, medical professionals, 
restaurants, and retail operations.
    Mr. Zinman provides tax services for businesses and 
individuals. Among other things, he is a member of the National 
Conference of CPA Practitioners, where he serves as the vice 
president and the chair of the Tax Policy Committee. He is also 
a member of the American Institute of Certified Public 
Accountants, the National Society of Accountants, and the 
National Association of Tax Professionals. In other words, he 
hangs out with a lot of accountants. [Laughter.] Mr. Zinman 
graduated from Iona College with an MBA in public accounting.
    Finally, as Senator Wyden pointed out, we are going to hear 
from Ms. Gayle Goschie, vice president of Goschie Farms, Inc. 
Ms. Goschie is a fourth-generation farmer and business owner in 
Silverton, OR. She works with her two brothers to manage the 
operation of the family farm that specializes in hops and wine 
grapes, among other crops.
    Goschie Farms grows 550 acres of hops and sells to some of 
the Nation's top breweries. The farm also grows 150 acres of 
wine grapes and more than 300 acres of other crops, including 
grass seed, corn, and wheat.
    Goschie Farms has been a leader and innovator in 
sustainable farming techniques, including powering a portion of 
its operations through solar energy. Ms. Goschie was also the 
first woman hop grower to be awarded the International Order of 
the Hop in 2009.
    I want to thank all of you for coming. I know this is an 
expansive topic, and the more insight and perspective that we 
can get, the better. We are grateful to have your expertise and 
experience to inform us on business tax issues, and we will 
look forward to hearing from all of you.
    Hopefully, you can come up with a way to make this all a 
little bit more understandable and hopefully easier--no, I do 
not think it is going to be easier for us to get this done. 
There are some very complex issues, as we found in our business 
tax working group, but it is a subject that we need to tackle 
and, as noted earlier, the sooner, the better.
    So we will proceed from left to right, my left and your 
right, starting with Mr. Barthold.
    Tom, please proceed with your opening statement.

    STATEMENT OF THOMAS A. BARTHOLD, CHIEF OF STAFF, JOINT 
             COMMITTEE ON TAXATION, WASHINGTON, DC

    Mr. Barthold. Thank you, Senator Thune, members of the 
committee.
    For today's hearing, Chairman Hatch and Ranking Member 
Wyden have asked me to briefly review some of the business tax 
reform issues raised by the committee's bipartisan Business 
Income Tax Working Group. I also note that my colleagues 
prepared for you more detailed background information that was 
released last Friday in our Joint Committee document JCX-35-
16.*
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    * For more information, see also, ``Background on Business Tax 
Reform,'' Joint Committee on Taxaton staff report, April 22, 2016 (JCX-
35-16), https://www.jct.gov/publications.html?func=
startdown&id=4903.
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    It is important to remember that in assessing any tax 
system reform, there are really four key dimensions that we 
always look at.
    First, does the tax system promote economic efficiency? 
Does the tax system promote economic growth? Is the tax system 
fair? Is the tax system administrable, both for the taxpayer 
and the Internal Revenue Service?
    Now, there may be other policy considerations as to where 
we fit in the budget picture, but invariably it is the case 
that these different policy goals are in conflict. Policy 
designed to promote economic neutrality may conflict with goals 
of fairness. Policy designed to promote fairness may lead to 
complexity and increased compliance costs. So those were issues 
that the Business Income Tax Working Group was always grappling 
with when thinking about the issues before them.
    Some of the proposals undertake comprehensive tax reform by 
broadening the base and lowering rates. As Senator Cardin 
pointed out, lowering the top rate of the corporate income tax 
by 1 percentage point from its current statutory rate of 35 
percent to 34 percent, we have estimated, against the current 
policy baseline, would cost $100 billion over the 10-year 
period.
    By comparison, among our staff estimates of the largest 
corporate tax expenditures, only a modest handful, in fact, 
exceed $50 billion. So, if we broaden the base to lower rates, 
it takes elimination of a lot of tax expenditures or other 
ideas.
    This was an approach that was taken by former House Ways 
and Means Committee chairman Dave Camp in his H.R. 1, which 
reduced the corporate income tax rate to 25 percent, but did so 
generally by slowing depreciation rules. It required 
amortization of 50 percent of advertising expenditures over 10 
years, required amortization of research and development 
expenditures, repealed LIFO accounting, repealed lower of cost 
or market methods of accounting, phased out the section 199 
deduction for manufacturing activities, and a number of other 
base broadeners.
    I think it is also important in this context, when we talk 
about conflicting goals, to recognize that some of the 
tradeoffs that can arise are exhibited in H.R. 1. If we lower 
corporate tax rates, that is good for investment. But if we 
slow depreciation, if we slow cost recovery of investment, that 
is bad for investment. So there is inherently always a 
tradeoff.
    Other issues that the working group looked at, as, again, 
noted in your opening statements, were the differences between 
pass-through entities in the United States as a business form 
and C corporations. As the next slide notes, a substantial 
amount of net business income in the United States is earned by 
enterprises that are not C corporations. So some business tax 
reform options have been proposed with the intent of 
maintaining a sense of parity between taxation of corporate and 
pass-through entities.
    However, the working group found that it is really not 
clear what parity should mean. Owners of C corporations, as 
noted by the chairman, generally bear two levels of tax that in 
total can exceed 50 percent. However, if you look at it in 
terms of earnings of the C corporation that are not 
distributed, the current tax burden of those earnings is 35 
percent.
    On the other hand, owners of pass-through entities 
generally do not bear a tax rate greater than 44 percent, but 
that tax rate may apply regardless of whether the earnings are 
distributed or retained.
    The slide before you gives you a more detailed analysis. It 
is not actually a simple comparison of one situation to another 
situation, a consequence of some of the other complexities that 
we currently have for business income taxation. Recognition of 
two levels of tax applicable to income of C corporations has 
led some to propose what is called corporate integration. The 
chairman described this. There are basically two approaches. 
One is referred to as complete integration and the other 
partial integration.
    In complete or full integration, you eliminate double 
taxation of both dividends and retained corporate earnings by 
including in shareholder income the distributed and 
undistributed earnings of the business entity. This is the way 
we tax S corporations under present law.
    On the other hand, partial integration is generally a form 
of dividend relief, reducing double taxation on distributed 
earnings only, with no change in tax on retained earnings. You 
might characterize our current-law lower rate of tax on 
qualified dividends as a form of partial integration.
    I know that I am exceeding my time here and that you want 
to hear from your other experts, but let me just make a brief 
note of one other important area that the working group looked 
at, and that was the role of innovation on the U.S. economy and 
the role of innovation in future growth.
    It was noted in the working group that outside the United 
States, a number of countries have established intellectual 
property regimes or patent boxes, as they have been called, 
which offer preferential tax treatment on income attributable 
to intellectual property. The goal here has been to increase 
domestic investment in research and development or encourage 
business enterprises to locate the ownership of that 
intellectual property in that particular country.
    Now, in the United States, we do have incentives, and 
significant incentives, for research and development. The PATH 
Act modified and made permanent our section 41 research credit, 
and we do allow full expensing of all research activities.
    The working group explored the notion of creating a patent 
box-type system for the United States, and I want to note that 
adopting a U.S. innovation box really presents, I think, some 
unique policy design and administrative issues for the members 
to consider, including what is in the box. Is it just patents? 
Is it a broader range of intellectual property, including trade 
secrets, and how do we define those in terms of applying this 
system administratively?
    Other questions are, what is the role of nexus, which has 
been important in terms of the European consideration of these 
patent box proposals, and then how would the income from this 
intellectual property be taxed?
    Well, the working group did review a number of other 
proposals, including some that have been offered by members of 
this committee, but I know that you want to take more time 
dealing with the distinguished witnesses that you have before 
you to my left, so I will conclude at this point, and I am 
happy, as always, to answer any questions that the members 
might have.
    [The prepared statement of Mr. Barthold appears in the 
appendix.]
    Senator Thune. Thank you, Mr. Barthold.
    Dr. Hines?

 STATEMENT OF JAMES R. HINES, JR., Ph.D., RICHARD A. MUSGRAVE 
COLLEGIATE PROFESSOR OF ECONOMICS AND L. HART WRIGHT COLLEGIATE 
    PROFESSOR OF LAW, UNIVERSITY OF MICHIGAN, ANN ARBOR, MI

    Dr. Hines. Good morning.
    It is terrific that the committee is looking into business 
tax issues, because U.S. businesses currently face heavy tax 
burdens, and these tax burdens depress business activity, 
somewhat distort it, and, as a result, create fewer economic 
opportunities for Americans, especially American workers.
    The challenge that you face is the following. If you want 
to enact a reform that is revenue-neutral within the business 
sector, it is going to be impossible to lower business tax 
burdens very much. That is pretty much obvious, because if you 
implement a reform that is revenue-neutral, it will not greatly 
change the average tax rate that businesses face.
    There is good that can be done by revenue-neutral reform, 
but let us be clear that there is a limit to how effective that 
is going to be in addressing the problems of heavy tax burdens 
on U.S. businesses, because any reform that is revenue-neutral 
will lower the tax on some activities and raise the tax on 
others and, as a result, will not greatly change the burdens.
    Now, within the constraints of revenue neutrality or really 
for any business tax setup, there are smarter ways to tax 
business income. Those efforts should be guided by principles, 
and economic theory says there are two principles we should 
apply. One, we want lighter tax burdens on activities that 
generate positive economic spillovers, and two, we want lighter 
tax burdens on activities that are more responsive to taxation.
    The challenge in taxing business, or really taxing 
anything, is that when you tax income, you discourage the 
production of income, and our goal should be to try to do the 
least damage to the economy that we can while raising the tax 
revenue that we need to fund government.
    So what does that mean in practice? On the spillovers 
question--some of this has already been discussed this 
morning--there are very strong reasons to have favorable tax 
treatment of research expenditures, because research creates 
positive spillovers for the economy and contributes to economic 
growth; for low-income housing, because low-income housing 
offers positive spillovers to communities; and to other 
activities that generate positive benefits that are not 
entirely captured by the people who undertake the activities.
    The second principle is that you want lower tax rates on 
activities that are highly responsive to taxation. An example 
might be domestic manufacturing. We currently have section 199, 
the domestic production activities deduction, that offers a 
favorable tax treatment of qualifying activities. There is 
pretty good evidence now that that deduction has been 
successful in stimulating more manufacturing investment than we 
otherwise would have had, and further evidence that 
manufacturing investment itself is more responsive to its tax 
treatment than is investment in other industries.
    As a result, tax reform that would be directed at lowering, 
say, the statutory corporate tax rate and financing some of 
that reduction by eliminating the section 199 deduction, based 
on the evidence that we have, probably would have the effect of 
reducing overall investment in the economy. It is true that a 
lower statutory rate encourages investment, but the problem is 
that if you finance it by removing the deduction for domestic 
production activities, then, on net, you discourage so much 
manufacturing investment by removing the deduction that you do 
not make it entirely back with the lower statutory rate.
    The issue of corporate integration has come up this morning 
as well. Economic theory does not actually say that we want 
equal tax treatment of debt-financed and equity-financed 
investment. But it says that the difference in the taxation of 
these two forms of investment, if there should be one, should 
be related to the responsiveness of this activity to taxation.
    We currently have a quite different tax treatment of debt- 
and equity-financed investment. In particular, as noted, 
equity-financed investment is taxed much more heavily, and 
efforts to integrate the corporate and personal tax systems and 
thereby reduce the heavy burden on equity-financed investment 
would surely be a movement in the direction of economic 
efficiency.
    The general implication of economic theory is that you do 
not actually want equal taxation of every economic activity. 
You do not. And the reason is that our tax system discourages 
economic activity. It just does. That is part of the cost of 
government.
    What we want to do is to discourage economic activity as 
little as possible while raising the revenue as well and as 
fairly as we can. So we should try to design the system with 
the responsiveness of different activities in mind, and that 
will be a nuanced system. It will be a system with differences 
in the taxation of different activities. But if we do it right, 
we will preserve as much as possible of the economic vibrancy 
of the country, and the whole country will benefit, 
particularly American workers.
    [The prepared statement of Dr. Hines appears in the 
appendix.]
    Senator Thune. The chairman is back.
    Thank you, Dr. Hines.
    Dr. Toder?

  STATEMENT OF ERIC J. TODER, Ph.D., INSTITUTE FELLOW, URBAN 
INSTITUTE, AND CO-DIRECTOR, URBAN-BROOKINGS TAX POLICY CENTER, 
                         WASHINGTON, DC

    Dr. Toder. Chairman Hatch, Ranking Member Wyden, and 
members of the committee, thank you for inviting me to appear 
today to discuss business tax reform. The views I am expressing 
are my own and should not be attributed to the Tax Policy 
Center or to the Urban Institute, its board, or its funders.
    Current U.S. business income taxes have many harmful 
effects. They discourage domestic investment, place U.S.-based 
firms at a competitive disadvantage, and have encouraged them 
to accrue over $2 trillion in overseas assets. They favor 
corporate debt over equity, retained earnings over 
distributions, and pass-through businesses over companies that 
must pay corporate income tax.
    There is bipartisan agreement that the corporate income tax 
rate needs to be cut and the tax on repatriated dividends 
reduced or eliminated. There is less agreement on how to pay 
for rate reduction and how to prevent additional tax avoidance 
through shifting profits to tax havens.
    A 1986-style tax reform that pays for lower rates by 
eliminating business preferences is not sufficient to pay for 
the needed rate cuts in the long run, and some of the base-
broadening measures under consideration would reduce domestic 
investment and not necessarily make them more productive or 
efficient.
    I suggest, therefore, that Congress look beyond business-
only tax reforms to other revenue sources to pay for corporate 
rate cuts. One approach would raise taxes on shareholders to 
help pay for lower corporate rates. Taxes based on shareholder 
residence fit better in today's global economy than taxes based 
on either corporate residence or source of corporate income.
    A corporation's tax residence may bear little relationship 
to the location of its production, sales, shareholders, or even 
top management, and the source of its income is difficult to 
determine when an increasing share of profits reflects returns 
to intangible assets not tied to a fixed location. In contrast, 
because a shareholder-level tax depends only on the residence 
of the shareholder, neither the residence of the corporation 
nor the source of its income would affect tax liabilities.
    Alternatives are to raise tax rates on realized capital 
gains and dividends, shift the taxation of shareholder income 
to an accrual or mark-to-market basis, or integrate the 
corporate and personal income taxes. In my written statement, I 
discuss the advantages and problems with each of these 
approaches.
    Another approach would replace a portion of the corporate 
and individual income taxes, as Senator Cardin suggests, with a 
new consumption tax, such as the destination-based VAT in use 
in over 150 countries around the world. Unlike the corporate 
income tax, a VAT would not discourage saving and investment 
and would not affect firms' choice of tax residence or location 
of production.
    A final alternative would introduce a carbon tax to address 
global climate change and use a large share of the new revenues 
for corporate rate reduction. This approach, though 
controversial, could appeal to both business and environmental 
groups.
    All of these options can be designed to raise the same 
revenues as under current law and make the tax burden as 
progressive or more progressive than it is now.
    I conclude that paying for the major corporate rate cut the 
U.S. needs requires that we look beyond the business tax base 
for additional revenues. I am encouraged that this committee is 
open to broader approaches.
    [The prepared statement of Dr. Toder appears in the 
appendix.]
    The Chairman. Mr. Zinman, we will now take your statement.

   STATEMENT OF SANFORD E. ZINMAN, CPA AND OWNER, SANFORD E. 
                 ZINMAN, CPA, PC, TARRYTOWN, NY

    Mr. Zinman. Chairman Hatch, Ranking Member Wyden, members 
of the committee, thank you for inviting me to discuss this 
topic. I am the vice president and tax policy chair of the 
National Conference of CPA Practitioners, NCCPAP. NCCPAP 
members serve more than 1 million business and individual 
clients and have long advocated for tax simplification and tax 
equality.
    When taxpayers understand the laws, they are more accepting 
of the rules. I will address the current business tax structure 
in the United States and its impact on the small and micro-
businesses.
    My 35 years as a CPA sole practitioner have involved 
working with and advising a variety of these businesses. What 
is already known is that small businesses make up an 
overwhelming majority of the number of businesses in our 
country. According to a GAO report published in June 2015, 
small businesses, as defined by less than $10 million in total 
revenue, make up roughly 99 percent of all businesses. That 
same report states that 69 percent of those small businesses 
are individual taxpayers, while 31 percent come from 
partnerships and corporations. The report also indicates that 
20 percent of small business populations hire at least one 
employee and produce about 71 percent of total small business 
income.
    The small business community is vital to America. Many mom-
and-pop businesses, which I call micro-businesses, operate the 
same way they did 50 years ago. Many are sole proprietors or 
subchapter S corporations.
    To start a business, the owner often seeks advice from his 
or her attorney and just as often gets the opinion of a 
qualified tax advisor, usually a CPA. The form of organization 
is often irrelevant to the business owners. They just want to 
make some money.
    These micro-business owners want to better their lives and 
keep as much of their profits as they legitimately can for 
themselves. That is the American way.
    When these individuals want to start a business, the first 
thing they want to know is, what is the simplest type of 
business to open which will protect their existing assets and 
cost them the least amount of tax? Of course, this is never a 
standard C corporation.
    Life was simpler 50 or 60 years ago, but we are not there 
anymore. New types of business organizations have been created. 
Each one has potential benefits and potential pitfalls. The CPA 
will explain the nuanced differences between a C corporation, 
an S corporation, a partnership, and an LLC. Ultimately, the 
differences are not extremely significant in the big picture. 
However, these differences can cause unnecessary complications 
in the decision-
making process.
    In the interview process, the CPA tries to determine a 
business owner's understanding of the tax law and tax 
regulations, and only after conversations with the owner can a 
CPA provide meaningful guidance. Yet, issues raised do not 
necessarily help the business owner in achieving his true 
objective: to put food on the table.
    Additionally, although the form of business entity chosen 
may meet the current needs of the owner, these needs may change 
over time. Then the organizational structure which was 
originally correct may no longer be the proper one.
    The similarities and differences amongst business entities 
often make the choice a difficult one. There should be a 
simpler common approach to taxation of various business 
entities.
    Thank you again for allowing me to address the committee 
today. We know that Congress cannot stop people from coming up 
with clever new forms of business organizations, but Congress 
can ensure a level playing field in business taxation.
    There are unnecessary inequities and complexities in our 
current system of business taxation which affect all 
businesses, both small and large. A simpler, equitable tax 
structure would allow business owners to better understand 
potential tax liabilities and make better business decisions.
    Allowing for a single level of tax for all business sizes 
will provide an understandable equity.
    Thank you again for the opportunity to present today, and I 
welcome your questions.
    [The prepared statement of Mr. Zinman appears in the 
appendix.]
    The Chairman. Thank you, Mr. Zinman.
    Ms. Goschie, we will turn to you now.

          STATEMENT OF GAYLE GOSCHIE, VICE PRESIDENT, 
                  GOSCHIE FARMS, SILVERTON, OR

    Ms. Goschie. Chairman Hatch, Ranking Member Wyden, co-
chairs of the Business Income Bipartisan Tax Working Group, and 
members of the Finance Committee, I would like to thank you for 
giving me the opportunity to testify today.
    My name is Gayle Goschie. I am a fourth-generation farmer. 
I am here today to represent Goschie Farms, Incorporated.
    Our family farm has a staff of 80 full-time and seasonal 
employees. Our customers include breweries located in multiple 
States throughout the country, some of which you would be 
representing here today. We also grow wine grapes for three 
Oregon companies.
    As you all know, the business of farming is fraught with 
uncertainty. A growing season can turn from an economic gain to 
an economic loss overnight. A change in the weather, product 
prices, labor supply, or our customers' needs, can have an 
extreme, often unforeseen, impact on our business.
    The agriculture industry has many uncertainties. Taxes 
should not be one of them. Taxes influence how we invest in our 
business. Tax rates affect the equipment we buy and when we buy 
it, the types of crops we grow, and our hiring and labor 
decisions.
    When there is uncertainty with taxes, we are unable to 
invest with confidence in our business. Fixing the present tax 
code is one of the ways Congress can help ensure that farms 
like mine can be positioned to grow.
    Congress has already enacted some changes that will have a 
positive impact on the farming sector. In December 2015, they 
permanently extended the small business expensing limitation 
and phase-out amounts of section 179. Prior to being made 
permanent, the amount allowed to be expensed was unknown, and 
needed investments were delayed. In addition, hundreds of 
purchases needed to be recorded and tracked independently, with 
inequalities from one industry to the next. For example, a 
tractor in agriculture is depreciated over 7 years, where that 
same tractor in construction would be over 5. It would be 
helpful to have uniform depreciations for similar items and 
allow items to be pooled together as opposed to being listed 
separately.
    Expensing also impacts our development costs. There are a 
number of expenses that come with the development of a 
vineyard. They include pre-productive costs of land clearing, 
soil and water conservation, and direct and indirect costs of 
vine, trellis, and irrigation systems. The pre-productive 
period costs of vines must be capitalized into the cost of the 
vines. With perennial crops like wine grapes, they are not 
depreciated until their first commercial harvest, a standard of 
3 years.
    As you can see, the tax code for small business owners, 
farmers like me, is complicated. Goschie Farms does not have 
accountants on staff to analyze every decision as it is made or 
maneuver each decision to maximize the tax benefits. Our time 
and efforts are needed in the fields to meet the demands of our 
customers. The work we do every day as farmers is a business 
story about the safe U.S.-grown quality products that are our 
livelihood. Both hop and wine-grape growers farm with 
certifications in best practices, sustainability, and energy 
conservation. With the hope of consistent energy tax 
incentives, these are just the beginnings of ongoing 
environmental investments.
    Another tax issue that would impact farms like ours is the 
Craft Beverage Modernization and Tax Reform Act, which was 
introduced by Senators Wyden and Blunt. Though this legislation 
does not directly impact hop and grape growers, it would 
recalibrate the Federal excise tax for craft beer, wine, and 
spirit products. When the craft beverage industry finds relief 
through a reduction in excise taxes, the grower will find 
expanding markets, increased demand, and a bolstered confidence 
in continuing to work with craft producers.
    It should come as no surprise that, in addition to the 
majority of the alcohol industry, this bill has the support of 
farm groups like the Hop Growers of America, the Oregon Wine 
Growers Association, and the National Barley Growers 
Association.
    With this unique example, a simplified tax code could bring 
relief to breweries, wineries, farmers, and the consumer.
    Thank you again for inviting me to testify today.
    [The prepared statement of Ms. Goschie appears in the 
appendix.]
    The Chairman. Thank you, Ms. Goschie.
    We appreciate all of you being here today.
    I have two articles here written by Mr. Mark Bloomfield, 
President of the American Council for Capital Formation. One of 
the articles, entitled ``Bipartisanship on Tax Reform,'' was 
printed in the Wall Street Journal and specifically commented 
on the work of the Business Tax Reform Working Group. I was 
pleased with that.
    The other article was featured in Fortune magazine and is 
titled ``This is the Fairest Way to Tax America.'' Now, this 
article is a broader commentary on the tax reform debate.
    Mr. Bloomfield, as most of us know, is no stranger to this 
committee. I appreciated his comments in these articles.
    I ask unanimous consent that they be included in the 
record.
    Without objection, they will be included in the record.
    [The articles referred to appear in the appendix beginning 
on 
p. 46.]
    The Chairman. Dr. Hines and Dr. Toder, I was very 
interested to read in both of your testimonies about the 
caution you suggest Congress take in addressing revenue-neutral 
business tax reform through lowering tax rates and broadening 
the tax base. You mentioned that corporate integration could 
potentially be a path forward.
    As I mentioned earlier, I am preparing a corporate 
integration proposal that I think will help address many of the 
problems we see in the business tax space today.
    Would you both elaborate on whether and to what extent 
corporate integration, in general, and its design, in 
particular, can strengthen the global competitiveness of U.S. 
companies, encourage more business activity in the United 
States, and go a long way in helping address multiple 
international tax issues that we are certainly going to be 
faced with and that we are seeing today, including inversions 
and earnings stripping?
    Mr. Barthold, I would like to hear your comments as well.
    Let us start with Dr. Hines, then Dr. Toder, and then Mr. 
Barthold.
    Dr. Hines. Thank you. A thoughtful corporate integration 
reform certainly could address some of the competitiveness 
issues that face American businesses, but as long as the United 
States maintains a worldwide tax system, we are never going to 
be competitive relative to any of the other G7 countries or 
really any of the major capital exporting countries, all of 
which have territorial systems.
    So I understand the spirit of the question in that, if we 
had corporate integration along with other beneficial reforms, 
would it be part of what contributes to the competitiveness of 
U.S. firms? The answer would be ``yes.''
    The Chairman. I do not see any reason not to. I think they 
are complementary--a territorial system and corporate 
integration.
    Dr. Hines. I see it the same way.
    The Chairman. Please continue.
    Dr. Hines. The advantage of corporate integration is, it 
lowers the taxation of equity-financed corporate investment, 
and we have a very heavy tax burden on that as it currently 
stands. But in addition, we would want to address some of the 
specific international issues if we are thinking about 
competitiveness more broadly.
    The Chairman. Dr. Toder?
    Dr. Toder. I think one of the advantages of corporate 
integration is, if it is designed in a way that it pushes the 
burden at the individual level, so individuals are taxed once 
on their business income, you get less determination of where 
the corporation earns money or invests affecting its tax 
liability.
    Now that, of course, depends on the corporation being 
interested in the tax liability of the shareholders. So one of 
the advantages of the Australian system is, if companies shift 
money overseas and do not pay Australian tax, then credits do 
not go out to the shareholders when they pay dividends. They 
are only going out when the tax is paid.
    So people can see that as one way of reducing some of the 
income-shifting problems while maintaining a territorial 
system, which is what they have.
    I think there are several challenges that you have to deal 
with. One is, you are still going to have a very high tax on 
corporate retained earnings. So those companies that do not 
distribute profits are not really going to get necessarily the 
benefit of that system, and that is going to be a tax at the 
corporate level, which could raise the cost of capital.
    A second problem is how to deal with the tax-exempts. In 
the United States, by our calculations, only about a quarter of 
dividends actually go to taxable U.S. shareholders. The rest go 
to tax-exempts or foreign shareholders or pension funds or 
retirement funds. So essentially what you are doing currently 
is, you are taxing those funds on their corporate equity 
income, because they are paying the corporate tax before it 
comes out. You have to deal with the issue that you might have 
to make that taxation a little bit more explicit or face a very 
large revenue loss.
    So it would be a matter of communicating to them, look, we 
are not really raising your taxes, we are just collecting it in 
a different way. But I think that is an issue you are going to 
have to wrestle with.
    The Chairman. Thank you.
    Senator Wyden?
    Senator Wyden. Thank you very much, Mr. Chairman. It has 
been an excellent panel.
    I want to start with you, Ms. Goschie and Mr. Zinman, 
because for me, the ballgame here is small business. That is 
where you have most of the jobs in America. That is going to be 
the litmus test of real tax reform.
    I also want to note that the Wall Street Journal recently 
said that the number of businesses owned by Asian-Americans, 
Hispanics, and African-American women grew faster than almost 
any other group during and after the recession. So what we are 
talking about is what the American economy is really all about. 
That is our priority when we talk about small business.
    It seems to me there are really two tax codes in America. 
One is for the large multinational corporations that have this 
fleet of tax attorneys and accountants who can figure out a way 
to manipulate the byzantine rules of the tax system to maximize 
their tax benefits, and the other is what you described, Ms. 
Goschie, this kind of la-la land of trying to guess what you 
are going to owe and you are trying to make the best decisions 
for your business and the like.
    I gather that what you are saying is that small businesses 
really do not have many specifics about what the tax 
consequences are going to be when they go out and invest in new 
equipment. That is what I read in your testimony, sort of 
reading between the lines. Is that correct?
    Ms. Goschie. Exactly. I mean, we do not have those 
accountants on staff. So it does take a phone call to be able 
to answer a question, to be able to decipher the consequences 
of a decision, and sometimes business gets in the way and we 
just need to make that decision.
    Senator Wyden. So you make the decision and kind of keep 
your fingers crossed. Like I said in my opening statement, you 
make the decision, you keep your fingers crossed, and you go to 
bed at night, that particular evening when you made this kind 
of call without all the accountants, saying, ``I sure hope I do 
not hear from the IRS in the future.''
    Ms. Goschie. That is correct.
    Senator Wyden. All right. Mr. Zinman, is that a fair 
assessment, in your view, with respect to what small businesses 
are dealing with when they are wrestling with their taxes?
    Mr. Zinman. It is a very fair assessment. There are a 
number of issues that small businesses deal with, and as Ms. 
Goschie indicated--she is absolutely right--if you had a room 
of accountants here and you were asking questions about the tax 
code and depreciation schedules, they would say, ``Well, that 
is why God made computers and tax software.''
    But the reality is that, as a small business, you are 
trying to wrestle with, do I have enough money today, what 
taxes will come up? In an S corporation, I constantly have, at 
the end of the year, owners who have a successful business, and 
they pay themselves a reasonable salary, and they are falling 
within the tax guidelines, and yet, all of a sudden, their 
business shows a profit. They have phantom income. They have to 
pay tax on that income that was unexpected, and they have not 
actually drawn out the money at that moment, and they have to 
wrestle with understanding the tax code and the complexities of 
what is supposed to be a simple S corporation and what to do 
with it.
    Senator Wyden. So you both have had a chance to look at the 
proposal that I released today, the Cost Recovery Reform and 
Simplification Discussion Draft, and the whole point of this is 
to end the water torture for small businesses. That is, in a 
nutshell, how I think we ought to look at this question and, in 
particular, to make sure that we end the day when small 
businesses face a situation where their dollar is worth less 
compared to the sophisticated firms that can afford to make the 
rules work for them.
    I would be interested in your reaction, because I know the 
staff has talked to both of you. Starting with you, Ms. 
Goschie, and then you, Mr. Zinman, in the time remaining, I 
would like your take on whether the simplification proposal we 
released today at least begins to respond to your concerns.
    Let us start with you, Ms. Goschie.
    Ms. Goschie. Sure. Absolutely, it addresses my concerns. 
Again, it is simplification. It takes out the inequities and it 
puts us on a fair playing field.
    Senator Wyden. Mr. Zinman?
    Mr. Zinman. Years ago, I went through hours and hours of 
training on MACRS and ACRS trying to figure out and trying to 
explain now to people about accelerated depreciation, straight-
line depreciation, section 179 and how it plays into the tax 
return, and we wind up, as accountants, doing a lot of work in 
the depreciation area and in projections for our clients 
because of the complexity of this depreciation.
    Any kind of simplification would be welcomed by business 
owners. The accountants do not mind making a couple of extra 
bucks by doing projections and doing analysis work. The 
business owners do want the simplification.
    Senator Wyden. Thank you both. The point of this really 
is--I know that you have had multiple generations on the farm 
in Oregon, Ms. Goschie, and we are so glad that you are here. 
The point of this particular part of the proposal is, this is a 
metaphor for what the debate is going to be all about. The big 
guys are going to have a lot of advocates--the multinational 
companies, the C corporations.
    I am so glad that both of you have focused your remarks on 
the small business people. That is going to be my top priority 
in the debate.
    I thank you for being here.
    The Chairman. Thank you, Senator.
    Senator Carper, you are next.
    Senator Carper. Thanks, Mr. Chairman.
    I want to thank you and Senator Wyden for pulling this 
together. We thank our witnesses for joining us from across the 
country.
    In the past 4 years, this committee has attempted not once, 
but twice, to reform our outdated and inefficient tax system. I 
do not think we should give up.
    I want to especially thank my colleague to my right, 
Senator Cardin, and Senator Thune, who is not here--yes, he is 
here--for their leadership on the business tax reform 
initiative for the last year.
    One thing that this process has made clear is the enormity 
of the complexity and the structural obstacles to reform, and, 
if we are going to lower business tax rates--and I think most 
of us on both sides of the aisle are interested in doing that--
then we would need to find enough permanent revenue to offset 
the cost of permanent rate reduction.
    That leaves us with a choice between base-broadening or 
identifying an alternative source of revenue, such as a value-
added tax. Both courses are, I believe, worth pursuing. Neither 
is easy. Even my persistent optimism is tested when I try to 
fathom the likelihood of a tax overhaul within the next year.
    So the question is, what do we do until then? In the 
meantime, while the business community waits for Congress to 
make the necessary tradeoffs to achieve tax reform, U.S. 
companies are choosing or, in some cases, being forced to 
choose between inversions, off-shoring, and profit shifting. 
These ongoing and growing threats to our international 
competitiveness are some of the main reasons that I continue to 
support the efforts of some of our colleagues, particularly 
Senator Schumer--Senator Portman is involved in this, and 
others--to enact a rifle-shot international tax reform.
    While we wait for and look forward to broader reform to 
occur, I think it makes sense to begin the reform process by 
first tackling some of our most pressing international tax 
challenges.
    I have questions, and I want to direct them to two of our 
witnesses. One is Dr. Toder; the other is Dr. Hines.
    I would just ask you, must tax reform be accomplished in 
one fell swoop, or, given political obstacles to comprehensive 
reform, is it possible to envision a multi-stage process where 
we bite off one piece at a time, sort of like we eat an 
elephant one bite at a time?
    I would welcome your comments on that, both of you.
    Dr. Toder. So I guess I have two responses to that. One is, 
there is a lot of complexity we have in the tax law, which, 
unfortunately, is going to be there because the world is 
complicated. But there is also what I call gratuitous 
complexity, where you could make things a lot simpler within 
the framework of current policy.
    I think of Senator Wyden's proposal as one that 
accomplishes that. Any place you can do that, you should do 
that. I mean, that does not require a large agreement on broad 
conceptual reform directions.
    So I think there are a lot of pieces both in the business 
code and in the individual tax code where that could be done. I 
have been encouraging that for years. The Taxpayer Advocate has 
written a lot about things like that. So I think there are a 
lot of measures.
    The other area is international reform, where there seems 
to be at least a conceptual agreement on measures that would 
accompany eliminating the repatriation tax; that is, having a 
one-time tax on assets abroad and having some minimum tax going 
forward on foreign profits.
    I think that would make our current international system a 
little more efficient than it is and lower the cost, because 
you would not have this disincentive to repatriate. However, I 
do not think it solves the fundamental problems of 
competitiveness, inversions, or the shifting of income 
overseas.
    So, while I would encourage doing that, I think you need to 
go further.
    Senator Carper. All right. Was your term ``gratuitous''? 
What was that term?
    Dr. Toder. Yes. I use the term ``gratuitous'' to refer to--
--
    Senator Carper. There were two words, gratuitous----
    Dr. Toder. Complexity.
    Senator Carper. Yes. What would be the opposite of that?
    Dr. Toder. I would say that there is some complexity that 
we just have to have because the world is complicated. So, if 
you want to have an income tax--you know, I use a car in my 
business. You do not want me to deduct the car for my personal 
use, but you do want me to deduct it for my business use; it is 
a little complicated to do that.
    Senator Carper. Thank you. Thanks.
    Dr. Hines, same question, please.
    Dr. Hines. Sure. Yes. We can do international-only reform, 
and we should do international-only reform if the alternative 
is to do nothing. But I think everyone in this room agrees that 
it would be nice to do more than just that, to try to address a 
lot of issues, including the complexity that small business 
owners face and lots of other ways to improve the efficiency of 
the tax code.
    But if the choice was nothing versus moving in the 
direction of a territorial tax system, like every other capital 
exporting country has, the answer is ``yes.''
    Again, I am not sure that everybody agrees on the details, 
such as the need for minimum taxes abroad and things like that. 
In fact, I am quite sure that they do not agree on that. But 
this committee, I am sure, would do an excellent job of 
hammering out the details of international reform.
    Senator Carper. Your confidence in us is appreciated. 
[Laughter.] Thank you.
    The Chairman. Thank you, Senator.
    Senator Thune?
    Senator Thune. Thank you, Mr. Chairman.
    Our group produced this little document here, which I would 
recommend for nighttime reading. But actually, staff did a 
great job of breaking down the issues related to the business 
part of the tax code, and we had a number of overlapping 
working groups, so some of these issues were dealt with on some 
level in other committees as well.
    But one of the issues that we got at, or tried to at least, 
was this tension, the trade-off, if you will, when it comes to 
faster cost recovery versus a lower rate through base-
broadening and what is the best way to achieve economic growth. 
There are different proposals out there, some that call for 
full expensing right away. The Camp proposal actually, last 
year, slowed depreciation in an effort to reduce rates in a 
revenue-neutral manner.
    So I guess my question is, of those two approaches, in your 
view, what is the best way to generate economic growth? And if 
Congress could choose either a tax reform plan that cut the 
corporate rate more aggressively but lengthened depreciation 
schedules, or one that cut the corporate rates less 
aggressively but allowed businesses to write off their 
investment more quickly, what factors would we want to consider 
in making that decision?
    I have another question. So if you can answer that 
quickly--that is a big subject to answer quickly, but give me 
your best answer on what is the best way to get growth.
    Anybody?
    Dr. Hines. If you have more generous capital cost recovery 
provisions, then you stimulate investment. Lowering the 
statutory rate also stimulates investment but, on the capital 
investment side, will do so much less dollar-for-dollar than 
you get by capital cost recovery.
    The thing about the lower statutory rate is, it has effects 
on all kinds of other decisions too: debt versus equity, 
foreign versus domestic income, things like that. So you have 
to add them together.
    The thrust of almost all of the economic analysis is that 
it is not a very cost-effective bargain to finance lower 
statutory rates with reduced capital cost recovery, because you 
get a lot less investment. It is true you get benefits on other 
margins of business decision-making, but the cost of that 
reduced investment is pretty substantial.
    Senator Thune. Does anybody have a different view on that? 
Do you agree generally?
    Dr. Toder. I agree as far as what Jim said, but I would 
actually caution you against going the other direction to full 
expensing as well, because that creates sheltering 
opportunities unless you restrict interest deductions. And then 
if you move toward what might be called a consumption tax model 
at the business level, you have contradictions between how you 
are treating businesses and how you are treating individuals.
    So I guess I would say there is no really simple answer to 
this. I do not think moving in one direction or another is 
going to improve matters that much.
    Senator Thune. Tradeoffs. All right. The other thing I want 
to ask about--because I did mention in my opening remarks that 
addressing the challenge of reforming the taxation of pass-
through businesses is going to be key if we are going to get 
this done. It seems, to me at least, that we want to do 
everything we can to reduce the top individual tax rate, but it 
is going to be a very difficult proposition in this 
environment.
    So we did not have jurisdiction over individual tax rates 
in our working group, but we did examine some potential 
alternative approaches. One was a business equivalency rate 
where pass-throughs and corporate income are subject to the 
same rate; second was a targeted tax benefit approach for pass-
throughs involving higher expensing limits and cash accounting 
limits; or, third, a flow-through business deduction whereby 
pass-through businesses receive a deduction on their business 
income so as to lower their effective tax rate.
    Which of those approaches do you think would be the most 
equitable for pass-through businesses in a business tax reform 
effort that is also cutting the corporate tax rate?
    Dr. Toder. I will try first and let Dr. Hines correct me.
    I guess I am never a fan of targeted benefits, but I think 
that is probably the best way, given the alternatives, to 
approach this situation, meaning more generous expensing and 
other kinds of capital recovery benefits for small businesses.
    I think the difficulty with a rate differential is, it is 
very hard to tell what is the margin between a small business 
and an employee when you get to closely held companies, and you 
are going to have a lot of gaming between the rates on 
compensation and the rates on business profits, and I think 
that would create some very difficult problems. So I would not 
go in the direction of a special rate.
    I think, also, I would point out that there is an advantage 
to being a small business or being a pass-through, even if you 
pay a higher rate, because you are not paying two levels of 
tax. You are not paying a second tax on distributions.
    So the real issue has to be with small companies that--if 
the corporate rate were lowered relative to the pass-through 
rate--would try to incorporate. So you might have to have rules 
that define what kinds of entities could be pass-throughs and 
what could be corporations.
    Senator Thune. Dr. Hines, quickly.
    Dr. Hines. I agree with Dr. Toder. The targeted benefits 
make more sense than the broad rate differential because of the 
endogenous formation of small businesses, that people who 
otherwise would be employees can become self-employed and take 
advantage of the lower rate, if it is available.
    We should really apply the principles. Where you want the 
more favorable tax treatment is where activities generate 
economic spillover benefits or where activities are highly 
responsive to taxation, and I think they both point in the 
direction of more favorable treatment of investments by small 
businesses.
    Senator Thune. Thank you, Mr. Chairman. Thank you all.
    The Chairman. Senator Cardin?
    Senator Cardin. Thank you, Mr. Chairman.
    I want to thank the panel. I found this extremely helpful.
    Mr. Chairman, I appreciate you mentioning Mark Bloomfield 
and the American Council for Capital Formation. It has worked 
in a bipartisan manner, bringing together many of us on both 
sides of the aisle to look at better ways to do our tax policy. 
I remember his predecessor, Charles Walker, very well as a 
person who provided a good deal of information to us.
    To Senator Carper's point, all of us are interested in 
making progress whenever we can. We understand that it is 
unlikely in the next month or two that we are going to pass a 
major tax reform proposal, and we want to make progress where 
we can make progress.
    There has been a lot of information that Senator Thune and 
I explored in our work that can lead to, I think, some 
significant improvements in our tax code. I mentioned earlier 
the reform of S corporation provisions; it is not 
controversial, it would help, and we should get it done.
    But the fundamental points that you all are raising, which 
are high tax rates on business, which are not competitive; the 
lack of simplification, so you need to have an accountant on 
your fast dial in order to get information because you just 
cannot figure this out; and I would also add the predictability 
of our tax code, which affects investor decisions, all were the 
goals of the 1986 tax reform.
    I remember our predecessors saying, we accomplished it, 
and, obviously, they did not accomplish it. It led to the tax 
code that we have today.
    So I really want to get to the proposal that I brought 
forward that was discussed in our working group that, if we 
were able to substitute part of our income tax revenues with a 
national consumption tax that would be at least as progressive 
as our current tax code so that middle-income families are not 
going to be more burdened, that gives us rates that are, on 
average, 5 percentage points below the OECD countries, as I 
explained earlier.
    What impact would that have on the type of questions that 
we have been raising on American competiveness globally, on the 
international side, on dealing with the challenges of small 
businesses, on complexity, and on giving predictability for 
investment in America?
    Dr. Hines?
    Dr. Hines. It would do all of that. A move like that would 
reduce the inefficiencies in the current system, stimulate 
investment and growth, and make the system more competitive.
    Senator Cardin. Dr. Toder?
    Dr. Toder. I agree with Dr. Hines on all of his points. I 
would add, though, that you are comparing a system that is 
designed perfectly with no exemptions in the value-added tax, 
and, when you get through the process here, you might have some 
exemptions in the value-added tax. It might not look as good. 
So I think that is just a caution.
    Senator Cardin. I am not interested in getting rid of the 
Senate Finance Committee. [Laughter.]
    I understand the challenges every year that we are going to 
have to deal with. But let me just correct one statement. We 
use a credit method, not a subtraction method, which is, as you 
know, a difference, and we feel pretty strongly that using a 
credit method is a better way and a fairer way to have a 
national consumption tax.
    Dr. Toder. When I use that term, I mean the credit method. 
So we are in agreement.
    Senator Cardin. I just wanted to make sure that that point 
was made. Does anyone else want to comment?
    [No response.]
    Senator Cardin. Let me then raise an issue directly dealing 
with small businesses. Small businesses generally use the 
personal income tax rates. A lot of them are pass-throughs. A 
lot of them just use the schedule and the income tax for 
income.
    Therefore, if we were to deal just with the corporate rate 
and not deal with the individual rate, what impact would that 
have, if any, on small businesses?
    Mr. Zinman. Well, you have to remember that a lot of small 
businesses are paying a higher rate because of the pass-
through, and it is important to look at a broad spectrum and 
keep all businesses competitive.
    When you have an individual in an S corporation who is 
making a reasonable salary, whatever that may be, and is 
looking to stay out of AMT--I come from the New York area, and, 
if you look at the New York area, an individual who is running 
a business, if he owns a house and has two kids ready for 
college, automatically he is paying AMT.
    So you are looking for a way to provide equity to the small 
business as well as the big business. The big businesses are 
hit with the double taxation, and that is absolutely true, and 
yet the small business owners very often wind up paying as high 
a rate as some of the top corporate rates.
    Senator Cardin. Thank you, Mr. Chairman.
    The Chairman. Senator Coats?
    Senator Coats. Mr. Chairman, thank you. I am juggling 
several things this morning, so I was not able to hear some of 
the testimony by our witnesses.
    I think one of the areas that I would like to talk about 
goes to what has already been talked about. So I hope I do not 
duplicate that effort.
    As chairman of the Joint Economic Committee, last week I 
held a hearing, and we were talking essentially about the 
complexity of the tax code and its impact, in particular, upon 
small business. We did not want to cut down several Capitol 
trees, which would have been necessary to provide an example of 
the number of pages of the current tax code, so we had empty 
boxes stacked up in the hearing room, and it was a pyramid of 
some dimension.
    We had testimony from a small business owner from Indiana 
whom I invited to come. He has a cybersecurity business, 
clearly qualifies as a small business. He gave a compelling 
testimony relative to what he has to go through in order to 
file his taxes.
    We have all heard this, but he said, ``The large 
corporations can have stables of tax accountants sitting in the 
backroom to deal with the complexity,'' he said, ``but I have 
to deal with a lot of the same complexity, and I cannot afford 
to have a back room of accountants working for me.''
    So he said, ``There was an issue where I wanted to make an 
additional investment in a certain business, and so I took it 
to a tax accountant. He charged me a lot of money to give me 
advice, saying, `This is what you can do and this is what you 
cannot do.' '' He said, ``I thought I ought to double down and 
get somebody else, because I did not want to make a mistake, 
because I sensed that he was not totally certain that the 
advice he had given me was the correct advice. Well, the second 
accountant gave me exactly the opposite advice. So I have to 
break the tie here. So I go to a third, and he gave me a third 
indication of what it would mean for me from a tax standpoint. 
So three well-qualified,'' he said, ``all totally qualified, 
highly paid, highly respected tax lawyers, basic advisors, 
basically gave me three different pieces of advice. And so I am 
a small business guy sitting here. Do I want to buy into this 
new business which would increase my employment or what? And 
what do I do?''
    I did not have an answer for him, and we do not have an 
answer for him. So whether it is the complexity, the need for 
simplicity, the differentiation between what the small guy and 
the big guy can do, it is extraordinarily frustrating to the 
people I talk to.
    I know, Ms. Goschie--I am sorry I was not here. I think 
Senator Wyden, my staff tells me, asked you a question and you 
responded to this. I guess I am here to make more of a 
statement than I am to hear your answers, because I do not want 
to duplicate what has already been said.
    But it has been a long, long time of talking and not 
getting it done. So I am hoping this committee can take action 
with the House. Obviously, it is going to have to be after the 
election and in a new year. I will not be here, but I guess I 
would say to my colleagues, there really is an urgency in terms 
of maintaining the ability of small businesses to address 
something so complicated.
    I had three tax courses in law school. I would be in jail 
if I did my own tax returns. [Laughter.]
    So I think it is time that we step up to the plate here. I 
know the chairman wants to do that.
    I guess one question I have in the few seconds that I have 
left is just your take--I am sorry if you have already talked 
about this--on the separation of business tax reform from 
comprehensive tax reform. Is this something that is desirable, 
something that is just absolutely necessary because we cannot 
get there any other way?
    Our businesses are hurting. We are not competitive. But 
there is a lot of concern among the small business people I 
talk to about how they are going to get left out in the cold.
    Are there any really quick responses to that?
    Dr. Toder. Very quickly, because I think I said this in my 
remarks also, I do not think looking at corporate reform only 
is viable. I think you need to go through to business and you 
also need to go through to the owners of corporations as 
individuals.
    So I do not think--I think you really need to go broader 
than just business only.
    Senator Coats. Does anybody disagree with that?
    Dr. Hines. I think there are valuable things we can do with 

business-only tax reform, but they are very limited. In that 
sense, I agree with Dr. Toder. There is a limit to how much 
good you can do with business-only reform, but there are ways 
to improve things that way. It is just that you will do better 
still if you integrate the whole thing.
    Mr. Zinman. One issue that I want to raise is, when you 
start putting band-aids on some of these tax rules, it makes 
things more complicated. As a matter of fact, on the plane down 
here, I was talking to somebody next to me. He has an S 
corporation.
    He said, ``This whole thing with the 2-percent owners' 
health insurance''--and a lot of people do not understand it, 
accountants do not even understand it sometimes, but basically 
what happens is, if you are a 2-percent shareholder in an S 
corporation and you have health insurance paid for by the 
corporation, you add it back into your income and then you go 
to your personal tax return and you take it out of your income, 
and that is a band-aid approach to what happened before.
    Senator Coats. Thank you all. Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator.
    Senator Heller?
    Senator Heller. Mr. Chairman, thank you and thanks for 
holding this hearing.
    I want to thank all of our witnesses for being here, and 
everybody else on this committee. We really do appreciate your 
insight and your help on some of these issues.
    I want to thank Senators Thune and Cardin for their hard 
work in the working group for small business, and also Senators 
Portman and Schumer on the international tax reform side. A lot 
of research has gone on lately in this committee. Whether or 
not it becomes law or legislation, I am not certain at this 
point, but I think a lot of us know what the problem is.
    The problem is that we have more small businesses in 
America that are going out of business than new startups. It is 
historical data--since World War II, we have not seen that.
    So what is wrong? What is wrong? Why are businesses, more 
businesses, going out of business as opposed to new startups?
    The second problem we have is inversions. We have had over 
1,300 inversions in the last 10 years. I mean, we are talking 
big companies here in America that have multiple accountants. 
So you have multiple accountants, and you still cannot make it 
work.
    So what do you do? You are inverting companies like 
Louisville Slugger, Burger King, and the problem is not getting 
better. The problem is getting worse. We are going to see this 
continue to advance if we do not do something about the tax 
structure we have here in this country.
    I want to share a quick story about a company back in 
Nevada, a good company, not a multinational company, although 
they do international work. It is called the Hamilton Company. 
They do robotics. They also do medical devices. Talking with 
the owner--we sat down a couple of weeks ago--he says, ``You 
know, it costs me $10 million for my business to stay here in 
America, and,'' he says, ``I am willing to pay it. I am willing 
to pay it, but it costs me an additional $10 million to do 
business right here in the United States.''
    He is a patriot. He is a good citizen. So he is willing to 
pay it. ``But,'' he says, ``I will tell you what will happen 
when I get too old to run this company and we merge or get a 
buyout. What they are going to do is, they are going to move 
this company to outside the country because of more favorable 
regulations, tax rates, and fees.''
    So I guess my question is, how do you keep--I know we are 
repeating this question over and over, but I think it is the 
issue of this particular hearing. Starting with you, Dr. Hines, 
how do you keep the Hamilton Company in America?
    Dr. Hines. Two things. One, we have to adopt a territorial 
tax system like every other large country has; and two, we have 
to lighten business tax burdens. If you do those two things, 
then you will keep a lot more companies in America.
    Senator Heller. I thought that would be your answer.
    Dr. Toder?
    Dr. Toder. I would actually add that I do not think a 
territorial system is necessarily sufficient to accomplish 
that, because foreign-owned companies operating here in the 
United States have a tremendous advantage with the ability to 
strip profits out of the U.S.--out of their U.S. subsidiaries.
    So I think you really need to look at the issue more 
broadly and all the ways in which foreign-owned companies might 
be advantaged relative to U.S. companies, and some of that 
might have to do with limits on interest deductions.
    The Treasury has taken a step in that direction. I think it 
is a rather blunt instrument what they have done, but I think a 
legislative solution to that problem or legislative action in 
that area is certainly called for.
    Senator Heller. Mr. Zinman, you have talked about the 
corporate tax rate and the fact that individuals in pass-
throughs actually pay a higher rate. If you were to lower the 
corporate tax rate, would you see a movement back to C corps 
from these pass-throughs if the rate were to be competitive at 
20 percent?
    Mr. Zinman. Yes. When people want to start a company, the 
first thing they do is, a lot of times, they go to an attorney 
and they say, ``We want to open up a restaurant, we want to own 
a building, we want to rent property.'' Often, the attorneys 
will recommend a corporation because that is what they know.
    LLCs have been around for quite a while, but they are still 
somewhat new. There is more tax law and case study on 
corporations.
    So they go with the corporations, and then they go to the 
accountants and they say, ``My attorney told me to come over to 
see you. Should I be a C corporation or should I be an S 
corporation?''
    Well, on a small business level, sometimes it is irrelevant 
because, depending on the amount of income, depending on the 
shareholders, the owners, what kind of salaries they want to 
take, you can strip a lot of the profit out of a corporation 
just by paying a salary, which is not necessarily a bad thing, 
because when somebody pays a salary, they pay into Social 
Security, they get the pension benefits, et cetera.
    So, yes, if you lower the C corporation profit tax 
percentage, you might get some turning toward that rather than 
using the S corporation as a device.
    Senator Heller. Mr. Chairman, thank you.
    The Chairman. Thank you, Senator.
    Senator Portman, you are next.
    Senator Portman. Thank you, Mr. Chairman.
    I have really enjoyed the testimony today, and I thank you 
all for being here.
    Thanks to my colleagues, Senators Thune and Cardin, for 
putting out a great report. Also, thanks to Senator Schumer on 
our report on international taxation.
    We do have a lot of the information, and I think we are 
poised to act. We just need a little political will to do so.
    I thought the chairman gave a great speech on the floor 
last week. He said there was a glimmer of hope with the 
findings and recommendations of the Finance Committee's 
bipartisan International Tax Reform Working Group. However, as 
is too often the case, that glimmer of hope may well be 
overtaken by the politics of the moment. We have to get beyond 
the politics of the moment because of everything you guys said 
here today.
    With all due respect to my colleagues who say this is about 
small businesses versus big businesses, this is about people. 
This is about workers. I will tell you, in my home State of 
Ohio today, we are losing workers and losing investment because 
of the fact that our tax code is not competitive. It is not 
about the boardroom. The boardroom is going to be fine. When 
you do these inversions--I could not agree more with my 
colleague, Senator Heller, on this, and I could not agree more 
with Senator Carper on this when he talked about the need to 
address this.
    If we do not address this, what is going to happen is, you 
are going to continue to see more pressure on wages, salaries. 
That is what the Joint Committee on Taxation has said, and that 
is what the CBO has said. That is the impact here. It is on 
workers, and, specifically, when you have these inversions, 
that is the tip of the iceberg.
    It is really the foreign takeovers, it is the foreign 
acquisitions of U.S. companies; they take workers with them. 
And as we sit here today, it is happening in my home State of 
Ohio. The Eaton Corporation, a great corporation in Ohio with a 
great storied history, finally had to kind of say ``uncle'' 
because the tax code was hurting them so much. So they went 
over to Ireland, inverted with a smaller company about a 
quarter of their size. They are going to save hundreds of 
millions on their tax bill.
    Now, you see what is happening. Some workers are leaving 
Ohio, and they are going overseas to get away from the net of 
the U.S. tax code. This is outrageous, and we cannot let 
politics stop us from dealing with it.
    Look, I am a small business owner. I grew up in a pass-
through entity. I totally agree with this thought that we need 
to help the small businesses. All of you have said we need to 
simplify. Put me at the top of that list and at the head of 
that line. I could not agree more. Let us do that.
    I would like to have total reform of our tax code, of 
course--we know we need that--but we do not have the consensus 
on that at this point.
    The issue that no one has raised here today is that the 
other side of the aisle and the administration insist on a 
couple trillion dollars of new taxes in order to do reform. 
That is what is in the President's budget. I think it is even 
higher than that this year.
    That is the reality. So we are not going to get to that. We 
cannot find common ground there. Where we can find common 
ground is to deal with simplification, as you all have said, 
particularly on the business side.
    Ms. Goschie gave some great comments on that. By the way, 
we all loved your comments particularly on hops and beer. That 
was my favorite part. We have now 115 craft brewers in Ohio. 
Thank you for supporting Senator Wyden's legislation. I think 
that is really important to get passed.
    But the second thing is this international piece. We are 
going to continue to have more and more of our workers lose 
their jobs or not have their pay go up as it should because of 
the fact that our tax code is not competitive. Every single 
day, these companies are competing with one hand tied behind 
their back.
    So I just want to thank you for being here and for making 
this so clear to all of us. I loved when you said we need--I 
think it was Dr. Hines--a smarter way to tax business income.
    Dr. Toder, you talked about the $2 trillion-plus locked up 
overseas. That is another huge issue. Not only are we losing 
workers--and again, it is happening right now in my home 
State--but we are not taking advantage of $2 trillion-plus that 
are locked up overseas that the Europeans and others are going 
after now through not just the BEPS project, but also these 
state aid cases. In other words, this is revenue that ought to 
come back here and be invested in jobs and infrastructure.
    So I guess, Dr. Hines, I would just ask you a question, if 
I could. You talked about adopting what is called a territorial 
tax system rather than a worldwide tax system. Talk about not 
just what would be good about it, but what are the consequences 
for U.S. businesses and for U.S. workers if we do not move in 
this regard?
    Dr. Hines. The consequence is we will continue to lose in 
competition with foreign businesses, resulting in depressed 
investment in the United States and less demand for American 
labor.
    The more vibrant and competitive the American business 
sector is, the greater the opportunities for American workers. 
Workers are paid based on their productivity in a competitive 
economy like the United States, and the more productive we can 
make businesses, the more productive is capital and labor. We 
do not have a competitive tax system, so it reduces the 
productivity of labor and thereby reduces job opportunities.
    Senator Portman. So if we do nothing, we are going to 
continue to see that loss of workers.
    Dr. Toder, I just have 8 seconds remaining, but I would 
love to hear your comments on that: if we do nothing.
    Dr. Toder. Well, bad things are going to happen if we do 
nothing, but I think a territorial system by itself without 
safeguards to prevent shifting of profits and investment 
overseas by U.S. firms is----
    Senator Portman. You saw our report, and we had that in our 
report.
    Dr. Toder. Yes.
    Senator Portman. You need to do that as well, and I think 
it is necessary not just for U.S. companies, but you would say 
also for foreign companies invested here.
    Dr. Toder. Yes.
    Senator Portman. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Scott?
    Senator Scott. Thank you, Mr. Chairman.
    I thank each of the panelists for being here this morning 
and having an important conversation about an issue that seems 
to be a burden to the taxpayers from a corporate perspective, 
but also to every single American, because at the end of the 
day, the biggest taxpayer in the country is the individual who 
bears the burden of all the tax reform. All that conversation 
ends up on the shoulders of the individual.
    Speaking of individuals, I think back to South Carolina, 
where I am from, where we have a wide range of life sciences 
companies that reflect the growing diversity of the life 
sciences industry across the United States. The life sciences 
sector employees almost 14,000 South Carolinians, and, 
specifically, about 8,000 are concentrated in the 
biopharmaceutical and medical device sectors.
    Over time, the life sciences industry has grown rapidly to 
include companies that are contracted to specifically oversee 
and carry out the development and commercialization phase of 
the other companies' developed IP.
    These companies face the same pressures to compete in the 
global marketplace that any other U.S. multinational company is 
facing today, including the pressure to locate facilities and 
plants either in the U.S. or abroad, threatening the livelihood 
of thousands of U.S. workers.
    One of the most effective tax incentives utilized by 
several European nations is the patent box.
    My question to you, Dr. Hines, is, given the growing 
diversity of companies in the life sciences industry, the 
increasingly specialized roles of these companies in bringing 
IP to market, and the hundreds of thousands of high-paying jobs 
in the commercialization, development, and manufacturing of 
these products, how do you suggest that we equitably allocate 
benefits in the context of a patent or innovation box model 
specifically as it relates to our competitors around the world 
who are already moving in this direction?
    I know this, to me, appears to be a complication to the tax 
code, but at the same time, without these companies, we would 
have fewer dollars coming in from this specific area.
    Dr. Hines. We cannot ignore international competition. The 
question for the committee is, if the United States is not 
going to adopt some form of an intellectual property box or 
patent box, then what are we going to do?
    Are we going to just ignore what is going on in the rest of 
the world? It hardly seems like a good idea. But the downside, 
and people have noted this, of the patent boxes or intellectual 
property boxes is that, unless they are carefully crafted, you 
can have a serious problem of encouraging too much property 
being included in the patent box and you get a lot of revenue 
erosion that way, and it is pretty undesirable.
    The issue really is, what are we trying to achieve with the 
intellectual property box, patent box, and I think the answer 
should be that we want to encourage activities that we would 
otherwise lose. If we find ourselves in that situation, then we 
should try to figure out a way to craft one of these things. 
The rest of the world is doing it, and we ignore them at our 
peril.
    Dr. Toder. I think I have a different perspective on this.
    Senator Scott. Certainly.
    Dr. Toder. Some of the articles by Marty Sullivan in Tax 
Notes have described a lot of the problems with patent boxes. I 
see this as something that may end up not increasing innovation 
and just being another vehicle for corporate income shifting, 
and I would much rather, if you want to increase innovation, to 
just have tax credits or more generous tax credits for 
activities in the United States.
    With regard to what other countries are doing, yes, they 
are engaged in a race to the bottom to try to subsidize their 
multinationals in various ways. They are also moving toward 
taxing our multinationals, and I think we may need to start 
going after some of theirs before the situation comes back into 
balance.
    But it is a troubling situation, and that is why I am very 
much in favor of moving away from the corporate level and more 
toward the individual level taxing of individual income that 
comes from corporations.
    Senator Scott. Any thoughts, Dr. Hines, on how we would 
attract other countries' companies to our 35-percent tax rate 
and make it competitive?
    Dr. Hines. Well, it is hard as long as you have a 35-
percent rate, that is for sure, and as long as you have a 
worldwide tax system.
    But the issue with the intellectual property boxes, the 
justification, the strongest justification, is not that they 
encourage research activities, but that these are businesses 
that you would not otherwise have unless you offered a 
favorable treatment.
    It is not that any one business would necessarily do more 
intellectual property development as a result of the box, but 
it is part of the whole package in attracting companies.
    Senator Scott. It appears to me--thank you, Mr. Chairman, 
for the time.
    I would suggest that if we do not figure out how to engage 
in this conversation, it appears to me that IP is the first 
iteration of the conversation, manufacturing may be the last, 
and ultimately they are all gone.
    Thank you.
    The Chairman. Senator Schumer?
    Senator Schumer. I am going to be very brief, because we 
only have 1 minute or 2 left on the vote. So I will just maybe 
ask some questions in writing.
    First, I want to welcome Mr. Zinman, a fellow New Yorker 
from Westchester County. Thank you for being here.
    Second, I just want to say I heard what Senator Carper, 
Senator Portman, and Senator Hatch said on the floor. I believe 
in international reform. I believe we have to do something 
about inversions. I believe we have to make our companies 
competitive, and international reform is a lot easier to bite 
off than broad corporate tax reform, even though that is 
desirable, in my opinion, as well.
    I am still ready to work with the chairman and with all the 
others, and I know Senator Wyden is as well, and Senator 
Carper, Senator Warner, Senator Brown--people who were part of 
our little international tax reform group--to get something 
done. Even if we could get it done this year, I am game to do 
it, because I think it is really important for American 
competitiveness.
    My advice would be, let us do the international side first, 
then we can deal with all the complicated issues elsewhere.
    With that, Mr. Chairman, I am going to yield back my time, 
because I know we have a vote coming up.
    The Chairman. Thank you, Senator Schumer. I appreciate your 
hard work in this area, and I intend to work with you, and we 
will find a way of doing it.
    I want to thank all of you for being here.
    Mr. Barthold, I had questions for you, but we have run out 
of time, but we will get those to you separately. This has been 
a very interesting hearing, and I appreciate the time that you 
have given. I just wish we had more time, but we have three 
votes occurring now, so we are going to recess until further 
notice.
    Thanks so much for being here.
    [Whereupon, at 11:20 a.m., the hearing was concluded.]

                            A P P E N D I X

              Additional Material Submitted for the Record

                              ----------                              


       Prepared Statement of Thomas A. Barthold, Chief of Staff, 
                      Joint Committee on Taxation
                   navigating business tax reform \1\
---------------------------------------------------------------------------
    \1\ This document may be cited as follows: Joint Committee on 
Taxation, Testimony of the Staff of the Joint Committee on Taxation 
Before the Senate Committee on Finance Hearing on Navigating Business 
Tax Reform (JCX-36-16), April 26, 2016. This document can also be found 
on the Joint Committee on Taxation website at http://www.jct.gov.
---------------------------------------------------------------------------
    My name is Thomas Barthold. I am the Chief of Staff of the Joint 
Committee on Taxation. The purpose of today's hearing is to discuss 
issues arising in attempting to reform the Federal tax system. For 
today's hearing, Chairman Hatch and Ranking Member Wyden have asked me 
to briefly review some of the business tax reform issues raised by the 
committee's bipartisan Business Income Tax Working Group.\2\ Some 
business tax reform proposals maintain the basic structure of income 
taxation, while others offer a structural change in income taxation. In 
addition, some proposals may be more accurately characterized as 
consumption-based taxes. My written testimony provides additional 
details and includes further information.\3\ Members have separately 
been provided with several charts and tables to which I will refer 
during my oral testimony.
---------------------------------------------------------------------------
    \2\ The Business Income Tax Working Group report is available at 
http://www.finance.
senate.gov/download/?id=B4AEDDC8-9E94-4380-9AF4-9388953FB347.
    \3\ For additional background information and brief description of 
a number of the business tax reform proposals reviewed by the working 
group, see, Joint Committee on Taxation, Background on Business Tax 
Reform (JCX-35-16), April 22, 2016.

    In assessing any tax system or reform, policymakers make their 
---------------------------------------------------------------------------
assessment across four dimensions.

    1.  Does the tax system promote economic efficiency? That is, is 
the tax system neutral or does it create biases in favor of or against 
certain economic activities when compared to choices taxpayers would 
make in the absence of taxes?

    2.  Does the tax system promote economic growth? How does the tax 
system affect the potential for citizens to be better off in the future 
than they are today?

    3.  Is the tax system fair? Are similarly situated taxpayers 
treated similarly? Are tax burdens assessed recognizing that different 
taxpayers have different abilities to pay?

    4.  Is the tax system administrable for both the taxpayer and the 
Internal Revenue Service? Does the tax system minimize compliance costs 
for taxpayers and administrative costs of the tax administrator?

    There may, of course, be other important policy considerations.

    How one addresses these questions shapes the reform. It is 
invariably the case that these different policy goals are in conflict. 
Policy design to promote economic neutrality may conflict with goals of 
fairness. Policy design to promote fairness may lead to complexity and 
increased compliance costs. Additional constraints that may also shape 
reform include: maintaining budget neutrality as conventionally 
estimated, maintaining the current distribution of tax burdens across 
income groups, and not achieving low tax rates on C corporate business 
income at the expense of higher taxes on passthrough business income. 
There are always tradeoffs. Many business tax reform proposals are the 
result of such tradeoffs.
Base Broadening to Lower Rates
    Some proposals undertake comprehensive tax reform by broadening the 
tax base and lowering tax rates. Lowering tax rates in an economy as 
large as that of the United States results in substantial revenue 
losses as conventionally estimated. The Joint Committee staff estimates 
that relative to the current baseline forecast reducing the highest 
statutory income tax rate of the corporate income tax by one percentage 
point would result in a $44 billion revenue loss over the first 5 years 
of the budget period and a 10-year revenue loss of $100 billion.


              Joint Committee Staff Estimate of Revenue Effect of One Percentage Point Decrease in  Top Statutory Corporate Income Tax Rate
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Billions of dollars                     2017    2018    2019    2020     2021     2022     2023     2024     2025     2026   2017-2026
--------------------------------------------------------------------------------------------------------------------------------------------------------
Change in Revenues.....................................    -6.1    -8.7    -9.1    -9.8    -10.3    -10.5    -10.9    -11.3    -11.7    -12.2     -100.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation staff estimate.
Note: This option would take effect for tax years beginning after December 31, 2017. Estimates are relative to CBO's January 2016 baselineprojections.


    By comparison, among the Joint Committee staff 5-year estimates of 
corporate tax expenditures, only a modest handful exceed $50 
billion.\4\
---------------------------------------------------------------------------
    \4\ A tax expenditure calculation is not the same as a revenue 
estimate for the repeal of the tax expenditure provision. First, unlike 
revenue estimates, tax expenditure calculations do not incorporate the 
effects of the behavioral changes that are anticipated to occur in 
response to the repeal of a tax expenditure provision. Second, tax 
expenditure calculations are concerned with changes in the reported tax 
liabilities of taxpayers and may not reflect timing of tax payments. 
Third, the tax expenditure estimate includes only income tax effects 
and not interactions between income tax provisions and other Federal 
taxes. Fourth, the tax expenditure estimates reported here reflect 
provisions in Federal tax law enacted through September 30, 2015, and 
are based on the January 2015 Congressional Budget Office (``CBO'') 
revenue baseline, while the revenue estimates reflect present law and 
the current CBO revenue baseline. Nevertheless the orders of magnitude 
of revenue loss are represented fairly.


            Largest U.S. Corporate Tax Expenditures 2015-2019
------------------------------------------------------------------------
                                                         Total Amount
             Corporate Tax Expenditure                   (Billions of
                                                           Dollars)
------------------------------------------------------------------------
Deferral of active income of controlled foreign                   563.6
 corporations
Deduction for income attributable to domestic                      61.5
 production activities
Deferral of gain on like-kind exchanges                            57.4
Exclusion of interest on public purpose State and                  50.5
 local government bonds
Credit for low-income housing                                      41.2
Expensing of research and experimental expenditures                27.6
 
MEMORANDUM
Depreciation of equipment in excess of alternative                -20.9
 depreciation system
------------------------------------------------------------------------
Source: Joint Committee on Taxation, Estimates of Federal Tax
  Expenditures for Fiscal Years 2015-2019 (JCX-141R-15), December 7,
  2015.


    Former House Ways and Means Committee Chairman Dave Camp took the 
approach of broadening the tax base to achieve a lower statutory tax 
rate on corporate income.

     Tax Reform Act of 2014 \5\
---------------------------------------------------------------------------
    \5\ H.R. 1 (113th Cong.), introduced December 10, 2014, by then 
Chairman Dave Camp. Additional Joint Committee on Taxation staff 
analysis of H.R. 1 can be found in Technical Explanation, Estimated 
Revenue Effects, Distribution Analysis, and Macroeconomic Analysis of 
the Tax Reform Act of 2014, A Discussion Draft of the Chairman of the 
House Committee on Ways and Means to Reform the Internal Revenue Code 
(JCS-1-14), September 2014. This document can also be found on the 
Joint Committee on Taxation website at http://www.jct.gov.

      a.  Introduced in December 2014 by Mr. Camp (then House Ways and 
---------------------------------------------------------------------------
Means Committee Chairman).

      b.  Reduces corporate income tax rate to 25 percent.

      c.  Changes depreciation rules.

        i.  Expands expensing permitted under section 179.

        ii.  Allows bonus depreciation to expire.

        iii.  Requires straight-line method of cost recovery over 
applicable recovery period.

        iv.  Makes available election to index basis to chained 
consumer price index for all urban consumers (``CPI-U'').

      d.  Requires amortization of 50 percent of advertising 
expenditures over 10 years.

      e.  Requires amortization of research and experimentation 
expenditures over 5 years.

      f.  Repeals last-in, first-out (``LIFO'') and lower of cost or 
market (``LCM'') methods of accounting.

      g.  Phases out section 199 domestic production activities 
deduction.

      h.  Proposes other base-broadening measures.

    H.R. 1 illustrates tradeoffs in tax policy. In the context of 
business income tax reform, lower tax rates at the expense of 
lengthening capital cost recovery periods is an important tradeoff. For 
example, if to achieve a revenue neutral tax change, the corporate tax 
rate were reduced at the same time that tax depreciation were made less 
generous, these two changes would have offsetting effects on the user 
cost of capital. The net impact could increase, decrease, or have no 
net effect on the user cost of capital. Economists on the Joint 
Committee staff have studied the issue and have published a study 
simulating the macroeconomic effects of a number of hypothetical 
proposals that would reduce the top statutory corporate tax rate from 
35 percent to 30 percent.\6\ One of the proposals involved financing a 
revenue neutral reduction in the corporate tax rate with a partial 
repeal of the Modified Accelerated Cost Recovery System (``MACRS'').\7\ 
The study found that the proposal would lower the economy's long-run 
capital stock by between 0.2 and 0.4 percentage points. These 
simulation results suggest that slowing down cost recovery methods 
could reduce investment even if the corporate tax rate is reduced at 
the same time.
---------------------------------------------------------------------------
    \6\ See Nicholas Bull, Timothy A. Dowd, and Pamela Moomau, 
``Corporate Tax Reform: A Macroeconomic Perspective,'' National Tax 
Journal, vol. 64, no. 4, December 2011, pp. 923-941.
    \7\ Ibid.
---------------------------------------------------------------------------
Maintaining Parity Between Corporate and Passthrough Entities
    More so than in a number of other countries, substantial business 
income in the United States is not subject to a separate entity level 
tax such as our corporate income tax but rather is passed through to an 
individual's income tax return and taxed as part of the business 
owner's individual income.\8\ For example, in 2012, more than 40 
percent of all business income reported in the United States was earned 
by S corporations, partnerships, and nonfarm sole proprietorships.\9\
---------------------------------------------------------------------------
    \8\ In a study analyzing corporate and individual shares of net 
income from business activities in five countries, it was observed that 
``[t]he corporate share of net income from business operations was 81.9 
percent in Australia, 74.5 percent in Canada, and 67.5 percent in the 
United Kingdom in 2009, while it was 34.1 percent in Germany in 2007 
and 43.8 percent in the United States in 2009. In 2010, roughly equal 
shares of business income were earned by corporations and individuals 
in Japan.'' Joint Committee on Taxation, Foreign Passthrough Entity Use 
in Five Selected Countries, October 2013, p. 11. This document is 
available on the Joint Committee on Taxation website at http://
www.jct.gov.
    \9\ The partnership data reported here, as compiled by the 
Statistics of Income Division of the Internal Revenue Service, include 
partnerships whose partners are C corporations. In 2012, approximately 
two-thirds of the income reported on partnership returns was ultimately 
reported on individual returns. Therefore, there may be some double 
counting of partnership income that flows to partners that are C 
corporations.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    Some business tax reform options have been proposed with the intent 
of maintaining parity between corporate and passthrough entities; for 
example, by attempting to equalize the top corporate tax rate with the 
top individual tax rate. However, it is not clear what parity should 
---------------------------------------------------------------------------
mean.

    Owners of C corporations generally bear two levels of tax that in 
total can exceed 50 percent. However, if the earnings of the C 
corporation are not distributed the current tax burden of those 
earnings is 35 percent or less. On the other hand, owners of 
passthrough entities generally do not bear a tax rate greater than 44 
percent, but that rate of tax may apply regardless of whether the 
earnings of the entity are distributed or retained.

    The top marginal 2016 Federal tax rate on income of business 
entities depends on three principal factors. The first is the tax 
classification of the business: C corporation, S corporation, or 
partnership. C corporations have a top marginal rate of 35 percent, 
though distributed income--generally in the form of a dividend--is also 
taxed in the hands of shareholders. By contrast, S corporations and 
partnerships are passthrough entities generally not taxed at the entity 
level, only at the shareholder or partner level, whether or not the 
income is distributed to shareholder or partner. Limited liability 
companies (``LLCs'') can be treated as partnerships for tax purposes.

    The second factor, applicable only to C corporations, is whether 
the income is distributed to equity holders or not, and if distributed, 
whether it is a qualified dividend or an ordinary dividend in an 
individual equity holder's hands. An individual is taxed on a qualified 
dividend at top rate of 23.8 percent, which is the sum of the income 
tax rate of 20 percent, plus the 3.8 percent net investment income 
(``NII'') tax. An individual is taxed on an ordinary dividend at the 
top rate of 43.4 percent, which is the sum of the income tax rate of 
39.6 percent, plus the 3.8-percent NII tax.\10\ Taking into account the 
top corporate rate of 35 percent, the ``all-in'' Federal tax rate on 
distributed corporate income of an individual is either 50.47 percent 
(for qualified dividends) or 63.21 percent (for ordinary dividends). 
Undistributed corporate income is taxed only at the corporate level at 
the ``all-in'' rate of 35 percent.
---------------------------------------------------------------------------
    \10\ However, dividends received from C corporations by individuals 
are more commonly qualified dividends.

    The third factor, applicable to individual owners of S corporations 
and partnerships, is whether the individual is active (or performs 
services) in the entity's business, or is a passive investor. This 
factor determines whether the 3.8-percent NII tax applies (or, in the 
case of a limited partner, the Medicare hospital insurance (``HI'') 
component of the self-employment tax applies, also at 3.8 percent). 
Neither the self-employment tax nor the NII tax generally applies to 
active S corporation shareholders: the ``all-in'' top rate on S 
corporation business income is 39.6 percent. This is the top individual 
marginal income tax rate. The ``all-in'' rate on individuals who are 
passive shareholders of an S corporation is 43.4 percent, the sum of 
the 39.6-percent income tax rate and the 3.8-percent NII tax rate. The 
``all-in'' rate on partners who are individuals is generally 43.4 
percent, the sum of the 39.6 percent income tax rate and the 3.8-
percent NII tax (or the 3.8-percent HI component of the self-employment 
tax). The S corporation or partnership itself is not taxed, and the S 
corporation shareholders or partners are taxed whether or not the 
---------------------------------------------------------------------------
income is distributed to them.

    On distributed income, the partners and S corporation shareholders 
have an ``all-in'' Federal tax rate of either 39.6 or 43.4 percent. 
Distributed income of a C corporation has an ``all-in'' Federal tax 
rate of either 50.47 percent or 63.21 percent.

    On undistributed income, the partners and S corporation 
shareholders again have an ``all-in'' Federal tax rate of either 39.6 
or 43.4 percent. Undistributed income of a C corporation has an ``all-
in'' Federal tax rate of 35 percent.


 Top Marginal 2016 Tax Rates on Distributed and Undistributed Net Income
           of C Corporations, S Corporations, and Partnerships
------------------------------------------------------------------------
       Income           C Corporations    S Corporations   Partnerships
------------------------------------------------------------------------
Qualified dividend   35% + (20% + 3.8%
 received by          (NII) on after-tax
 individual           distribution)
                      (15.47%) = 50.47%
Ordinary dividend    35% + (39.6% + 3.8%
 received by          (NII) on after-tax
 individual           distribution)
                      (28.21%) = 63.21%
Undistributed        35%
 corporate income
Share of business                         39.6%
 income of
 individual active
 S shareholder
Share of business                         39.6% + 3.8%
 income of                                 (NII) = 43.4%
 individual passive
 S shareholder
Share of most                                             39.6% + 3.8%
 business income of                                        (HI) = 43.4%
 individual
 partners
Share of business                                         39.6% + 3.8%
 income of                                                 (NII) = 43.4%
 individual limited
 partner not
 performing
 services
------------------------------------------------------------------------

Corporate Integration
    Recognition of the two levels of tax applicable to the income of C 
corporations has led some to propose what is called corporate 
integration as a business tax reform. There are two broad categories of 
integration: (1) complete integration and (2) partial integration in 
the form of dividend relief.

    Complete (or ``full'') integration eliminates double taxation of 
both dividends and retained corporate earnings by including in 
shareholder income both distributed and undistributed earnings. S 
corporations are taxed under a regime of complete integration since 
earnings of an S corporation, whether retained or distributed, are 
treated as income of the shareholders for tax purposes.

    Dividend relief, unlike complete integration, reduces the double 
taxation on distributed earnings, with no change in the taxation of 
retained earnings. Dividend relief may be accomplished by reducing tax 
at either the corporate or shareholder level. At the corporate level, 
the tax burden on distributed earnings may be alleviated by means of a 
dividends paid deduction or a lower corporate income tax on distributed 
versus retained income. At the shareholder level, the tax burden on 
dividends may be reduced by allowing shareholders to exclude from gross 
income, or deduct, dividends received, or by providing shareholders 
with a credit equal to all or a portion of the corporate-level tax paid 
by the corporation.
Innovation
    Outside of the United States, a number of countries have 
established intellectual property regimes (or ``patent boxes''), which 
offer preferential tax treatment on income attributable to intellectual 
property. Policymakers have adopted ``patent boxes'' or ``innovation 
boxes'' to increase domestic investment in research and development and 
to encourage companies to locate intellectual property in their 
countries. Federal income tax rules provide incentives for research 
activities by providing a deduction for research expenditures in the 
year incurred, as well as a credit for certain qualified research 
expenditures. However, there are currently no Federal income tax 
provisions that provide for preferential rates, deductions, or credits 
for profits derived from the sale or license of intellectual property 
or products using or incorporating intellectual property.

    Adopting a U.S. innovation or patent box presents unique policy and 
administrative issues, including the types of intellectual property 
that would qualify (for example, limiting to patents or expanding to 
include a broader range of intellectual property, such as trade 
secrets); whether a nexus requirement should be adopted to require 
development of the intellectual property to take place in the United 
States; how the intellection property income would be taxed; and 
identifying what types of intellectual property income will receive 
preferential treatment. A primary question related to this last issue 
is whether qualifying income should include income from foreign-use of 
the intellectual property in question. European Union countries cannot 
limit their innovation box regimes to income from domestic use due to 
European Union treaty obligations. The United States, however, could 
design an innovation box that requires domestic use. While the Working 
Group focused more on the policy effects of these types of provisions, 
the resolutions of these issues would affect the efficacy and cost of 
any innovation or patent box proposal.
Other Business Income Tax Reform Proposals
    The Working Group also reviewed a number of other business income 
tax reform proposals, which are included and summarized on pages 7 
through 11 of the accompanying materials.


              Joint Committee Staff Estimate of Revenue Effect of One Percentage Point Decrease in PTop Statutory Corporate Income Tax Rate
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Billions of dollars                     2017    2018    2019    2020     2021     2022     2023     2024     2025     2026   2017-2026
--------------------------------------------------------------------------------------------------------------------------------------------------------
Change in Revenues.....................................    -6.1    -8.7    -9.1    -9.8    -10.3    -10.5    -10.9    -11.3    -11.7    -12.2     -100.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation staff estimate.
Note: This option would take effect for tax years beginning after December 31, 2017. Estimates are relative to CBO's January 2016 baseline projections.



            Largest U.S. Corporate Tax Expenditures 2015-2019
------------------------------------------------------------------------
                                                         Total Amount
             Corporate Tax Expenditure                   (Billions of
                                                           Dollars)
------------------------------------------------------------------------
Deferral of active income of controlled foreign                   563.6
 corporations
Deduction for income attributable to domestic                      61.5
 production activities
Deferral of gain on like-kind exchanges                            57.4
Exclusion of interest on public purpose State and                  50.5
 local government bonds
Credit for low-income housing                                      41.2
Expensing of research and experimental expenditures                27.6
 
MEMORANDUM
Depreciation of equipment in excess of alternative                -20.9
 depreciation system
------------------------------------------------------------------------
Source: Joint Committee on Taxation, Estimates of Federal Tax
  Expenditures for Fiscal Years 2015-2019 (JCX-141R-15), December 7,
  2015.


   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



 Top Marginal 2016 Tax Rates on Distributed and Undistributed Net Income
           of C Corporations, S Corporations, and Partnerships
------------------------------------------------------------------------
       Income           C Corporations    S Corporations   Partnerships
------------------------------------------------------------------------
Qualified dividend   35% + (20% + 3.8%
 received by          (NII) on after-tax
 individual           distribution)
                      (15.47%) = 50.47%
Ordinary dividend    35% + (39.6% + 3.8%
 received by          (NII) on after-tax
 individual           distribution)
                      (28.21%) = 63.21%
Undistributed        35%
 corporate income
Share of business                         39.6%
 income of
 individual active
 S shareholder
Share of business                         39.6% + 3.8%
 income of                                 (NII) = 43.4%
 individual passive
 S shareholder
Shore of most                                             39.6% + 3.8%
 business income of                                        (HI) = 43.4%
 individual
 partners
Share of business                                         39.6% + 3.8%
 income of                                                 (NII) = 43.4%
 individual limited
 partner not
 performing
 services
------------------------------------------------------------------------

                    Corporate Integration Approaches

_______________________________________________________________________

    q  Some alternative approaches to integration of corporate and 
individual levels of tax on corporate income

      q  ``Full integration''--shareholder allocation method (treat 
corporate income like passthrough income)

      q  Partial integration approaches (``dividend relief'')

        q  Corporation deducts dividends paid to shareholders

        q  Tax on corporate income applies partially at shareholder 
level, corporation withholds tax on distributions

        q  Reduced tax rate for shareholders on dividends received and 
gains on stock sale/exchange

        q  Shareholders exclude from income (or deduct) dividends 
received

        q  Shareholders get a tax credit for some corporate-level tax 
paid on distributed amounts

               Features of Selected Tax Reform Proposals

_______________________________________________________________________

    q  Tax Reform Act of 2014, introduced December 10, 2014 by Mr. Camp 
(H.R. 1, 113th Congress)

      
     Corporate tax rate reduced to 25 percent

      
     Repeals numerous present-law business tax provisions

      
     International business: moves to dividend exemption approach

      
     Individual tax rate structure reduced to 10, 25, 35 percent

      
     40-percent deduction for individuals' dividends, capital gains

    q  Five largest non-international business revenue raisers (over 10 
years)

      
     Depreciation changes ($269.5 billion)

      
     Amortize R&E expenditures ($192.6 billion)

      
     Amortize advertising expenditures ($169.0 billion)

      
     Phase out section 199 manufacturing deduction ($115.8 billion)

      
     Repeal LIFO accounting ($79.1 billion)

    Source: Joint Committee on Taxation, Estimated Revenue Effects of 
the ``Tax Reform Act of 2014'' (JCX-20-14), February 26, 2014.

  Consumption Tax Proposals--Progressive Consumption Tax Act of 2014, 
    introduced December 11, 2014 by Senator Cardin (S. 3005, 113th 
                               Congress)

_______________________________________________________________________

    q  Adds credit-invoice VAT at 10 percent rate

      
      Exports zero rated

      
      Exemption provided for

        n  Specified financial products and services

        n  Residential housing

        n  Residential rent

        n  De minimis supplies

    q  Reduces top corporate income tax rate to 17 percent

    q  Reduces top individual income tax rate to 28 percent

    q  Provides income tax exemption of $100,000 for joint filers 
($50,000 for single) to provide progressivity

    q  Rebates VAT in a manner intended to replace repealed income tax 
credits (EITC, CTC, ACTC)

    q  Rebates excess VAT if revenues from it exceed 10 percent of GDP 
for the calendar year

Consumption Tax Proposals--FAIR Tax Act of 2015, introduce January 13, 
 2015, by Senators Moran, Perdue, and Isakson (S. 155, 114th Congress)

_______________________________________________________________________

    q  Repeals individual and corporate income tax, self-employment and 
payroll tax, and estate and gift tax

    q  Imposes sales tax on use or consumption in the U.S. of taxable 
property and services

    q  Rate is 23 percent for 2017

      
      Thereafter, rate is 14.91 percent general revenue rate increased 
by OASDI and HI rates

    q  Credit against tax for

      
      Exports and intermediate sales for a business purpose

      
      Business use of purchased property

      
      Bad debts, insurance proceeds, sales that are refunded

    q  Family consumption allowance (rebate) based on poverty level and 
family size

    q  Authority provided for States to collect tax in conjunction with 
State sales tax

    q  Repealed if 16th Amendment (income tax) not repealed within 7 
years after enactment

     Cost Recovery and Tax Accounting--Bipartisan Tax Fairness and 
   Simplification Act of 2011, introduced April 5, 2011, by Senators 
           Wyden, Coats, and Begich (S. 727, 112th Congress)

_______________________________________________________________________

    q  Unlimited expensing of depreciable assets and inventories for 
small businesses

      
      Average annual gross receipts of $1M or less

    q  Eliminates depreciation on tangible property in excess of ADS 
for businesses other than small business

    q  Repeals LCM

 Cost Recovery and Tax Accounting--Economic Growth and Family Fairness 
    Tax Reform Plan of Senators Rubio and Lee, published March 2015

_______________________________________________________________________

    q  Full expensing of capital purchases for all businesses

      
      Immediate expensing of all investment in equipment, structures, 
inventories and land

      
      No depreciation

    q  Businesses pay taxes on earnings after deducting all expenses 
from taxable income

                                 ______
                                 
         Prepared Statement of Gayle Goschie, Vice President, 
                          Goschie Farms, Inc.
    Chairman Hatch, Ranking Member Wyden, Co-Chairs of the Business 
Income Bipartisan Tax Working Group, and members of the Finance 
Committee, I would like to thank you for giving me the opportunity to 
testify today.

    Senators Cardin and Thune, I also thank you for your efforts on the 
Working Group's report to address the challenges of our present tax 
code. Your interest in tax fairness and certainty is appreciated, as is 
your willingness to consider innovative approaches to dealing with 
challenges posed by current tax law.

    My name is Gayle Goschie, and I am here today to represent Goschie 
Farms, Inc. and the Hop Growers of America. I am a fourth generation 
farmer. My two brothers and I run Goschie Farms in Silverton, Oregon. 
Our land, which has been in our family for more than 130 years has 
1,000 acres; 550 of which are devoted to hops. Another 150 acres is 
farmed with wine grapes. We supply hops and grapes to craft breweries 
and independent wineries throughout the Unites States.

    Goschie Farms, Inc. has a staff of 80 full-time and seasonal 
employees. Our customers include 20 breweries located in Oregon, 
Washington, California, Colorado, Wisconsin and Michigan, and we grow 
wine grapes for three Oregon companies.

    As you all know, the business of farming is fraught with 
uncertainty. A growing season can turn quickly from an economic gain to 
an economic loss overnight. A change in the weather, product prices, 
labor supply, or our customers' needs can have an extreme, often 
unforeseen impact on our business. Furthermore, the complex and 
sometimes arbitrary and inequitable nature of our tax laws can impact 
how we buy equipment, what type of crops we plant and our hiring 
practices. The agriculture industry has many uncertainties, taxes 
should not be one of them.

    Taxes influence how we invest in our business. Tax rates affect the 
equipment we buy and when we buy it, the type of crops we grow and our 
hiring/labor decisions. When there is uncertainty with taxes we are 
unable to invest with confidence in our business. Fixing the present 
tax code is one of the ways Congress can help ensure that farms like 
mine are positioned for growth.

    Stated simply, perhaps the greatest thing Congress could do for 
millions of American small businesses is to streamline and simplify our 
incredibly complex tax code. Real tax reform will help us do what we do 
best--run our small businesses.

    Congress has already enacted some changes that will have a positive 
impact on the farming sector. In December 2015, Congress permanently 
extended the small business expensing limitation and phase-out amounts 
in section 179 when it passed the PATH Act. Prior to section 179 being 
made permanent we did not feel confident making needed purchases 
throughout the growing season. The amount allowed to be expensed was 
unknown and needed investments were delayed. This permanent extension 
has allowed us to invest in renewable energy as well as water and 
energy savings practices and we are hoping to do more.

    This is a step in the right direction. We hope that it will 
encourage Congress to focus on other issues like the current 
depreciation schedule we follow under ``Uniform Capitalization,'' a tax 
concept governed by Internal Revenue Code (I.R.C) section 263A, which 
is complicated and time consuming. In addition, hundreds of purchases 
need to be recorded and tracked independently and there are 
inequalities from one industry to the next. For example, a tractor in 
agriculture is depreciated over 7 years, whereas depreciation for the 
same tractor in construction would be over 5 years. It would be helpful 
to have uniform depreciations for similar items and to allow items to 
be pooled together as opposed to being listed separately.

    It also impacts our development costs. There are a number of 
expenses that come with development of a vineyard, they include land 
clearing, soil and water conservation, direct and indirect costs of 
vine, trellis, and irrigation systems, and preproductive costs. The 
general rule under I.R.C. Sec. 263A is that all preproductive costs 
incurred during the preproductive period of vines must be capitalized 
into the cost of the vines. Depreciation on those capitalized costs 
would begin when the vines have experienced their first commercially 
harvestable crop, a period of at least 3 years. The plant and trellis 
pre-production costs in hops can be written off much sooner than wine 
grapes, but most crops have no restrictions at all.

    As you can see, the tax code for small business owners, farmers 
like me, is complicated and difficult to interpret. Goschie Farms does 
not have accountants on staff to analyze every decision as it is made 
or to maneuver each decision to maximize the tax benefits. Our time and 
efforts are needed in the fields to meet the demands of our customers.

    The work we do every day as farmers is a business story about the 
safe, U.S. grown, quality products that are our livelihood. It is my 
generation's responsibility to carry our farming business practices 
forward with soil that is healthy, and an environment that is 
productive and safe. Both hop and wine grape growers farm with 
certifications in best practices, sustainability and energy 
conservation. Additionally, our farm has invested in a grid-tied solar 
system that harnesses up to 32 kW of direct current power and our total 
hop acreage is efficiently watered and fed through more than 250 miles 
of drip tubing. With the hope of consistent energy tax incentives, 
these are just the beginnings of ongoing environmental investments.

    Another tax issue that would impact farms like ours is the Craft 
Beverage Modernization and Tax Reform Act (S. 1562), which was 
introduced by Senators Wyden and Blunt. Though this legislation does 
not directly impact hop and grape growers, it would recalibrate the 
federal excise tax for craft beer, wine and spirits producers.

    The majority of our customers would use savings from this 
legislation to grow their business, invest in larger tanks, and 
increase their purchase of supplies--such as hops and grapes. Their 
savings will impact how they purchase ingredients and in many cases 
allow them to be more consistent, something that would significantly 
impact the agriculture producers who supply them with their 
ingredients. It should come as no surprise that in addition to the 
majority of the alcohol industry this bill has the support of farm 
groups like the Hop Growers of America, the Oregon Winegrowers 
Association and the National Barley Growers Association.

    The cost of growing hops, like grapes, is not insignificant for a 
farmer. With the number of craft breweries in the United States over 
4,000 and growing the demand for hops increases year after year, but 
there are many factors a hop farmer must take into account when 
evaluating the feasibility of growing their hop production; capital, 
labor, natural resources, crop yield, cultural practices, input prices, 
prices of hops, management skills, size of the operation, type and size 
of machinery, and irrigation systems are all factors that must be 
considered (Galinato and Tozer, 2015, p. 1).

    When the craft beverage industry finds relief through a reduction 
in excise taxes, the grower will find expanding markets, increased 
demand and a bolstered confidence in continuing to work with the craft 
producers. With this unique example, a simplified tax code could bring 
relief to breweries, wineries, farmers and consumers.

    In conclusion, I want to thank you again for inviting me here today 
to testify. I know you have heard many stories like mine and that you 
agree that our federal tax code must be reformed. Streamlining and 
simplifying the Internal Revenue Code must be a top priority for the 
Congress. Tax reform will create a tremendous economic benefit for 
businesses small and large--and for the American people.

    Reference: Ms. Suzette P. Galinato and Dr. Peter R. Tozer (2015). 
2015 Estimated Cost of Establishing and Producing Hops in the Pacific 
Northwest (Report). School of Economic Sciences, Washington State 
University, Pullman, WA.

                                 ______
                                 
              Prepared Statement of Hon. Orrin G. Hatch, 
                        a U.S. Senator From Utah
WASHINGTON--Senate Finance Committee Chairman Orrin Hatch (R-Utah) 
today delivered the following opening statement at a hearing to explore 
ways Congress can reform the business tax code to make it more globally 
competitive and to consider the findings of the committee's bipartisan 
business income tax working group:

    Good morning. It's a pleasure to welcome everyone to today's 
hearing, which we've titled ``Navigating Business Tax Reform.''

    I think this title accurately describes the challenges we have 
before us in moving forward on business tax reform specifically and on 
comprehensive tax reform more generally. In the recent past, 
identifying and developing certain bipartisan policy proposals and 
moving them through the legislative process have proven especially 
difficult. But I am an optimist, and I believe we can, and should, find 
common ground on a path forward for comprehensive tax reform.

    Of course, as I've said in the past, successful tax reform will 
take a President who truly makes it a priority and works closely with 
Congress to get it over the finish line. Currently, I think it's safe 
to say that we haven't met that prerequisite with this administration, 
which, most acknowledge, means that, for now, we have to wait. But, in 
the interim, this committee will continue to lay the foundation and 
develop pro-growth proposals for when the appropriate opportunity 
arises.

    That is why, last year, Senator Wyden and I asked members of our 
committee to work in various Tax Reform Working Groups to help identify 
issues and develop consensus, if possible, around tax policy proposals. 
Today we will focus our attention on business tax reform issues, 
including topics that were covered in the report issued by the 
Bipartisan Business Income Tax Working Group.

    I want to thank the co-chairs of that working group--Senators Thune 
and Cardin--as well as the other members of the working group: Senators 
Roberts, Burr, Isakson, Portman, Toomey, Coats, Stabenow, Carper, 
Casey, Warner, Menendez, and Nelson. A lot of time and effort went into 
examining these issues and compiling this report. I appreciate 
everyone's willingness to help advance this cause.

    Tom Barthold, the Chief of Staff for the Joint Committee on 
Taxation, is with us today to provide background on business tax reform 
issues and highlight some of the major topics reviewed in the working 
group's report. We have a great group of additional witnesses here 
today as well that will provide important insights and recommendations 
about broad design issues of the business tax system and practical, on-
the-ground issues that are important for us to keep in mind as we 
further develop and refine proposals in the business tax space.

    I want to take a minute to discuss one particular business tax 
issue that was discussed in the working group report and that I believe 
warrants real consideration by everyone here today: corporate 
integration.

    In very general terms, corporate integration means eliminating 
double taxation of certain corporate business earnings. Under current 
law, a corporation's earnings are taxed once at the corporate entity 
level and then again at the shareholder level when those earnings are 
distributed to shareholders as dividends.

    In other words, under our system, if a business is organized as a C 
corporation, we tax the earnings of the corporation itself AND those 
same earnings when paid out to the individual owners of the business. 
This creates a number of inequities and distortions, and my staff and I 
have been working for a few years now to develop a proposal to address 
this problem.

    I was glad to see that the business tax working group addressed 
corporate integration in its report, noting that ``eliminating the 
double taxation of corporate income would reduce or eliminate at least 
four distortions built into the current tax code: (1) the incentive to 
invest in non-corporate businesses rather than corporate businesses; 
(2) the incentive to finance corporations with debt rather than equity; 
(3) the incentive to retain rather than distribute earnings; and (4) 
the incentive to distribute earnings in a manner that avoids or 
significantly reduces the second layer of tax.''

    Depending on its design, corporate integration could have the 
effect of reducing the effective corporate tax rate and help address 
some of the strong incentives we are seeing today for companies to 
relocate their headquarters outside of the United States. It would also 
have the likely effect of making the United States a more attractive 
place to invest and do business. I'll have much more to say on this 
topic in the coming weeks and months. But, I plan to raise this issue 
in general terms here today.

    Once again, I want to welcome our witnesses. I look forward to a 
robust and informative discussion.

                                 ______
                                 

              [From the Wall Street Journal, July 9, 2015)

        ``Who Would Have Guessed? Bipartisanship on Tax Reform''
                           By Mark Bloomfield
    The Senate Finance Committee announced Wednesday that five 
bipartisan working groups had completed reports analyzing the tax code 
and ways to make it simpler, fairer, and more efficient. It's rare that 
Democrats and Republicans find common ground on any major issue in 
Washington, but on tax reform it is monumental. Business groups, 
interest groups, and other stakeholders in today's system are scouring 
the reports to identify winners and losers among the recommendations.

    Amid the many pages was a nugget that could have big ramifications 
for tax policy, the 2016 presidential election, and the economy.

    Senators Ben Cardin (D-MD) and John Thune (R-SD), the co-chairmen 
of the working group in business income, note on Page 40 of their 
report to the Finance Committee: ``Making a fundamental shift to 
consumption-oriented taxation is a major change that may not 
necessarily be undertaken in the near term. However, given the pro-
growth effects of consumption taxes, the working group believes that 
the issues above and consumption-based tax systems in general deserve 
the attention of the committee as tax reform efforts continue.''

    These few words confirm the consensus of many mainstream 
economists: a consumption tax produces more growth than an income tax.

    The need for pro-growth solutions to economic malaise has reached 
global levels. Greece is desperate to find a way out of its austerity 
and bailout policies and to put itself on a path that creates jobs and 
growth.

    Here at home, the need for economic growth to revive our still 
sluggish economy has transcended party lines. Hillary Clinton has 
stumped on it. Senators from across the political spectrum, including 
Ben Cardin, Rand Paul, Mike Lee, and Marco Rubio, have proposed 
versions of a consumption tax. Unlike the stigmatized European VAT, 
Senator Cardin has proposed what he calls a ``progressive consumption 
tax.'' Senator Paul suggests a ``business activities tax.'' The 
business-income working-group report says the joint reform plan of 
Senators Rubio and Lee ``contains several provisions that would shift 
the tax code in the direction of a consumption tax.'' On the business 
side of the Rubio-Lee plan, capital investment would be immediately 
expensed. On the individual side, investment income from capital gains, 
dividends, and interest would be tax-free.

    This is not about importing a European-style VAT. Progressives, 
tea-partyers, and all points in between could craft a consumption tax 
tailored to the political, cultural and economic needs of our country.

    To address conservatives' concerns that traditional VATs pull in 
too much revenue for government coffers, Senator Cardin proposes a 
rebate to taxpayers if revenues from a consumption tax exceed 10% of 
the economy. To counter charges of a ``tax on the poor,'' Senator Paul 
would repeal the regressive payroll tax paid by the working poor and 
exempt from income tax the first $50,000 of wages.

    These proposals capture the spirit of Ben Franklin's admonition 
that a penny saved is a penny earned, while working around European 
pitfalls.

    As Senators Cardin and Thune noted, a consumption tax is unlikely 
to be adopted in the near term. But the 2016 presidential election may 
be the first and best chance to build a true mandate for tax reform, 
particularly for Republican candidates looking for a way to stand out 
in a crowded field.

                                 ______
                                 

                [From Fortune magazine, April 13, 2016]

               ``This Is the Fairest Way to Tax America''
                           By Mark Bloomfield
    There's a better way beyond taxing workers' paychecks.

    The tax deadline is upon taxpayers this week. Our insufferable 
forms and surrender of hard earned money to the U.S. Treasury causes 
one to think that there's got to be a better way. The hope of tax 
reform springs eternal; it won't happen this year but it could happen 
in 2017 with a new president and Congress, when major policy 
initiatives historically can get done.

    To judge the current U.S. tax regime, there are three criteria most 
economists agree upon--fairness, efficiency and simplicity. Tax reform 
is not just about what the tax rate should be, but a question of what 
should be taxed. A consumption tax is better than a tax on income under 
the three criteria.

    First, let's take a look at fairness. Jared Bernstein, Vice 
President Biden's former chief economist recently commented on the 
fairness of Paul Ryan's tax plan in the Washington Post, citing the Tax 
Policy Center's ``distribution'' tables: the top 0.1% get a tax cut of 
$1 million; middle-class families just a couple of thousand dollars; 
the bottom fifth, a tax cut of a $560. Bernstein highlighted an 
interview CNBC's John Harwood had with Paul Ryan where Harwood asked, 
``aren't you worried the blue-collar Republicans are saying `you're 
taking care of people at the top more than me?' ''

    This brings us to the issue of fairness, which is in the eye of the 
beholder. According to the same Tax Policy Center ``the top 1% of U.S. 
earners were projected to pay nearly half of Federal income taxes in 
2014; the bottom 60%, less than 2%.'' But Bernstein also fundamentally 
missed something about the psyche of Americans best explained to me by 
my French wife: If you've got a French farmer who has three cows, his 
neighbor five cows, the less fortunate farmer will scream ``there is 
something crooked going on here. The only fair thing to do is to 
redistribute the cows so both of us have four cows.'' The American 
farmer's response would be, ``It's good that my neighbor has three, 
great the other fellow has five, but I'm going to work real hard and 
get 10 cows.''

    Harvard economist Greg Mankiw addressed another aspect of fairness. 
Consider the story of twin brothers--Spendthrift Sam and Frugal Frank. 
Sam lives the high life, enjoys expensive vacations and throws lavish 
cocktail parties. Frank, meanwhile lives more modestly. He keeps his 
fortune invested in the economy where it finances capital accumulation, 
new technology and economic growth. Who should pay higher taxes? Under 
Bernstein's preference of an even more progressive income tax, both 
twins would be taxed the same.

    Under a consumption tax, however, Frugal Sam would be taxed much 
less and more fairly than his brother. It's not just what the tax rate 
should be, but about also what is taxed--income or consumption?

    ``Efficiency,'' another one of the three important criteria for a 
good tax policy, is an economist's term for eliminating tax barriers to 
economic growth and job creation. Perhaps the time for a new tax system 
has arrived--taxing consumption rather than income. The Washington Post 
editorial board thinks it should be given serious consideration.

    They commended ``(Senator) Ben Cardin's creative proposal for tax 
reform,'' which is called a Progressive Consumption Tax (PCT). The 
liberal Senator's proposal is a massive shift in taxation from 
household and corporate income to consumption. It addresses the liberal 
concerns about regressivity and conservative concerns about being a 
``money machine.'' The Washington Post also recognizes the political 
reality that it may no longer be possible to fix the income tax because 
of entrenched tax preferences: ``a grand swap of fewer loopholes for 
lower rates may no longer be politically or fiscally practical.''

    Last July, the Senate Finance Committee released the report of its 
bipartisan Working Group on Business Income, co-chaired by Cardin and 
Senator John Thune (R-SD). The report noted making a fundamental shift 
to a consumption-oriented tax as a major change. ``However, given the 
pro-growth effects of a consumption tax, the working group believes 
that consumption tax systems in general deserve the attention of the 
committee as tax reform efforts continue.'' These few words confirm the 
consensus of many mainstream economists: a consumption tax provides 
more growth than the income tax.

    The average OECD corporate income tax rate (Federal and local) was 
28.8%; for the U.S., 39%, according to the most recent OECD data. 
What's more, a recent Ernest and Young report found that the U.S. has 
the highest integrated tax rate of capital (combined corporate level 
tax with individual investor level tax on dividends and capital gains) 
among OECD countries. If there is anything one can learn from the 
electorate today, it is that economic growth and job creation is the 
big priority. Moving toward taxing consumption, rather than saving and 
investment would be a great help.

    Finally, there is the third criterion of ``simplification.'' Our 
current tax code is 64,680 pages. Critics say it's the well-connected, 
the wealthy, the crony capitalist who knows how to manipulate the code 
to his or her advantage. Credit is due to any tax reform, which would 
simplify the code for the benefit of those who are not 1 percenters or 
the millionaires or billionaires who now benefit from complexity.

    Tax reform is not an overnight phenomenon. It took years of pent-up 
demand and hard work to provide the conditions that favored substantive 
tax reform in 1986. That is also the case today with former tax writing 
committee chairmen Senator Max Baucus and Congressman David Camp 
working almost full-time in 2013-14, crisscrossing the country, 
conducting endless hearings and educating their colleagues, the media 
and important constituencies from businesses to senior citizens to Joe 
Six Pack. In the end, Chairman Camp produced a tax reform plan that did 
not go anywhere because the time wasn't ripe for tax reform; it had an 
outdated economic and political formula and it didn't have the right 
leadership on board.

    Tax reform, to paraphrase GOP presidential candidate Donald Trump, 
is more about the art of the deal. In the 1986 tax deal Democrats 
wanted to close loopholes for the wealthy and corporations; Republicans 
wanted lower tax rates to spur economic growth. The Tax Reform Act of 
1986 gave both what they wanted and that's why it became law. Again, 
today it may no longer be possible to fix the income tax because of 
entrenched tax preferences. It explains in part why Camp's plan to 
reform the income tax was stillborn. It also explains the growing 
interest in turning the current tax code upside down, taxing spending 
rather than income to encourage saving and investment.

    Senator Cardin's creative consumption tax proposal might provide a 
formula for a deal today. For liberals, it would tax the conspicuous 
consumption of millionaires and billionaires, their yachts, and their 
million-dollar birthday; for conservatives, it would encourage the 
wealthy to put their riches into jobs and investment that would not be 
taxed. Both Democrats and Republicans would be pleased with replacing 
the corporate income tax with a consumption tax because it could end 
corporations fleeing abroad: forget parking corporate profits overseas. 
Forget corporate inversion mergers. Cardin's proposed formula addresses 
liberal concerns about regressivity with tax exemptions and credits and 
conservative fear of a ``money machine'' with a cap on revenue that 
could be raised.

    Tax reform requires bipartisan leadership. In 1986, the people who 
mattered--President Ronald Reagan, Republican Senate Finance Committee 
Chairman Bob Packwood and Democratic Ways and Means Chairman Dan 
Rostenkowski--wanted to do tax reform and it happened. The picture in 
2017 is cloudy.

                                 ______
                                 
 Prepared Statement of James R. Hines, Jr., Ph.D., Richard A. Musgrave 
    Collegiate Professor of Economics and L. Hart Wright Collegiate 
                Professor of Law, University of Michigan
    Mr. Chairman and members of this distinguished committee, it is an 
honor to participate in these hearings on business tax reform. I teach 
at the University of Michigan, where I am the Richard A. Musgrave 
Collegiate Professor of Economics in the department of economics and 
the L. Hart Wright Collegiate Professor of Law in the law school, and 
where I serve as Research Director of the Office of Tax Policy Research 
in the Stephen M. Ross School of Business. I taught for years at 
Princeton and Harvard prior to joining the Michigan faculty, and have 
been a visiting professor at Columbia University, the London School of 
Economics, the University of California--Berkeley, and Harvard Law 
School. I am a Research Associate of the National Bureau of Economic 
Research, Research Director of the International Tax Policy Forum, and 
former Co-Editor of the American Economic Association's Journal of 
Economic Perspectives.

    Business activity constitutes the core of the U.S. economy, and 
Americans benefit greatly from the opportunities provided by a thriving 
U.S. business sector. Heavy tax burdens threaten the vitality of U.S. 
businesses by discouraging business investments and reducing funds 
available for business expansions. A tax system that imposes undue 
burdens on U.S. businesses reduces the productivity of the U.S. 
economy, and in so doing reduces the wages and employment opportunities 
of Americans. Given the economic challenges facing the country now and 
in the future, it is important that U.S. businesses operate in a tax 
environment that does not excessively discourage investment and that is 
conducive to normal business operations.

    This committee is well aware of the challenging features of the 
current U.S. system of taxing business income. From the standpoint of C 
corporations, the U.S. corporate income tax rate of 35 percent is one 
of the highest in the world, and well above the OECD average; 
furthermore, the United States is the only major capital exporting 
country that taxes the active foreign business income of its resident 
corporations. From the standpoint of the millions of U.S. businesses 
such as partnerships, subchapter S corporations, and LLCs that are 
taxed on a pass-through basis, the progressive U.S. individual income 
tax system imposes tax rates that can exceed the 35 percent corporate 
rate. And from the standpoint of family farms and other family-owned 
businesses, U.S. estate and gift taxes can make intergenerational 
transfers of business assets problematic.

    There are features of the existing U.S. tax system that mitigate 
the burdens associated with high tax rates. These features include the 
deductibility of interest expense; accelerated depreciation of plant 
and equipment investment and R&D tax credits for low income housing 
investment and incremental research expenditures; the deduction for 
domestic production activities; deferral of U.S. taxation of 
unrepatriated foreign income; and many others. As a result of these and 
other aspects of the U.S. tax system, and the variety of taxpayer 
situations, business tax rates measured as ratios of tax payments to 
some measures of pretax business income may differ significantly from 
statutory rates, and in particular are often lower than statutory 
rates.

    It is true that these base-narrowing aspects of the U.S. tax system 
produce for many taxpayers average burdens that are somewhat below 
those suggested by statutory tax rates; but there are also many 
taxpayers who benefit little from them--and it is important not to be 
misled by some simple average tax rate calculations to conclude that 
the U.S. tax system imposes light burdens on U.S. firms. Tax 
obligations are the product of statutory provisions and taxpayer 
behavior, so heavy taxation that redirects business activity or 
discourages it altogether may generate only modest tax revenue even as 
it imposes significant burdens. For example, the Tax Reform Act of 1986 
greatly expanded the number of ``baskets'' used in the foreign tax 
credit calculation, thereby increasing U.S. taxation of income earned 
by international joint ventures, and in the process (and until repealed 
10 years later) significantly reducing the extent to whichU.S. firms 
undertook joint ventures in foreign countries. This imposed a burden on 
U.S. firms in the form of lost foreign business opportunities, but much 
of the burden did not appear in the ratio of tax payments to income.

    As the result of high U.S. tax rates together with other tax 
provisions that only partly mitigate the burden of high rates, U.S. 
businesses are currently taxed to an extent that business activity, and 
the employment opportunities that accompany it, is significantly 
reduced. Cross-country statistical evidence consistently shows that 
countries with heavier business tax burdens have lower rates of 
business formation, expansion, and capital investment. Indirect 
evidence of the impact of U.S. tax burdens appears in the induced use 
of substantial debt finance to produce interest deductions that help to 
mitigate tax burdens, and in the examples of U.S. corporations that 
undertake complicated and costly inversion transactions in order to 
become taxable by Canada, Britain, the Netherlands, or Ireland, rather 
than the United States.

    The tax system has two effects on the business sector. The first is 
that it collects revenues from income generated by businesses, and 
thereby reduces the extent of business formation and expansion. The 
second is that the tax system influences the character of business 
operations. Some of the behavioral influence of the tax system is 
deliberate; for example, the research and experimentation credit is 
designed to encourage and reward research spending, and the low-income 
housing credit is designed to encourage and reward provision of low-
income housing. As a result of these tax provisions, the U.S. economy 
has more research and more low-income housing than it would otherwise. 
But many of the behavioral effects of the tax system, such as 
encouraging the greater use of debt finance, affecting business 
organizational forms, and discouraging dividend payments and plant and 
equipment investment, are the undesired byproducts of a system that 
taxes investment returns.

    An obvious solution to the problems caused by heavy tax burdens is 
to reduce statutory tax rates on business income. The difficulty of 
course is that the government needs revenue with which to operate, so 
to the extent that lower tax rates reduce tax collections the resulting 
revenue shortfall would need to be financed with higher taxes on 
something else, spending cuts, or greater government borrowing, none of 
which may be a particularly attractive alternative.

    It is tempting in this situation to conclude that the most 
promising direction of reform is to broaden the business tax base and 
lower business tax rates in a 
revenue-neutral manner. Such a conclusion must be approached very 
cautiously. It is certainly true that sensible revenue-neutral tax 
reforms have the potential to improve the efficiency and fairness of 
the tax system by replacing undesirable tax provisions with better 
alternatives, but it is challenging to generate significant reductions 
in average business tax burdens with revenue-neutral business-only tax 
reforms, for the simple reason that a tax reform that is revenue-
neutral within the business sector leaves average business tax burdens 
largely unchanged.

    A revenue-neutral business tax reform that lowers statutory tax 
rates while expanding the tax base nonetheless has the potential to 
change incentives for different business activities, but to be clear, 
what such a change would do is to encourage some business activities 
while actively discouraging others. For example, a reform that limited 
the deductibility of interest expense and used the accompanying revenue 
to finance a reduction in statutory tax rates would encourage 
investment by some firms and discourage investment by others, the 
difference reflecting the ability and willingness of different 
taxpayers to finance their investments with debt. Proposals to reduce 
the deductibility of interest expense are typically motivated by a 
desire to level the playing field between debt and equity, and by a 
desire to finance a tax rate reduction. It is true that reducing the 
deductibility of interest expense reduces the attractiveness of debt 
finance, and it is also true that a statutory tax rate reduction by 
itself would encourage investment, but in this example it is not true 
that for the business sector as a whole this revenue-neutral reform 
necessarily increases investment incentives, because the loss of 
interest deductions also affects incentives to invest.

    This example is just one illustration of a much broader principle, 
which is that it is impossible to find a tax reform that reduces every 
marginal tax rate while keeping average rates unchanged. Marginal tax 
rates influence behavior, and the problem caused by taxation is that it 
produces positive marginal rates: a system that taxes income 
discourages the production of income. There is no avoiding this problem 
if the system is to raise revenue, since raising revenue requires a 
positive average tax rate, and the average tax rate in the economy, or 
in the business sector, is just the combination of the marginal rates. 
The implication for tax reform is that any revenue-neutral income tax 
reform increases some marginal tax rates and reduces others, 
discouraging income production by some taxpayers and encouraging income 
production by others.

    While this principle of taxation is obvious once stated, it is 
useful to stress its application to specific policies. If a tax reform 
were to repeal section 199, the domestic production activities 
deduction, and use the revenue thereby generated to finance a reduction 
in statutory tax rates, then the reform would encourage investment by 
firms that currently benefit little from the domestic production 
activities deduction and discourage investment by firms that currently 
benefit more than average from the deduction. If instead a tax reform 
were to impose further limits on the ability of corporate taxpayers to 
use loss carryforwards, using the revenue from this change to reduce 
statutory corporate tax rates, then the net effect of the change on 
aggregate corporate investment is unclear, since firms differ in the 
extent to which they anticipate possibly needing to use loss 
carryforwards in the future, and the degrees to which they value the 
form of tax insurance that loss carryforwards provide. This last 
example illustrates that even if a tax reform repeals favorable tax 
provisions not directly related to investment, and uses the revenue to 
finance statutory rate reductions, the effect of removing the favorable 
tax provisions is to increase tax burdens, and reduce investment, by 
firms that are significantly affected.

    What principles should guide tax reform, understanding that any 
reform that is revenue-neutral within the business sector will 
necessarily encourage some business activities and discourage others? 
Economic theory notes that an efficient tax system imposes the lightest 
tax burdens on two types of activity: those that generate positive 
spillover benefits for the economy, and those that are the most 
responsive to taxation. Research spending is a common example of the 
former. Studies consistently find that the social rate of return to 
research endeavors significantly exceeds the private return, implying 
that innovators capture only a portion of the benefits they provide the 
economy. As a result, the level of research activity undertaken by 
private researchers in the absence of external support is less than the 
level that maximizes economic performance, and in order to improve the 
efficiency of the economy it is necessary to provide additional 
inducements for research. This is, indeed, the standard justification 
for the tax system's favorable treatment of research expenditures.

    It is important to recognize that there are two ways in which the 
research and experimentation credit and favorable research cost 
recovery provisions encourage research undertaken in the United States. 
The first is by encouraging individual taxpayers to adjust their 
production processes in the direction of greater research intensity: 
for example, an electronics firm might spend more on research and less 
on advertising in response to a more favorable tax treatment of 
research. There is a good body of accumulated evidence that firms 
respond to the research credit in this way. The second channel is 
possibly even more consequential, and it is that the favorable tax 
treatment of research expenditures reduces the tax burden on firms that 
are research-intensive, and as a result these firms expand their 
operations more than do otherwise similarly-situated firms that are 
less research-intensive. This second channel does not require that any 
individual taxpayer modify its production process in reaction to 
research tax benefits, but the economy effectively does so by expanding 
the operations of some firms more than others.

    The second implication of economic theory is that business 
activities that are highly sensitive to taxation should be taxed at 
lower rates than business activities that are less sensitive to 
taxation. This reflects what is known as the Ramsey Rule, a proposition 
originally derived in the context of commodity taxes but that applies 
quite generally to settings in which taxes distort the economy. 
Business taxation is certainly one of those settings, because the 
imposition of business taxes necessarily reduces the level of business 
activity. The challenge for smart business tax design is to find a 
program that does the least possible damage to the economy while 
collecting the revenue that the government needs. In this context it 
makes little sense to attempt to impose heavy tax burdens on highly 
responsive business activities, since such taxes greatly depress 
investment and employment in the relevant business sectors, and if the 
heavy taxes were instead directed at less responsive activities, the 
results would not be great, but at least they would not impose as many 
economic costs.

    International shipping offers an example of a highly responsive 
business sector. Shipping firms can be headquartered anywhere, and the 
ships of course go everywhere, so any attempt to impose heavy home-
country taxes on international shipping income is doomed simply to 
encourage shipping assets and shipping companies to sail out of the 
U.S. tax jurisdiction. And that is exactly what has happened to the 
U.S. international shipping fleet over the last 40 years.

    To some degree the same process is responsible for the waves of 
corporate inversions and foreign takeovers of U.S. companies, and for 
the far greater number of other international business transactions 
that receive less attention but are nonetheless similar to inversions 
and takeovers. The worldwide tax system operated by the United States 
puts U.S. companies at a competitive disadvantage relative to firms 
from other countries, and as a result, foreign firms expand in third 
country markets at the expense of U.S. firms. This process goes on 
every day, and while not as visibly dramatic as a corporate inversion 
or a foreign takeover of a U.S. company, it has much of the same 
impact, in that a business asset that otherwise would have been owned 
and controlled by a U.S. company is instead under the control of a 
foreign company. The evidence is that foreign direct investment is 
extremely responsive to taxation, and also that when U.S. companies 
expand their foreign operations they correspondingly expand their 
domestic operations, so the disadvantage created by the U.S. tax system 
has the effect of significantly shrinking the size of the U.S. business 
sector relative to what it would be otherwise. This in turn reduces the 
demand for U.S. labor, and thereby depresses wages and employment 
opportunities in the United States.

    The evidence that international business activities are highly 
responsive to taxation, together with the reality that every other 
major capital exporting country operates a territorial tax system, 
implies that the U.S. attempt to subject active foreign business income 
to significant U.S. taxation is inconsistent with optimal tax 
principles. The same principles also carry implications for the 
taxation of domestic business operations. There is evidence that 
investment in domestic manufacturing industries is particularly 
responsive to taxation, which in turn implies that an efficient 
domestic tax system imposes a lower tax on returns to manufacturing 
investment than on returns to investment in other industries. This 
domestic production activities deduction is largely directed at 
domestic manufacturing, and to the extent that the activities that it 
covers in fact are highly responsive to taxation, this deduction is a 
sensible feature of an optimal tax system.

    Similar considerations may apply to patent boxes of the type 
recently introduced by European countries. These patent boxes offer 
favorable tax rates on certain forms of intellectual property income. A 
common justification for adopting patent boxes is that the favorable 
tax treatment of patent box income gives appropriate incentives in 
settings in which ownership of intellectual property has spillover 
economic benefits that cannot be addressed in some other way. A second 
and likewise important consideration is that the activities of firms 
that are apt to hold certain types of qualifying intellectual property 
may be particularly responsive to taxation, either because these firms 
and their assets are internationally mobile, or because the nature of 
competition and demand in their industries makes their operations 
likely to diminish significantly if confronted with competitors located 
in more favorable tax environments.

    The general point is that economic theory does not imply that it is 
efficient to have a level playing field in which all business 
activities and income are taxed to the same degree. Efficient tax 
burdens vary with spillovers associated with economic activity and with 
degrees of responsiveness to taxation. If businesses in different 
industries and lines of activity are equally responsive to taxation and 
produce the same economic spillovers, then they should be taxed 
equally; otherwise they should not.

    The propositions of optimal tax theory apply to a world of complete 
information in which behavioral elasticities and economic spillovers 
are readily identified and measured, and tax laws can be crafted with 
precision to distinguish taxpayers in different situations. The real 
world differs from this stark description. As a result, it may be 
difficult or impractical to introduce some of the distinctions between 
taxpayers that are implied by theory, and efforts to do so could be 
hampered by misinformation or create unanticipated opportunities for 
inefficient tax avoidance. It is natural in such a setting to conclude 
that an appropriate default position is that the tax playing field 
should be level unless there is a very strong reason to think 
otherwise.

    This position is perfectly reasonable, but it is inconsistent with 
our understanding of the effects of taxation on economic efficiency, 
and risks consigning the economy to a lower level of performance than 
is necessary given the tax burdens required to finance government 
expenditures. A more appropriate default, one that promotes economic 
efficiency, is that tax burdens should reflect the responsiveness of 
different activities to taxation, with more responsive activities 
subject to lower tax burdens. To the extent that it is difficult or 
costly to maintain and enforce tax distinctions among business 
activities with differing response elasticities, of course these 
practical considerations influence the desirability of attempting to 
draw such distinctions. But given the imperative of offering the best 
possible economic opportunities to American workers, entrepreneurs, 
customers, and others, and the significant burdens that taxes already 
impose on the U.S. business sector, it is important to tailor the U.S. 
tax system in a way that causes the least possible economic disruption.

    Several existing aspects of the U.S. tax system appear to be 
designed in this spirit, including provisions such as the domestic 
production activities deduction and the research and experimentation 
credit. It follows that an across the board reduction in business tax 
expenditures used to finance lower business tax rates is unlikely to 
improve the efficiency of the U.S. system. More targeted reforms, 
including the adoption of a territorial tax regime, are far more 
promising.

    Another promising direction of reform lies in efforts more 
effectively to integrate corporate and personal taxes. As many have 
noted, equity-financed corporate investment in the United States is 
taxed very heavily, and in particular is taxed more heavily than debt-
financed investment. To the extent that equity and debt finance are 
imperfect substitutes from the standpoint of borrowers the optimal 
taxation of the two is not identical, and there are reasons why debt 
financed investments may be somewhat more tax responsive than equity 
financed investments; but the magnitude of the difference in current 
tax treatment of debt and equity surely exceeds that implied by optimal 
tax theory. As a result, reforms that move in the direction of 
integrating corporate and individual taxes on corporate income have 
considerable appeal from an efficiency standpoint. They also have 
appeal from the standpoint of taxpayer equity, imposing less of a 
double burden on corporate income and better distinguishing 
shareholder/taxpayers with greater ability to pay from those with less 
ability to pay.

    It is important to address these and other significant issues in 
the design of U.S. business taxes, in part because the tax burdens on 
U.S. businesses are so substantial and their consequences so dramatic 
for the U.S. economy. American workers bear the brunt of these taxes in 
the form of diminished employment opportunities. Business tax 
reductions would stimulate business formation, expansion, and 
investment; improve productivity; and thereby create greater 
opportunities for American workers. At any rate of tax and level of 
business tax burden, however, it is valuable and necessary to design 
the tax system to cause the fewest economic disruptions, and theory 
indicates that simply broadening the base and lowering rates is 
unlikely to move the system in that direction. The existing U.S. tax 
system has many features that reflect the nuances of economic 
realities, and our goal should be to modernize and improve this system 
with attention to the details of taxpayer behavior and a sense of the 
appropriate level of business taxation in a modern economy.

                                 ______
                                 
 Prepared Statement of Eric J. Toder, Ph.D.,* Institute Fellow, Urban 
     Institute, and Co-director, Urban-Brookings Tax Policy Center
---------------------------------------------------------------------------
    * The views expressed are my own and should not be attributed to 
the Tax Policy Center or the Urban Institute, its board, or its 
funders. I thank Len Burman and Howard Gleckman for helpful comments 
and Lydia Austin for help in preparing this testimony.
---------------------------------------------------------------------------
                   approaches to business tax reform
    Chairman Hatch, Ranking Member Wyden, and members of the committee, 
thank you for inviting me to appear today to discuss corporate tax 
reform.

    No one is satisfied with the current rules for taxing income of 
corporations. The U.S. corporate tax system discourages investment in 
the United States, encourages U.S. multinational corporations to report 
income in low-tax foreign jurisdictions, places some U.S.-based 
multinationals at a competitive disadvantage compared with foreign-
based firms, and has encouraged U.S. companies to accumulate over $2 
trillion in assets overseas.

    At the same time, the U.S. corporate tax raises less revenue as a 
share of gross domestic product (GDP) than the corporate taxes of most 
of our major trading partners. Corporate receipts have been fairly 
steady at about 2 percent of GDP for most of the past 3 decades. 
However the Congressional Budget Office (2016) is now projecting that 
corporate receipts will decline to 1.6 percent of GDP in 2026, as U.S. 
multinationals continue to shift reported profits to low-tax foreign 
countries and more U.S. corporations ``re-domicile'' themselves as 
foreign-based corporations.

    The current corporate tax system is outdated because it has failed 
to adjust for four major developments: the increased globalization of 
economic activity, the reduction in corporate tax rates in other major 
countries and their shifts to territorial tax systems, the increased 
share of business wealth in the form of intangible property, and the 
increased share of economic activity in the United States by businesses 
that are not subject to corporate income tax.

    The current administration and leading Republicans agree that the 
top U.S. corporate tax rate needs to be lowered and that the United 
States should no longer tax foreign profits when U.S. corporations 
repatriate them by paying dividends to the U.S. parent company. There 
is less agreement, however, on how to make up the revenues from a 
reduced corporate rate. There is agreement that a tax on current 
overseas profits and new minimum taxes going forward on low-taxed 
foreign income should accompany elimination of the repatriation tax. 
But there are wide differences on the exact form these taxes should 
take and the rates that should be imposed.

    In my statement, I review the main problems with the corporate 
income tax and discuss why I believe that 1986-style tax reform that 
pays for reducing the corporate rate by broadening the business tax 
base is an insufficient solution. I make the case that revenue 
neutrality should not be sought within the business tax base alone. I 
discuss two approaches for paying for a reduced corporate income tax 
rate--increased taxation of shareholder income and introduction of new 
revenue sources.
                 problems with the corporate income tax
    The corporate income tax has long-standing problems that would 
exist even apart from the four major developments I just listed. It 
favors debt over equity finance for corporations because interest 
payments are deductible, though dividends are not deductible. It 
encourages corporations to retain profits instead of distributing them 
because dividends payments are taxable immediately and taxes on capital 
gains can be deferred until realization. It favors businesses organized 
as pass-through enterprises, such as limited liability partnerships and 
subchapter S corporations, over corporations organized under subchapter 
C of the InternalRevenue Code (C corporations). C corporations face two 
levels of tax, one at the corporate level and then a second tax on 
dividends and realized capital gains attributable to retained earnings. 
Between 1980 and 2012, the share of net business receipts from 
companies organized as pass-through enterprises, including sole 
proprietorships, increased from 14 to 39 percent and their share of 
taxable profits increased from 25 to 64 percent.\1\
---------------------------------------------------------------------------
    \1\ Excluding regulated investment companies and real estate 
investment trusts, the shares of net business receipts have increased 
from 15 to 32 percent and the shares of taxable profits increased from 
21 to 53 percent.

    These distortions cause corporations to incur more debt and pay 
fewer dividends than they would in the absence of a corporate tax, 
encouraging excessive leverage and weakening shareholder control over 
corporate behavior. They encourage firms to organize themselves as 
pass-through enterprises instead of C corporations and encourage the 
expansion of industries in which the pass-through form of business is 
more prevalent at the expense of those mostly characterized by publicly 
---------------------------------------------------------------------------
traded companies that cannot use the pass-through forms.

    Even bigger distortions result from the attempt of single countries 
to tax the income of corporations that are global in scope. Tax experts 
have long debated the choice between a worldwide system that taxes 
U.S.-resident corporations on their worldwide income with a credit for 
foreign income taxes, and a territorial system that taxes U.S. 
corporations only on their U.S.-source income. Worldwide taxation is in 
theory neutral between domestic and foreign investment of U.S.-resident 
companies, but would place these companies at a disadvantage compared 
with foreign-resident companies that do not pay home country tax on 
their foreign-source income. Territorial taxation is, in theory, even-
handed in its treatment of U.S. and foreign-based multinationals, but 
it would encourage U.S.-based multinationals to shift real investments 
and reported income to low-tax foreign countries. When countries impose 
different tax rates on corporate income, the United States acting alone 
cannot create both a level playing field between the domestic and 
foreign investments of its resident companies and a level playing field 
between U.S. and foreign-based companies because the United States 
cannot tax profits of foreign-based multinationals that are earned 
outside of the United States.

    The United States addresses this tradeoff between the conflicting 
objectives of international policy with a hybrid tax system that is 
neither purely worldwide nor purely territorial. By allowing U.S.-based 
multinationals to defer tax on most profits until they are repatriated, 
the United States taxes foreign-source income at a much lower effective 
rate than it taxes domestic source income of U.S. multinationals. 
Deferral creates an additional problem, however, because it encourages 
U.S. multinationals to retain foreign profits overseas instead of 
repatriating them to the U.S. parent company so they can be paid as 
dividends to shareholders or used for domestic investment. The result 
is that U.S. multinationals in recent years have accrued over $2 
trillion in overseas assets.\2\
---------------------------------------------------------------------------
    \2\ Richard Rubin, ``U.S. Companies Are Stashing $2.1 Trillion 
Overseas to Avoid Taxes,'' Bloomberg March 4, 2015, http://
www.bloomberg.com/news/articles/2015-03-04/u-s-companies-are-stashing-
2-1-trillion-overseas-to-avoid-taxes.

    No country uses a pure model of either worldwide or territorial 
taxation. Even countries with territorial systems usually impose taxes 
on some forms of foreign-source income to limit income-shifting 
techniques that would erode their domestic tax bases. These anti-
avoidance rules also may affect the taxation of inbound investment from 
foreign companies, which may enjoy an advantage over domestic firms to 
the extent that anti-avoidance rules affect home-based companies only 
and do not limit the shifting of reported profits of inbound 
---------------------------------------------------------------------------
investments by foreign-based companies.

    These economic distortions pale before the real-world distortions 
because of the inability to define in an economically meaningful way 
either the source of corporate income or the residence of multinational 
corporations. The source of profits may have been meaningful when most 
business wealth was in the form of fixed assets, such as plant and 
equipment. Today, however, a substantial share of business wealth is in 
the form of intangible assets that are not location-specific, such as 
patents, goodwill, business reputation, and corporate governance. 
Multinationals often shift ownership of intangibles to affiliates in 
low-tax jurisdictions. While these firms may have little production, 
employment, or sales in these countries, this shift still allows them 
to reduce tax on a substantial share of their global profits. In 
theory, the United States could tax the value of intangible assets when 
their ownership is initially transferred to a foreign affiliate, but 
often it is very difficult to value the intangible at the time of 
transfer before its contribution to profitability is established.

    According to data compiled by the Bureau of Economic Analysis, 
aggregate investment in intellectual capital as a share of total 
investment in structures, equipment, and intellectual property has 
increased from around slightly over 10 percent in the 1970s to around 
30 percent in the first decade of the 21st century (Figure 1). These 
figures probably understate the growth in intellectual property as a 
share of business wealth because they count only outlays for different 
types of investments and not the capital gains that accrue when highly 
successful new technologies and products are introduced.
FIGURE 1. Aggregate Investment in Intellectual Capital as a Share of 
Investment in Structures, Equipment, and Intellectual Property 
Products, 1970-2013

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



Source: U.S. Department of Commerce, Bureau of Economic Analysis, 
author's calculations.

FIGURE 2. Foreign Profits and Employment by U.S. Multinationals, 2012

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]






Source: U.S. Department of Commerce, Bureau of Economic Analysis, 2014.


                 TABLE 1. Profits and Employment of U.S. Multinationals as Share of Total, 2012
----------------------------------------------------------------------------------------------------------------
                                                             Net Income        Profits as a     Employment as a
                                                            (billions of      percentage of      percentage of
                                                              dollars)            total              total
----------------------------------------------------------------------------------------------------------------
Netherlands                                                         180.3              15.4%               1.7%
Ireland                                                             119.8              10.2%               0.8%
Bermuda                                                              81.8               7.0%                N/A
United Kingdom                                                       74.0               6.3%              10.3%
Switzerland                                                          56.2               4.8%               0.8%
Singapore                                                            42.6               3.6%               1.4%
UK Islands, Caribbean                                                39.7               3.4%               0.0%
China                                                                24.9               2.1%              11.2%
Australia                                                            20.7               1.8%               2.5%
Norway                                                               20.6               1.8%               0.3%
----------------------------------------------------------------------------------------------------------------
Source: U.S. Department of Commerce, Bureau of Economic Analysis, 2014.
Note: N/A = not available.


    U.S. multinationals have been successful in shifting the reporting 
of profits to low-tax jurisdictions, which are often places where 
little economic activity occurs. For example, in 2012, Bermuda, 
Ireland, and the Netherlands accounted for about 33 percent of the net 
foreign-source income of U.S. multinational corporations, but only 2.5 
percent of their foreign employment. (Figure 2 and Table 1).

    The residence of multinationals is also highly mobile. It too can 
bear little connection to real measures of corporate economic activity, 
such as assets, employment, sales, or the residence of shareholders. 
Multinationals have an incentive to establish residence based on tax 
considerations because this residence choice entails little real 
economic cost--and has little or no impact on where their production or 
sales occur or even where their top executives reside. However, this 
choice can substantially affect worldwide tax obligations.

    Inversion transactions in which U.S. companies merge with smaller 
foreign companies and then become the subsidiary of a foreign parent 
have raised awareness of how changing the place of incorporation can 
reduce the tax liabilities of U.S. companies. Though inversions, and 
the efforts by Congress and the administration to limit them, have 
received much attention, the share of economic activity accounted for 
by U.S.-resident multinationals can also decline through other 
channels. These include mergers of equal-sized firms that then 
establish foreign residence, foreign buyouts of smaller U.S.-resident 
companies or divisions of larger U.S.-resident companies, changes in 
the residence of startups, and shifts in the shares of worldwide 
activity between existing U.S.-resident and foreign-resident 
multinationals. Over the past decade, the share of sales and profits of 
the world's top multinationals that come from U.S.-based companies has 
been declining, although this may reflect mainly the growth in 
multinationals in emerging economies such as China more than any major 
tax-driven shift in the multinationals' choice of corporate residence.

    Between 2004 and 2014, the United States share of the top 2,000 
global companies declined from 37 to 28 percent (Figure 3). Among the 
top 2,000 firms, U.S.-
resident companies accounted for 39 percent of sales, 63 percent of 
profits, 34 percent of assets, and 49 percent of market value in 2004. 
By 2014, these shares had declined to 30 percent of sales, 39 percent 
of profits, 23 percent of assets, and 41 percent of market value. By 
any measure, the relative importance of U.S.-resident multinationals 
has been shrinking, although U.S.-resident companies are still dominant 
players in global markets.
FIGURE 3. Shares of U.S.-Resident Companies in the Global 2000



[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]




Source: Forbes Global 2000 (2004 and 2014) and author's calculations.

            why the u.s. corporate tax rate needs to be cut
    Higher corporate rates relative to our major trading partners 
encourage both U.S. and foreign-based multinationals to invest overseas 
instead of in the United States and to report profits in other 
jurisdictions (Clausing 2011, 1,580; Djankov et al. 2010; Gravelle 
2014; Grubert 2012;). Beyond this, companies can shift reported income 
without moving real economic activity through aggressive transfer 
pricing, debt-equity swaps, allocation of fixed costs to high-tax 
countries, and other techniques. Rules to enforce the sourcing of 
income are imperfect and are imperfectly enforced. It is especially 
difficult to determine transfer prices of unique intangibles in the 
absence of comparable arms-length transactions between independent 
firms.

    A firm's decision on where to locate investment is influenced by 
marginal effective tax rates on new investments, which are determined 
both by statutory tax rates and by other provisions affecting net 
investment returns, including capital recovery provisions and tax 
credits. The tax penalty that high U.S. corporate rates impose on 
domestic investment is partially offset by more favorable capital 
recovery provisions (Gravelle 2014 and Hassett and Mathur 2011). 
Corporations may not perceive much benefit to the tax deferral that 
accelerated depreciation provides, however, if they have to report a 
deferred tax liability to their shareholders when they claim 
accelerated depreciation deductions. A firm would, in this view, 
respond more to a lower statutory rate than to an equivalent cut in its 
effective tax rate cut produced by more generous capital recovery 
allowances.
             why 1986-style tax reform does not do the job
    Many recent reform plans would reduce corporate tax rates and 
eliminate business tax preferences. Some plans would also combine 
individual tax rate reduction with reduction of individual tax 
preferences. These plans include notably the tax reform proposal 
developed by former House Ways and Means Chairman Dave Camp in 2014 and 
the less-specific proposal by the President's 2010 National Commission 
on Fiscal Responsibility and Reform headed by former Senator Alan 
Simpson and former White House Chief of Staff Erskine Bowles. Both 
would have lowered the corporate tax rate to 25 percent, eliminated 
most business tax preferences, and also reduced individual tax rates 
and individual preferences. Some of President Obama's past budgets 
proposed to reduce the corporate tax rate to 28 percent and to 
eliminate some business preferences, but did not specify enough base-
broadening measures to pay for the rate reduction. These reforms are 
all modeled on the Tax Reform Act of 1986, which reduced the top 
corporate rate from 46 to 34 percent and eliminated the investment tax 
credit, removed or scaled back many other business preferences, and, on 
balance, increased corporate tax revenue within the budget window to 
pay for reduced individual income taxes.

    Reforms that reduce the corporate rate and broaden the business tax 
base can increase economic efficiency if they reduce targeted subsidies 
that encourage overexpansion of subsidized sectors. The goal is to 
encourage businesses to choose investments based on their real economic 
returns instead of tax considerations. However, some investments, such 
as research and development, may have positive spillover effects that 
are not fully captured by those making the investments and therefore 
may merit some public subsidy.

    There are other limitations to the traditional approach of paying 
for a lower corporate rate through additional base broadening. First, 
there are not enough business preferences to pay for the long run 
revenue loss of reducing the corporate rate to 25 or 28 percent, as 
leading political figures propose. Reform plans that cut rates to those 
levels have met 10-year revenue neutrality goals by counting revenues 
from one-time taxes on existing overseas assets and through proposals--
such as the elimination of accelerated depreciation--that change the 
timing of business deductions.

    Further, the biggest source of higher revenues, the elimination of 
accelerated depreciation for machinery and equipment, creates many 
problems.\3\ When combined with lower rates, accelerated depreciation 
would provide a windfall gain to income from existing investments, and 
raise the cost of capital for new investments. In addition, eliminating 
accelerated depreciation for machinery and equipment would not 
necessarily create a more level playing field within the domestic 
sector as a whole, given that most intangible investments--which 
comprise a growing share of business investments--already benefit from 
immediate expensing and would continue to do so under most proposals 
(Foertsch and Mackie 2015).
---------------------------------------------------------------------------
    \3\ The largest business tax expenditure, as reported by the Joint 
Tax Committee (2015), is deferral of tax on foreign-source profits. As 
discussed in this testimony, however, elimination of deferral would 
hurt the competitiveness of U.S. multinationals and encourage a shift 
to foreign residence and is therefore not a likely candidate for 
inclusion in tax reform proposals.

    The bottom line is that revenue-neutral business tax reform is a 
much less attractive proposition than it was in 1986. There are not 
enough business tax preferences to pay for the amount of corporate rate 
reduction that policymakers are discussing. To the extent one can come 
close to paying for lower rates, it is through removing preferences 
that benefit domestic investment. In addition, base-broadening 
provisions that raise revenue in the 10-year window by accelerating tax 
payments pay for a much smaller rate cut in the long run than they do 
in the first 10 years.
           alternative ways of financing corporate tax reform
    Because business-only tax reform has limited benefits, I encourage 
the Committee to pursue broader and bolder approaches. There are a 
number of alternatives worth exploring. The alternatives fall into two 
general categories: (1) shifting the collection of taxes on corporate 
income from the corporate to the shareholder level; and (2) considering 
new revenue sources that would shift the tax burden from income to 
consumption or address environmental concerns.
Shifting the Tax Burden from the Corporate to the Shareholder Level
    Corporate profits belong to the owners of corporate equity--the 
shareholders. Under current law, the taxation of corporate profits is 
bifurcated. The corporation is liable for a tax on its net profits, 
after deducting wages paid to employees, interest paid to shareholders, 
purchases of materials and services from other firms, and depreciation 
of capital equipment. Shareholders pay a second level of tax, at lower 
rates than applied to other income, on dividends paid out of those 
profits and on capital gains from the sale of corporate shares.

    The two levels of tax have different economic effects in a global 
economy. Corporations can avoid or defer the tax on their profits from 
investments in the United States by investing overseas or by shifting 
the reporting of income to countries with lower tax rates. To the 
extent they invest more overseas in response to the U.S. tax, they 
reduce the capital to labor ratio in the United States, lowering real 
wages and shifting a portion of the tax burden to workers (Randolph, 
2006). As I discussed, this shifting of investment and income could be 
countered by taxing worldwide income of U.S. corporations on a current 
basis, but full worldwide taxation would place U.S.-resident firms at a 
bigger competitive disadvantage than they are at today. And the 
corporate income tax would continue to discourage foreign-resident 
corporations from investing in the United States.

    In contrast, shareholder level taxes on dividends and capital gains 
apply to the worldwide income of U.S. investors in corporate shares. 
They do not distinguish between investments in U.S.-resident and 
foreign-resident corporations and do not make a distinction between 
whether the dividends and capital gains come from profits generated by 
economic output in the United States or output in other countries. 
Therefore, the shareholder level taxes do not discourage investment in 
the United States and do not place U.S.-resident corporations at a 
competitive disadvantage.

    For these reasons, in an economy open to trade and international 
capital movements, it is better to base tax liability on the residence 
of individual taxpayers than on either the tax residence of 
multinational corporations or the source of their profits. As discussed 
above, both the source of corporate income and corporate residence can 
easily be shifted in response to international tax differentials. In 
contrast, to avoid taxes based on U.S. residency, shareholders would 
have to relocate overseas. And because the United States taxes 
worldwide income of individuals on a citizenship instead of a residency 
basis, people would have to take the additional step of renouncing 
their U.S. citizenship--a step few are willing to take.

    There are several options for shifting the taxation of corporate 
profits from the corporate to the shareholder level. All have their 
advantages and disadvantages.
            1. Lowering the Corporate Tax Rate and Raising the Rate on 
                    Capital Gains and Dividends
    One simple option would be to lower the corporate tax rate and 
replace the revenue by increasing tax rates on capital gains and 
dividends. Altshuler, Harris, and Toder (2010) have analyzed a reform 
of this type, noting that other countries have moved in a similar 
direction in recent years, reducing their corporate rates and 
increasing tax rates on dividends. The United States, however, reduced 
the top rates on capital gains and dividends to 15 percent in 2003, 
while continuing to leave the corporate rate unchanged.

    The main drawback to this approach is that higher tax rates on 
capital gains would reduce capital gains realizations and could lower 
revenues from capital gains taxes if the rates are increased too much 
(see, for example Dowd et al. 2012). Since 2012, and including the 
high-income surtax, the top rate on capital gains realizations has 
increased from 15.0 to 23.8 percent. There is now much less room for 
offsetting the loss from corporate rate cuts with higher revenues from 
realized gains and dividends than there was several years ago.\4\
---------------------------------------------------------------------------
    \4\ The proposal in the President's fiscal year 2017 budget (U.S. 
Treasury Department, 2016) to tax unrealized capital gains at death 
would reduce the response of realizations to higher capital gains taxes 
because taxpayers would only be able to defer tax by holding onto 
assets with gains, not escape tax permanently.
---------------------------------------------------------------------------
            2. Lowering the Corporate Tax Rate and Taxing Accrued 
                    Income of Shareholders
    An alternative approach that is outlined in a paper I co-authored 
with Alan Viard of the American Enterprise Institute (2014) would 
replace the corporate income tax with an annual mark-to-market tax on 
accrued income from corporate share ownership. Individuals who hold 
shares of publicly traded corporations would be taxed on their sum of 
dividends and accrued capital gains during the year at the rates 
applied to ordinary taxable income. Because individual taxpayers would 
no longer be able to game the timing of losses, we would allow them 
each year to deduct any net capital losses from other income. Investors 
in nonpublicly traded firms would be taxable under rules currently 
applied to income from S corporations and partnerships and would 
continue to pay tax on capital gains as realized, with current law 
preferred rates and loss limitations.

    The main benefit of this proposal is that it would tax income U.S. 
residents receive from share ownership only once at the marginal rates 
that apply to their other sources of income. The tax code would no 
longer encourage corporate debt over equity and retained earnings over 
distributions, and would be much more even-handed in its treatment of C 
corporations and businesses subject to flow-through taxation. It would 
no longer favor foreign over U.S.-resident corporations and would 
encourage both U.S. and foreign-resident companies to invest more in 
the United States.

    Our original proposal had some real and perceived disadvantages, 
including a net loss in federal receipts, problems associated with 
increased volatility of the tax base, loss of revenue indirectly 
collected through the corporate income tax from non-
profits and foreign investors, and issues in defining the boundary and 
rules for transitions between firms whose assets are subject to 
individual accrual taxation and firms taxed under current rules for S 
corporations and partnerships. We are developing a modified version of 
the original proposal that would retain a 15 percent corporate income 
tax, impose a withholding tax on interest paid to non-profits and 
retirement plans to offset the benefit they receive from the lower 
corporate rate, introduce a credit to offset the corporate income tax 
burden of taxable shareholders, include rules for smoothing the 
fluctuations in annual taxable income that result from annual swings in 
stock prices, impose a low rate tax on accrued gains of firms that go 
public, and address a number of other issues with the proposal. The 
revised proposal will be roughly revenue-neutral and make the tax law 
slightly more progressive. We expect to release our revised paper soon.

    An alternative approach developed by Grubert and Altshuler (2015) 
would also reduce the corporate tax rate to 15 percent and replace the 
lost revenue by taxing gains and dividends of individuals at ordinary 
income rates. Grubert and Altshuler would continue to impose capital 
gains taxes upon realizations but with an interest charge designed to 
capture the benefit of deferring realization of gains, backed up by a 
tax on the transfer of unrealized gains at death. The intent of the 
deferral charge is to make individuals indifferent between realizing 
gains immediately or in the future and therefore to eliminate the 
increased lock-in to existing assets that higher capital gains rates 
would otherwise produce.

    The advantage of the deferral charge approach for taxing gains is 
that it could be applied equally to both privately held and publicly 
traded firms because it does not require valuation of assets that have 
not been traded. In contrast, we believe that applying the mark-to-
market approach to assets in closely held businesses would create 
insurmountable valuation problems (Toder and Viard 2014). This requires 
Toder and Viard to maintain separate taxing regimes for publicly traded 
firms subject to market to market and closely held firms for which 
gains are taxed on realization. However, differences in combined 
individual and shareholder tax rates between the two types of firms 
would be much less than the differences in tax rates between C 
corporations and flow-through businesses under current law.

    The disadvantage of the deferral charge approach is that the tax 
rate on realized gains would be very sensitive to assumptions about the 
appropriate interest rate to charge, the assumed growth in the asset's 
value over time, and the assumed marginal tax rates in earlier years 
when the accrued gains should have been taxed and the accrued losses 
are deducted. There could be also be substantial sticker shock, as the 
deferral charge could make the tax rate applied to the gain when 
realized significantly higher than the taxpayer's current marginal tax 
rate.

    Both of these methods of shifting tax obligations from corporations 
to shareholders also raise issues of political acceptability. 
Individuals ultimately bear the burden of corporate income taxes 
through lower investment returns, lower wages, or higher prices. It 
will, however, be challenging to defend a proposal that raises taxes on 
individual taxpayers to pay for a cut in the corporate income tax. The 
simple answer is that shifting tax liabilities from corporations to 
their shareholders just amounts to a different way of collecting taxes 
on the profits shareholders' investments earn, but persuading the 
public of this may be a hard sell.

    The methods of collecting tax from individuals will also raise 
objections. With the mark-to-market approach, it will be challenging to 
explain to people that their income is going up when the prices of the 
shares they own increase, even though they have not actually converted 
the gain into cash that can be used for personal consumption or other 
investments. Some shareholders may have to liquidate assets to pay the 
tax. With the deferral-charge approach, it will be challenging to 
explain why taxpayers will often be required to include more than 100 
percent of their current year's realized gains in taxable income.
            3. Integrating the Corporate and Individual Income Taxes
    An alternative approach would integrate the corporate and personal 
income taxes, so that only one level of tax is imposed on corporate 
dividends. Various methods of corporate integration have been 
suggested, some of which would reduce corporate liability and others 
that would reduce individual tax liability by allowing dividend 
recipients to claim credits for corporate taxes paid. Proposals for 
corporate integration have been introduced by the Ronald Reagan and 
George W. Bush administrations (Council of Economic Advisors 2003; U.S. 
Department of the Treasury 1984) and were included in Treasury reports 
published during the Gerald Ford and George H.W. Bush administrations 
(Bradford and U.S. Treasury Tax Policy Staff 1984; U.S. Department of 
the Treasury 1992).

    One option for corporate integration could be modeled on the system 
Australia currently uses (Graetz and Warren 2014). Australia allows 
corporate shareholders to claim credits for corporate level taxes paid 
to Australia when they receive ``franked'' dividends from Australian 
resident companies. When they pay corporate taxes, Australian companies 
accumulate these franking credits that they can attach to dividends; if 
they pay no corporate tax to Australia, the dividends do not come with 
franking credits attached. Anti-streaming rules attempt to prevent 
companies from allocating franked dividends to Australian taxpayers who 
can use the credits and unfranked dividends to foreign shareholders who 
cannot.

    Australian shareholders in Australian companies must gross up their 
dividends for the franked credits they receive and report these gross 
dividends as taxable income. They then can claim the credits to offset 
the individual income taxes they would otherwise pay. The result is 
that they are taxed once on the income corporations use to pay them 
dividends at the marginal rate that applies to them under the 
Australian individual income tax.

    An advantage of the Australian system is that it reduces the 
incentive for Australian companies to shift reported profits to low-tax 
jurisdictions. To the extent they can reduce their corporate tax 
liability, the tax saving is offset by higher taxes on shareholders who 
receive dividends that do not carry with them franking credits. The 
Australian system also more generally reduces benefits that firms 
receive from any corporate tax preferences because the value of the 
preference can be washed out when they pay dividends.

    Although this system reduces the incentive to use preferences, it 
does not entirely eliminate it if a corporation is retaining and 
reinvesting some of their profits. For example, suppose a company pays 
out 50 percent of its profits in dividends and is able to reduce its 
corporate tax liability 50 percent through income shifting and the use 
of domestic tax preferences. The amount of franked credits would then 
be sufficient for all the dividends it plans to pay, and it would 
benefit fully from the tax preferences it uses. Additional use of 
preferences, however, would come at an offsetting cost in terms of lost 
credits to shareholders.

    An Australian-type integration system would not necessarily work as 
well in the United States. In Australia, a much larger share of 
dividends is eligible for credits than would be the case in the United 
States because Australia taxes the income people accrue within 
qualified retirement plans (so-called ``superannuation'' plans). In 
contrast, in the United States, taxable shareholders hold only about 24 
percent of equities issued by U.S. corporations (Rosenthal and Austin, 
forthcoming). This means that U.S. companies would use up franking 
credits much more quickly than Australian companies and therefore would 
retain incentives to avoid U.S. corporate income taxes. In addition, 
the proposal would create incentives for portfolio specialization among 
investors, with non-taxable shareholders (tax-exempt organizations and 
qualified retirement plans) holding shares of U.S. companies with low 
effective tax rates (because they cannot use the credits) and taxable 
shareholders investing in companies with high effective tax rates (to 
maximize use of the credit).

    My understanding is that Senator Hatch is developing a plan for 
corporate tax integration. I welcome this direction in tax policy and 
look forward to seeing details of the forthcoming proposal.

    In conclusion, there are many advantages to proposals that shift 
some of the tax burden from corporations to the individual shareholder 
level. All the proposals under study are complex and involve difficult 
design decisions and trade-offs. No approach will be perfect, but this 
general direction promises a real reduction in the economic costs that 
the corporate income tax imposes on the U.S. economy without 
sacrificing revenues or providing large reductions in tax burdens for 
the high income individuals who own most corporate shares.
New Revenue Sources
    Two new revenue sources that reformers might consider as 
replacements for reduced corporate income tax receipts are a new 
Federal value-added tax (VAT) and a tax on carbon emissions.
            1. Replacing Corporate Revenues with a Value Added Tax
    VATs are in place in over 150 countries throughout the world and 
have some important advantages as components of an overall revenue 
system. First, because they allow firms to immediately deduct the costs 
of capital purchases, they do not tax the normal return to investment--
that is, the portion of the investment return that compensates savers 
for the time value of money. In that sense, a VAT is neutral between a 
household's choice of consuming today or consuming tomorrow.

    Because of this feature, a VAT, if included as part of a revenue-
neutral reform that lowered income tax rates, would improve incentives 
to save and invest. This would contribute in the long run to larger 
economic output and improved living standards, as the nation 
accumulates additional capital. And it would help to reverse a long-
term decline in the national saving rate that reflects both rising 
deficits and a reduced private saving rate.

    Second, because VATs in place around the world exempt exports and 
tax imports (are destination-based), they do not interfere with 
production location decisions. Under a destination-based VAT, the tax 
rates imposed on goods and services consumed in the United States would 
be independent of where the goods are produced. A VAT would also make 
no distinction between products of U.S.- and foreign-
resident companies. Therefore, if a VAT is used to replace part of the 
revenue from the corporate income tax, it will reduce the problems 
caused when multinational corporations change their corporate residence 
and the source of their income to reduce tax liability.

    The one major drawback of a VAT is that it could make the tax 
system less progressive because it is imposed at a flat rate instead of 
graduated rates and because normal returns to capital, which a VAT 
exempts, are a larger share of income for high-income than for low-
income households. A VAT that replaced only a portion of individual and 
corporate taxes need not make the tax system less progressive, however, 
if an income tax is retained for upper-income taxpayers and additional 
refundable credits are provided for lower-income households.

    In 2014, Senator Cardin introduced a bill that would impose a new 
consumption tax and maintain a progressive tax system.\5\ Goods and 
services would be taxed at 10 percent, and income tax exemptions would 
be expanded to $50,000 for single filers, $75,000 for head of household 
filers, and $100,000 for joint filers (indexed for inflation). Cardin 
would impose a top marginal individual income tax rate of 28 percent on 
taxable income over $500,000 for joint filers, and would retain 
deductions for charitable contributions, state and local tax payments, 
mortgage interest payments, and tax preferences for health and 
retirement benefits. The alternative minimum tax and lower rate on 
capital gains would be eliminated. Cardin would also cut the corporate 
tax rate to 17 percent and maintain business preferences.
---------------------------------------------------------------------------
    \5\ Progressive Consumption Tax Act of 2014, S. 3005, 113th 
Congress, https://www.congress.
gov/bill/113th-congress/senate-bill/3005.

    Cardin's plan follows the outline of a tax reform plan originally 
developed by Professor Michael Graetz (2002). Graetz would also remove 
most individual income taxpayers from the tax rolls, retain a corporate 
tax and an individual income tax for high-income taxpayers to maintain 
a progressive tax system, and provide additional credits for low-income 
---------------------------------------------------------------------------
households.

    Nunns and Rosenberg (2013) have recently updated earlier estimates 
(Nunns, Toder, and Rosenberg 2012) of the Graetz plan. They find the 
proposal would be revenue neutral and make the distribution of tax 
burdens by income group slightly more progressive than under current 
law at a VAT rate of 12.9 percent, a corporate rate of 15 percent (with 
business base broadening) and a three bracket individual rate structure 
on income in excess of $50,000 ($100,000 for joint returns) of 14 
percent, 27 percent, and 31 percent. Measures to offset the burden of 
the VAT for low-income households would include a refundable pre-child 
rebate of $1,500, phased out at incomes of $150,000 and over, and a per 
worker rebate of 15.3 percent, also phased out at high incomes.

    Introducing a VAT would be a major change in the U.S. tax system 
and would raise many concerns, including the additional costs of 
administering a VAT alongside the income tax and the need to coordinate 
a federal VAT with state retail sales taxes. As with the shift in 
taxation of corporate income from the corporate to the shareholder 
level, there are complex issues that need to be resolved. Nonetheless, 
such an approach offers a promising way to reduce the burden of the 
U.S. corporate income tax, without sacrificing revenue or making the 
tax laws less progressive.
            2. Replacing Corporate Revenues With a Carbon Tax
    Economists across the political spectrum generally support the use 
of pricing mechanisms as the best way to reduce the environmental 
damage from greenhouse gas emissions. Higher carbon prices would 
encourage energy conservation and substitution of less carbon-intensive 
or renewable energy sources in electric power generation, 
transportation, and other activities without dictating the specific 
reactions of firms or households. And a planned trajectory of higher 
carbon prices would encourage the development of new and cleaner energy 
technologies.

    Phasing in a carbon tax is one way to raise carbon prices and over 
time address the worldwide problem of climate change. But a carbon tax 
would hurt affected industries, raise the cost of power generation and 
other business inputs, and could reduce economic growth. Reduction in 
other taxes, especially those with high economic costs such as the 
corporate income tax, could offset any short- or medium-term economic 
harm from a carbon tax.\6\
---------------------------------------------------------------------------
    \6\ In the long run, a carbon tax could make economic growth higher 
than it might otherwise be by lowering the economic damage that might 
result from global climate change.

    Marron and Toder (2013) estimated that a carbon tax that raised 
$1.2 trillion over 10 years could finance a reduction in the top 
corporate rate to 25 percent, without any other measures.\7\ Such a tax 
shift would be regressive, however, so an alternative would be to 
distribute some of the revenues in a more progressive fashion. Marron, 
Toder, and Austin (2015) estimate that if half the revenues were used 
to reduce the corporate tax rate and half to provide an equal 
refundable per capita credit to all households, tax burdens would 
decline in the bottom and top portions of the income distribution and 
increase slightly in the middle. Other ways of using carbon tax 
revenues also merit consideration and could promote other goals such as 
providing targeted relief for workers in affected industries or 
communities and promoting basic energy research (Marron and Morris 
2016). Nonetheless, combining a carbon tax with significant corporate 
tax relief is one way of creating a coalition among environmentalists 
and business groups and promoting simultaneously the apparently 
unrelated goals of reducing the harm from climate change and reforming 
the taxation of business income.
---------------------------------------------------------------------------
    \7\ The revenue estimate for a carbon tax was based on an estimate 
by the congressional budget of the revenue effect of introducing a tax 
at $20 per ton of carbon and increased the tax rate 5.6 percent per 
year.


 TABLE 3. Distributional Effects of Using Carbon Tax Revenue to Pay for
          Corporate Tax Cuts and a Refundable per Capita Credit
------------------------------------------------------------------------
                                                   Net tax change as a
                                                 share of pre-tax income
------------------------------------------------------------------------
Lowest quintile                                                    -0.25
Second quintile                                                    -0.16
Middle quintile                                                     0.07
Fourth quintile                                                     0.14
Top quintile                                                       -0.02
------------------------------------------------------------------------
Source: Marron (2015).

                              conclusions
    The current system for taxing corporate income is broken and in 
dire need of reform. However, the traditional approach of broadening 
the business tax base to pay for corporate rate reduction has limited 
potential. Eliminating business preferences will not raise enough money 
in the long run to pay for a very large cut in the corporate income tax 
rate. And even absent political considerations, there are important 
arguments for retaining some of the largest tax preferences--including 
deferral, incentives for research, and accelerated depreciation.

    The business tax environment has changed significantly since 1986 
and different reform approaches are needed today. I have argued that 
paying for the major reductions in the corporate tax rate that are 
needed requires that we look beyond the business tax base for 
additional revenues. A number of alternatives are promising, including 
substitution of higher shareholder-level for corporate-level taxes, 
integrating the corporate and individual income taxes, and substituting 
new consumption taxes for a portion of corporate and/or individual 
income taxes. All the options that are under discussion raise complex 
issues and none are perfect. I find it encouraging, however, that 
Congress is open to considering broader approaches to corporate tax 
reform.
_______________________________________________________________________

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                                 ______
                                 
                 Prepared Statement of Hon. Ron Wyden, 
                       a U.S. Senator From Oregon
    If you own a small business today, you're in danger of being 
ensnared in an outdated, overgrown tax code that Americans spend 6.1 
billion hours and more than $100 billion complying with each year. The 
code is punishing to those who don't have a team of accountants and the 
luxury of time to plan investments around taxes. The tax code tells 
small businesses that their dollar is worth less, compared to 
sophisticated firms that can afford to make the rules work for them. I 
see an enormous opportunity to modernize the code and strip out a lot 
of that unfairness by radically simplifying our system of depreciation. 
That's why today I released the Cost Recovery Reform and Simplification 
Act of 2016.

    For small, cash-strapped firms to grow and create jobs, they need 
to invest in basic things like new cash registers, office computers, or 
farm equipment when it makes business sense--not when it makes tax 
sense. Today, to figure out the tax deductions on these investments, 
you have to navigate more than 100 sets of tax rules. My proposal gets 
rid of the headache and lays out six categories for depreciation that 
are easy to work with.

    Today, you have to do the math as many as three separate times 
under different programs for each and every asset. My proposal says one 
round of math is enough, and businesses shouldn't have to do individual 
calculations for every car on the lot, every computer in the lab, or 
every machine in the shop.

    Today's rules were written in the 1980s. They're stuck in an era of 
fax machines and VCRs that predates the tech boom that transformed the 
way Americans live and work. My proposal says our business tax rules 
should reflect our 21st century economy, and they should help cutting-
edge entrepreneurs thrive, not hold them back.

    It makes no sense to cling to an outdated system that taxes some 
high-tech investments, such as computer servers and MRI machines, at 
more than double the rate of other investments. A startup owner 
shouldn't be told they're not allowed to use a work laptop in a coffee 
shop, or they'll face a financial hit on their taxes. And in my view, 
the tax code shouldn't get in the way of public-private partnerships 
that want to build new roads, bridges and highways around the U.S. So 
my proposal will fix these issues with new rules based on common-sense 
and a realistic appreciation of how businesses operate today.

    It's my hope that we're able to take a look at these proposals and 
more as the committee considers how to bring our tax code up to date. I 
look forward to today's hearing, and I thank our witnesses for being 
here. I'm especially thrilled that we're joined by Gayle Goschie of 
Goschie Farms in Silverton, Oregon. The hundreds of acres of hops they 
grow at Goschie Farms are a big part of what makes Oregon beer the best 
that money can buy. So I'm thrilled to have her here today.

                                 ______
                                 
        Prepared Statement of Sanford E. Zinman, CPA and Owner, 
               Sanford E. Zinman, CPA, PC, Tarrytown, NY
    Chairman Hatch, Ranking Member Wyden, and members of the committee: 
thank you for inviting me to discuss this important topic. My name is 
Sanford Zinman, and I am the Vice President and Tax Policy Chair of the 
National Conference of CPA Practitioners--NCCPAP. NCCPAP is the 
country's second largest CPA organization, comprised mostly of small 
CPA firms. NCCPAP members serve more than 1 million business and 
individual clients. NCCPAP has long advocated for tax simplification 
and tax equality. When taxpayers understand the laws they are more 
accepting of the rules.

    My testimony today will address the current business tax structure 
in the U.S. and its impact on the small and ``micro'' businesses. My 35 
years as a CPA sole practitioner involves working with and advising a 
variety of these businesses. My clients include grocery stores 
operating as cooperative corporations, building contractors and home 
builders, medical professionals, attorneys and everything in between.
             small business and micro business--an overview
    What's already known is that small businesses make up an 
overwhelming majority of the number of businesses in our country. 
According to a GAO report published in June of 2015, small businesses, 
as defined by less than $10 million in total revenue, make up roughly 
99 percent of all businesses. That same report States that 69 percent 
of those small businesses are individual taxpayers while 31 percent 
come from partnerships or corporations. The report also indicates that 
20 percent of the small business population hire at least one employee 
and produce about 71 percent of total small business income. The small 
business community is vital to America. It's vital to our economy and 
it's vital to keeping alive the American dream for all. Today, small 
business deals with massive hurdles brought on by the burden of dealing 
with tax compliance related activities. These compliances vary 
depending on the type of business entity, industry type, number of 
employees, asset size, to name a few. Without going into the 
overwhelming number of separate items which would necessitate the 
conversation for sweeping tax reform, we need to now resolve the 
tremendous cost burden that the small business owners must endure.

    Many Mom and Pop businesses, which I call ``micro'' businesses, 
operate the same way they did 50 years ago. Many are sole proprietors 
or Subchapter S corporations. The life of a business often begins when 
the owner seeks advice from his or her attorney. Just as often, the 
attorney recommends that the owner gets the opinion of a qualified tax 
advisor--usually a CPA. The form of organization is often irrelevant to 
the business owners. They just want to get out there and make some 
money.

    What do these ``micro'' business owners want? They want to better 
their lives and keep as much of their profits as they legitimately can 
for themselves. It's safe to say that this is the American way. When 
these individuals come to me and want to start a business, the first 
thing they want to know is what is the simplest type of business to 
open that will protect their existing assets while costing them the 
least amount of tax. Of course, this is never a standard ``C'' 
corporation.

    Life was simpler 50 or 60 years ago, but we aren't there anymore. 
New types of business organizations have been created. Each one has 
potential benefits and potential pitfalls. CPA's will explain the 
nuanced differences between a corporation, an S corporation, a 
partnership and an LLC. Ultimately, the differences are not extremely 
significant in the big picture. However, these differences can cause 
unnecessary complications in the decision making process.

    The interview process requires the CPA to determine a business 
owner's sophistication regarding the tax law and tax regulations. Do 
they understand the payroll process along with the filing and paying of 
payroll taxes? Are they responsible to pay their own quarterly 
estimated taxes? What are their medical insurance needs? Only after 
these conversations can a CPA provide meaningful guidance. Yet the 
issues raised do not necessarily help the business owner in achieving 
his or her true objective: to put food on the table. Additionally, 
although the form of business entity chosen may meet the current needs 
of the owner, these needs may change over time. Then the organizational 
structure, which was originally correct, may no longer be the proper 
one. Over the years I have met with business owners believing that 
their lawyer or CPA caused problems because they set things up wrong. 
After some prodding I find that the nature of the business changed and 
what was correct before no longer is.

    We try to help our clients choose a business structure that is 
right for them. The similarities and differences among business 
entities often make the choice a difficult one. There can be a simpler 
common taxation approach to the various business entities.
                types of business entities--an overview

 (Sources: Internal Revenue Service and Small Business Administration)

    This section is not meant to be a complete review of all types of 
business entities or the related taxes.
                             c corporations
    In forming a corporation, prospective shareholders exchange money, 
property, or both, for the corporation's capital stock. A corporation 
generally takes the same deductions as a sole proprietorship to figure 
its taxable income. A corporation can also take special deductions. For 
federal income tax purposes, a C corporation is recognized as a 
separate taxpaying entity. A corporation conducts business, realizes 
net income or loss, pays taxes and distributes profits to shareholders. 
The profit of a corporation is taxed to the corporation when earned, 
and then is taxed to the shareholders when distributed as dividends. 
This creates a double tax. The corporation does not get a tax deduction 
when it distributes dividends to shareholders. Shareholders cannot 
deduct any loss of the corporation.
                             s corporations
    S corporations are corporations that elect to pass corporate 
income, losses, deductions, and credits through to their shareholders 
for Federal tax purposes. Shareholders of S corporations report the 
flow-through of income and losses on their personal tax returns and are 
assessed tax at their individual income tax rates. This allows S 
corporations to avoid double taxation on the corporate income. S 
corporations are responsible for tax on certain built-in gains and 
passive income at the entity level.

    All States do not tax S corps equally. Most recognize them 
similarly to the Federal Government and tax the shareholders 
accordingly. However, some States (like Massachusetts) tax S corps on 
profits above a specified limit. Other States don't recognize the S 
corporation election and treat the business as a C corporation with all 
of the tax ramifications. Some States (like New York and New Jersey) 
tax both the S corps profits and the shareholder's proportional shares 
of the profits. The corporation must file the Form 2553 to elect ``S'' 
status within 2 months and 15 days after the beginning of the tax year 
or any time before the tax year for the status to be in effect.

    To qualify for S corporation status, the corporation must meet the 
following requirements:

     Be a domestic corporation;

     Have only allowable shareholders;

        May be individuals, certain trusts, and estates, and

        May not be partnerships, corporations or non-resident 
alien shareholders;

     Have no more than 100 shareholders;

     Have only one class of stock; and

      Not be an ineligible corporation (i.e., certain financial 
institutions, insurance companies, and domestic international sales 
corporations).

    An S corporation is created through an IRS tax election. An 
eligible domestic corporation can avoid double taxation (once to the 
corporation and again to the shareholders) by electing to be treated as 
an S corporation.

    What makes the S corporation different from a traditional 
corporation (C corporation) is that profits and losses pass through to 
the shareholder's personal tax return. Consequently, the business is 
not taxed itself. The corporation must furnish copies of Schedule K-1 
(Form 1120S) to the partners by the date Form 1120 is required to be 
filed, including extensions. There is an important caveat, however: any 
shareholder who works for the company must pay him or herself 
``reasonable compensation.'' Basically, the shareholder must be paid 
fair market value, or the IRS might reclassify any additional corporate 
earnings as ``wages.''
                     advantages of an s corporation
      Tax Savings. One of the best features of the S Corp is the tax 
savings for the owners and the business. While members of an LLC are 
subject to employment tax on the entire net income of the business, 
only the wages of the S Corp shareholder who is an employee are subject 
to employment tax. The remaining income is paid to the owner as a 
``distribution,'' which is taxed at a lower rate, if at all.

      Business Expense Tax Credits. Some expenses that shareholder/
employees incur can be written off as business expenses. Nevertheless, 
if such an employee owns 2% or more shares, then benefits like health 
and life insurance are deemed taxable income.

      Independent Life. An S corp designation also allows a business 
to have an independent life, separate from its shareholders. If a 
shareholder leaves the company, or sells his or her shares, the S corp 
can continue doing business relatively undisturbed. Maintaining the 
business as a distinct corporate entity defines clear lines between the 
shareholders and the business that improve the protection of the 
shareholders.
                   disadvantages of an s corporation
      Stricter Operational Processes. As a separate structure, S corps 
require scheduled director and shareholder meetings, minutes from those 
meetings, adoption and updates to by-laws, stock transfers and records 
maintenance.

      Shareholder Compensation Requirements. A shareholder must 
receive reasonable compensation. The IRS takes notice of shareholder 
red flags like low salary/high distribution combinations, and may 
reclassify distributions as wages. An owner could pay a higher 
employment tax because of an audit with these results.
                              partnerships
    A partnership is the relationship existing between two or more 
persons who join to carry on a trade or business. Each person 
contributes money, property, labor or skill, and expects to share in 
the profits and losses of the business. A partnership must file an 
annual information return to report the income, deductions, gains, 
losses, etc., from its operations, but it does not pay income tax. 
Instead, any profits or losses pass through to its partners. Each 
partner includes his or her share of the partnership's income or loss 
on his or her tax return. Partners are not employees and should not be 
issued a Form W-2. The partnership must furnish copies of Schedule K-1 
(Form 1065) to the partners by the date Form 1065 is required to be 
filed, including extensions. Because partnerships entail more than one 
person in the decision-making process, it's important to discuss a wide 
variety of issues up front and develop a legal partnership agreement. 
This agreement should document how future business decisions will be 
made, including how the partners will divide profits, resolve disputes, 
change ownership (bring in new partners or buy out current partners) 
and how to dissolve the partnership. Although partnership agreements 
are not legally required, they are strongly recommended and it is 
considered extremely risky to operate without one.
                         types of partnerships
    There are three general types of partnership arrangements:

      General Partnerships assume that profits, liability and 
management duties are divided equally among partners. If partners opt 
for an unequal distribution, the percentages assigned to each partner 
must be documented in the partnership agreement.

      Limited Partnerships (also known as a partnership with limited 
liability) are more complex than general partnerships. Limited 
partnerships allow partners to have limited liability as well as 
limited input with management decisions. These limits depend on the 
extent of each partner's investment percentage. Limited partnerships 
are attractive to investors of short-term projects.

      Joint Ventures act as general partnership, but for only a 
limited period of time or for a single project. Partners in a joint 
venture can be recognized as an ongoing partnership if they continue 
the venture, but they must file as such.

    To form a partnership, the partners register the business with 
resident State, a process generally done through the Secretary of 
State's office. A business name must be established. The legal name is 
the name given in the partnership agreement or the last names of the 
partners or a fictitious name (also known as an assumed name, trade 
name, or DBA name, short for ``doing business as'').

    Most businesses will need to register with the IRS, register with 
State and local revenue agencies, and obtain a tax ID number or permit. 
A partnership must file an ``annual information return'' to report the 
income, deductions, gains and losses from the business's operations, 
but the business itself does not pay income tax.

    Partnership taxes generally include:

      Annual Return of Income;

      Employment Taxes; and

      Excise Taxes.

    Partners in the partnership are responsible for several additional 
taxes, including:

      Income Tax;

      Self-Employment Tax; and

      Estimated Tax.
                      advantages of a partnership
      Easy and Inexpensive. Partnerships are generally an inexpensive 
and easily formed business structure. The majority of time spent 
starting a partnership often focuses on developing the partnership 
agreement.

      Shared Financial Commitment. In a partnership, each partner is 
equally invested in the success of the business. Partnerships have the 
advantage of pooling resources to obtain capital. This could be 
beneficial in terms of securing credit, or by simply doubling seed 
money.

      Complementary Skills. A good partnership should reap the 
benefits of being able to utilize the strengths, resources and 
expertise of each partner.

      Partnership Incentives for Employees. Partnerships have an 
employment advantage over other entities if they offer employees the 
opportunity to become a partner. Partnership incentives often attract 
highly motivated and qualified employees.
                     disadvantages of a partnership
      Joint and Individual Liability. Similar to sole proprietorships, 
partnerships retain full, shared liability among the owners. Partners 
are not only liable for their own actions, but also for the business 
debts and decisions made by other partners. In addition, the personal 
assets of all partners can be used to satisfy the partnership's debt.

      Disagreements Among Partners. With multiple partners, there are 
bound to be disagreements Partners should consult each other on all 
decisions, make compromises, and resolve disputes as amicably as 
possible.

      Shared Profits. Because partnerships are jointly owned, each 
partner must share the successes and profits of their business with the 
other partners. An unequal contribution of time, effort, or resources 
can cause discord among partners.
                                  llcs
    A limited liability company is a hybrid type of legal structure 
that provides the limited liability features of a corporation and the 
tax efficiencies and operational flexibility of a partnership. The 
``owners'' of an LLC are referred to as ``members.'' A Limited 
Liability Company (LLC) is a business structure allowed by State 
statute. Each State may use different regulations. Depending on the 
State, the members can consist of a single individual (one owner), two 
or more individuals, corporations or other LLCs. Unlike shareholders in 
a corporation, LLCs are not taxed as a separate business entity. 
Instead, all profits and losses are ``passed through'' the business to 
each member of the LLC. LLC members report profits and losses on their 
personal federal tax returns, just like the owners of a partnership 
would.

    A few types of businesses generally cannot be LLCs, such as banks 
and insurance companies. There are special rules for foreign LLCs. 
Depending on elections made by the LLC and the number of members, the 
IRS will treat an LLC as either a corporation, partnership, or as part 
of the LLC's owner's tax return (a ``disregarded entity''). 
Specifically, a domestic LLC with at least two members is classified as 
a partnership for Federal income tax purposes unless it files Form 8832 
and affirmatively elects to be treated as a corporation. And an LLC 
with only one member is treated as an entity disregarded as separate 
from its owner for income tax purposes (but as a separate entity for 
purposes of employment tax and certain excise taxes), unless it files 
Form 8832 or Form 2553 and affirmatively elects to be treated as a 
corporation. An LLC that does not want to accept its default Federal 
tax classification, or that wishes to use its classification, uses Form 
8832, Entity Classification Election, to elect how it will be 
classified for federal tax purposes. Generally, an election specifying 
an LLC's classification cannot take effect more than 75 days prior to 
the date the election is filed, nor can it take effect later than 12 
months after the date the election is filed. An LLC may be eligible for 
late election relief in certain circumstances.

    In the eyes of the Federal Government, an LLC is not a separate tax 
entity, so the business itself is not taxed. This is similar to an S 
Corporation or a partnership. Instead, all Federal income taxes are 
passed on to the LLC's members and are paid through their personal 
income tax. While the Federal Government does not tax income on an LLC, 
some States do. Since the Federal Government does not recognize an LLC 
as a business entity for taxation purposes, all LLCs must file as a 
corporation, partnership, or sole proprietorship tax return. As noted 
above, LLCs that are not automatically classified as a corporation can 
choose their business entity classification. To elect a classification, 
an LLC must file Form 8832. This form is also used if an LLC wishes to 
change its classification status. There is always the possibility of 
requesting S-Corp status for an LLC by making a special election with 
the IRS to have the LLC taxed as an S-Corp using Form 2553. The LLC 
remains a limited liability company from a legal standpoint, but for 
tax purposes it can be treated as an S-Corp.
                          advantages of an llc
      Limited Liability. Members are protected from personal liability 
for business decisions or actions of the LLC. This means that if the 
LLC incurs debt or is sued, members' personal assets are usually 
exempt. This is similar to the liability protections afforded to 
shareholders of a corporation.

      Less Recordkeeping. An LLC's operational ease is one of its 
greatest advantages. Compared to an S-Corporation, there is less 
registration paperwork and there are smaller start-up costs.

      Sharing of Profits. There are fewer restrictions on profit 
sharing within an LLC, as members distribute profits as they see fit. 
Members might contribute different proportions of capital and sweat 
equity. Consequently, it's up to the members themselves to decide who 
has earned what percentage of the profits or losses.
                        disadvantages of an llc
      Limited Life. In many States, when a member leaves an LLC, the 
business is dissolved and the members must fulfill all remaining legal 
and business obligations to close the business. The remaining members 
can decide if they want to start a new LLC or part ways. However, the 
operating agreement can include provisions to prolong the life of the 
LLC if a member decides to leave the business.

      Self-Employment Taxes. Members of an LLC are considered self-
employed and must pay the self-employment tax contributions towards 
Medicare and Social Security. The entire net income of the LLC is 
subject to this tax.

    Thank you again for allowing me to address this committee today. My 
primary focus today was about business taxation for small business. We 
know that Congress cannot stop people from coming up with clever new 
forms of business organizations. But Congress can insure a level 
playing field in business taxation. There are unnecessary inequities 
and complexities in our current system of business taxation which 
affect all business both small and large. A simpler, equitable tax 
structure would allow business owners to better understand potential 
tax liabilities and make better business decisions. To do this, the 
effect of income tax on the overall profitability of a business must be 
taken out of the equation. Allowing for a single level of tax for all 
business sizes will provide an understandable equity.

    Thank you for the opportunity to present today, and I welcome your 
questions.

                                 ______
                                 

                             Communications

                              ----------                              


                     American Bar Association (ABA)

                         321 North Clark Street

                         Chicago, IL 60654-7598

                             (312) 988-5109

                          Fax: (312) 988-5100

                      [email protected]

April 26, 2016

The Honorable Orrin G. Hatch        The Honorable Ron Wyden
Chairman                            Ranking Member
Committee on Finance                Committee on Finance
U.S., Senate                        U.S. Senate
Washington, DC 20510                Washington, DC 20510

Re:   Today's Hearing on ``Navigating Business Tax Reform,'' the Need 
to Preserve Cash Accounting for Law Firms and Other Personal Service 
Businesses, and Concerns Over Burdensome Mandatory Accrual Accounting 
Proposals

Gentlemen:

On behalf of the American Bar Association (``ABA''), which has over 
400,000 members, I am writing to express our views regarding an 
important aspect of the tax reform legislation that your Committee and 
its tax reform working groups are in the process of developing. In 
particular, we strongly oppose those proposals--such as Section 51 of 
the Committee's staff discussion draft bill to reform cost recovery and 
tax accounting rules prepared during the 113th Congress and other 
similar proposals now under consideration--that would require personal 
service businesses with annual gross receipts over $10 million to 
switch from the traditional cash receipts and disbursements method of 
accounting to the more complex and costly accrual method. These 
mandatory accrual accounting proposals are also strongly opposed by the 
Utah State Bar, Oregon State Bar, and over 30 other state, local, and 
specialty bars throughout the country. We ask that this letter be 
included in the record of today's hearing.

Although we commend you and your colleagues for your efforts to craft 
legislation aimed at simplifying the tax laws--an objective that the 
ABA and its Section of Taxation have long supported--we are concerned 
that mandatory accrual accounting proposals like Section 51 would have 
the opposite effect and cause other negative unintended consequences. 
These far-reaching proposals would create unnecessary new complexity in 
the tax law by disallowing the use of the cash method; increase 
compliance costs and corresponding risk of manipulation; and cause 
substantial hardship to many lawyers, law firms, and other personal 
service businesses by requiring them to pay tax on income long before 
it is actually received. Therefore, we urge you and your colleagues not 
to include these or any other similar mandatory accrual accounting 
proposals in the new tax reform legislation that is currently being 
developed.

Under current law, businesses are permitted to use the simple, 
straightforward cash method of accounting--in which income is not 
recognized until cash or other payment is actually received--if they 
are individuals or pass-through entities (e.g., partnerships or 
Subchapter S corporations) or their average annual gross receipts for a 
three year period are $5 million or less. In addition, all personal 
service businesses--including those engaged in the fields of law, 
accounting, engineering, architecture, health, actuarial science, 
performing arts, or consulting--are exempt from the revenue cap and can 
use the cash method of accounting regardless of their annual revenues, 
unless they have inventory. Most other businesses are required to use 
the accrual method, in which income is recognized when the right to 
receive the income arises, not when the income is actually received.

Mandatory accrual accounting proposals like Section 51 would 
dramatically change current law by raising the gross receipts cap to 
$10 million while eliminating the existing exemption for law firms and 
other personal service businesses, other sole proprietorships and pass-
through entities, and farmers. Although these proposals would allow 
certain small business taxpayers with annual gross receipts in the $5 
million to $10 million range to switch to--and thereby enjoy the 
benefits of--the cash method of accounting (a concept that the ABA does 
not oppose), the proposals would significantly complicate tax 
compliance for a far greater number of small business taxpayers, 
including many solo practitioner lawyers, law firms, and other personal 
service businesses, by forcing them to use the accrual method.

Sole proprietors, partnerships, S corporations, personal service 
corporations, and other pass-through entities favor the cash method 
because it is simple and generally correlates with the manner in which 
these business owners operate their businesses--i.e., on a cash basis. 
Simplicity is important from a compliance perspective because it 
enables taxpayers to better understand the tax consequences of 
transactions in which they engage or plan to engage. In this regard, 
simplicity helps to mitigate compliance costs, which already are 
significant, and to improve compliance with the tax code.

If law firms and other personal service businesses are required to use 
the more complex accrual method of accounting, they would be forced to 
calculate and then pay taxes on multiple types of accrued income, 
including work in progress, other unbilled work, and accounts 
receivable (where the work has been performed and billed but payment 
has not yet been received). To meet these requirements, law firms and 
other affected businesses would need to keep much more detailed work 
and billing records and hire additional accounting and support staff. 
This would substantially raise compliance costs for many law firms and 
other personal service businesses while greatly increasing the risk of 
noncompliance with the tax code.

In addition to creating unnecessary complexity and compliance costs, 
these mandatory accrual accounting proposals would lead to economic 
distortions that would adversely affect all law firms and other 
personal service businesses that currently use the cash method of 
accounting and their clients in several ways.

First, the proposals would impose substantial new financial burdens on 
many thousands of personal service businesses throughout the country--
including many law firms--by forcing them to pay taxes on income they 
have not yet received and may never receive. Requiring these businesses 
to pay taxes on this ``phantom'' income--and to borrow money or use 
their scarce capital to do so--would impose a serious financial burden 
and hardship on many of these firms. The legal profession would suffer 
even greater financial hardship than other professions because many 
lawyers are not paid by the clients until long after the work is 
performed.

Second, mandatory accrual accounting would adversely affect clients, 
interfere with the lawyer-client relationship, and reduce the 
availability of legal services. If law firms are required to pay taxes 
on accrued income they have not yet received, the resulting financial 
pressures could force many firms charging on a traditional hourly fee 
basis to collect their fees immediately after the legal services are 
provided to the client or at least much sooner than they currently do. 
As a result, many clients could find it more difficult to afford legal 
counsel. In addition, many law firms would no longer be able to 
represent as many accident victims, start-up companies, or other 
clients on an alternative or flexible fee basis as they now do, and 
many firms would also have to reduce the amount of pro bono legal 
services they currently provide to their poorest clients.

Third, the proposals would constitute a major, unjustified tax increase 
on small businesses and discourage economic growth. The Joint Committee 
on Taxation estimated that the similar House proposal introduced in the 
last Congress, which closely parallels Section 51 of the Senate draft 
bill, would generate $23.6 billion in new taxes over ten years by 
forcing many thousands of small businesses to pay taxes on income up to 
a year or more before it is actually received--if it is ever received. 
Because this acceleration of a firm's tax liability would be permanent 
and continue year after year, it would constitute a major permanent tax 
increase for the firm, when compared to the taxes the firm currently 
pays under the cash method, until the firm eventually dissolves, merges 
with another firm, or otherwise ceases to exist.

The proposals would also discourage professional service providers from 
joining with other providers to create or expand a firm, even if it 
made economic sense and would benefit their clients, because it could 
trigger the costly accrual accounting requirement. For example, solo 
practitioner lawyers would be discouraged from entering into law firm 
partnerships--and existing law firms would be discouraged from growing 
or expanding--because once a firm exceeds $10 million in annual gross 
receipts, it would be required to switch from cash to accrual 
accounting, thereby accelerating its tax payments. Sound tax policy 
should encourage, not discourage, the growth of small businesses, 
including those providing legal services, especially in today's 
difficult economic environment.

For all of these reasons, as discussions on tax reform continue, we 
urge you and the Committee to preserve the ability of law firms and 
other personal service businesses to use the simple cash method of 
accounting and not to support any proposals that would require these 
businesses to switch to the more burdensome accrual method.

Thank you for considering the ABA's views on this important issue. If 
you have any questions regarding our position, please contact ABA 
Governmental Affairs Director Thomas Susman at (202) 662-1765 or 
Associate Governmental Affairs Director Larson Frisby at (202) 662-
1098.

Sincerely,

Paulette Brown
President, American Bar Association

cc:   Members of the Senate Finance Committee
     The Honorable Mark J. Mazur, Assistant Secretary of the Treasury 
for Tax 
Policy

                                 ______
                                 
                American Council of Life Insurers (ACLI)

                   Financial Security . . . for Life.

         101 Constitution Avenue, NW, Washington, DC 20001-2133

                              www.acli.com

           Hearing Statement of the Honorable Dirk Kempthorne

                 President and Chief Executive Officer

  U.S. Senate Committee on Finance Hearing ``Navigating Business Tax 
                                Reform''

                             April 26, 2016

The American Council of Life Insurers (ACLI) is pleased to submit this 
statement for the record for today's hearing titled ``Navigating 
Business Tax Reform.'' We thank Chairman Orrin Hatch and Ranking Member 
Ron Wyden for holding this hearing. ACLI would like to take this 
opportunity to respectfully comment on a ``corporate integration'' 
proposal as publicly reported.

ACLI is a Washington, DC-based trade association with approximately 300 
member companies operating in the United States and abroad. ACLI 
advocates in Federal, State, and international forums for public policy 
that supports the industry marketplace and the 75 million American 
families that rely on life insurers' products for financial and 
retirement security. ACLI members offer life insurance, annuities, 
retirement plans, long-term care and disability income insurance, and 
reinsurance, representing more than 90 percent of industry assets and 
premiums.

On behalf of the U.S. life insurance industry, we share the goal of 
encouraging economic growth through a competitive tax system. We 
understand that Chairman Hatch's corporate integration proposal would 
provide corporations with a dividends paid deduction which would be 
paid for, at least in part, by a nonrefundable 35 percent withholding 
tax on both interest and dividends paid.

The nature of the life insurance business is very different from that 
of a manufacturer or retailer in that it involves the satisfaction of 
long-duration promises. Life insurers receive premiums in exchange for 
a contractual promise to pay insurance or annuity benefits. Life 
insurers utilize those premiums as well as investment returns on the 
premiums to pay policyholder benefits as they arise, often many decades 
in the future. The protections and guarantees our products provide are 
not available from any other financial services companies.

The life insurance industry has priced its products and made guarantees 
to its policyholders based on receiving 100 percent of the investment 
income as it is earned by its investment portfolios in order to fulfill 
the future obligations and promises under its insurance and annuity 
contracts. A 35 percent, nonrefundable withholding tax on gross 
investment income would amount to a de facto gross income tax with a 
substantial retroactive effect on existing business. Specifically, 
earnings from current investments would fall far short of providing 
sufficient income each year to pay contractual obligations on in-force 
business. Therefore, a withholding tax on investment income would have 
a crippling effect on the life insurance industry.

The ACLI appreciates the opportunity to comment and point out the 
unique features of our products that make them so critical to the 
financial security of all Americans. ACLI and its member companies look 
forward to working with Senate Finance Committee Chairman Hatch and his 
staff to address the industry's concerns on these very important 
issues.

                                 ______
                                 
                    American Farm Bureau Federation

                      SENATE COMMITTEE ON FINANCE

             HEARING ON ``NAVIGATING BUSINESS TAX REFORM''

                             April 26, 2016

                  Presented by Zippy Duvall, President

The Farm Bureau supports replacing the current federal income tax with 
a fair and equitable tax system that encourages success, savings, 
investment and entrepreneurship. We believe that the new code should be 
simple, transparent, revenue-
neutral and fair to farmers and ranchers. We appreciate the opportunity 
to file this statement for the record for the full committee hearing on 
Navigating Business Tax Reform.

Agriculture operates in a world of uncertainty. From unpredictable 
commodity and product markets to fluctuating input prices, from 
uncertain weather to insect or disease outbreaks, running a farm or 
ranch business is challenging under the best of circumstances. Farmers 
and ranchers need a tax code that recognizes the financial challenges 
they face.

Tax reform should embrace the following overarching principals:

      Comprehensive: Tax reform should help all farm and ranch 
businesses: sole proprietors, partnerships, sub-S and C corporations.

      Effective Tax Rate: Tax reform should reduce rates low enough to 
account for any deductions/credits lost due to base broadening.

      Estate Taxes: Tax reform should repeal estate taxes. Stepped-up 
basis should continue.

      Capital Gains Taxes: Tax reform should lower taxes on capital 
investments. Capital gains taxes should not be levied on transfers at 
death.

      Cost Recovery: Tax reform should allow businesses to deduct 
expenses when incurred. Cash accounting should continue.

      Simplification: Tax reform should simplify the tax code to 
reduce the tax compliance burden.

Pass-through Businesses: Any tax reform proposal considered by Congress 
must be comprehensive and include individual as well as corporate tax 
reform. More than 96 percent of farms and 75 percent of farm sales are 
taxed under IRS provisions affecting individual taxpayers. Any tax 
reform proposal that fails to include the individual tax code will not 
help, and could even hurt, the bulk of agricultural producers who 
operate outside of the corporate tax code.

Effective Rates: Any tax reform plan that lowers rates by expanding the 
base should not increase the tax burden of farm and ranch businesses. 
Because profit margins in farming and ranching are tight, farm and 
ranch businesses are more likely to fall into lower tax brackets. Tax 
reform plans that fail to factor in the impact of lost deductions for 
all rate brackets could result in a tax increase for agriculture.

Cash Accounting: Cash accounting is the preferred method of accounting 
for farmers and ranchers because it provides the flexibility needed to 
optimize cash flow for business success, plan for business purchases 
and manage taxes. Cash accounting allows farmers and ranchers to 
improve cash flow by recognizing income when it is received and 
recording expenses when they are paid. This gives them the flexibility 
they need to plan for major investments in their businesses and in many 
cases provides guaranteed availability of some agricultural inputs. 
Loss of cash accounting could create a situation where a farmer or 
rancher would have to pay taxes on income before receiving payment for 
sold commodities.

Accelerated Cost Recovery: Because production agriculture has high 
input costs, farmers and ranchers place a high value on immediate 
expensing of equipment and equipment repairs, production supplies and 
preproduction costs. This includes fertilizer and soil conditioners, 
soil and water conservation expenditures, the cost of raising dairy and 
breeding cattle, the cost of raising timber, endangered species 
recovery expenditures and reforestation expenses. Farm Bureau also 
places a priority on Section 179 small business expensing and supports 
bonus depreciation, shorted depreciation schedules, and the carry 
forward and back of unused deductions and credits. There should be 
annual expensing of preproduction expenditures and equipment repair 
costs should be treated as an expense rather than a capital 
improvement.

Estate Taxes: Farm Bureau supports permanent repeal of federal estate 
taxes. Until permanent repeal is achieved, the exemption should be 
increased, and indexed for inflation, and it should continue to provide 
for portability between spouses. Full unlimited stepped-up basis at 
death must be included in any estate tax reform. Farmland owners should 
have the option of unlimited current use valuation for estate tax 
purposes.

Capital Gains Taxes: Farm Bureau supports eliminating the capital gains 
tax. Until this is possible, the tax rate should be reduced and assets 
should be indexed for inflation. In addition, there should be an 
exclusion for agricultural land that remains in production, for 
transfers of farm business assets between family members, for farmland 
preservation easements and development rights, and for land taken by 
eminent domain. Taxes should be deferred when the proceeds are 
deposited into a retirement account. Farm Bureau supports the 
continuation of stepped-up basis.

Like-Kind Exchanges: Farm Bureau supports the continuation of Section 
1031 like-kind exchanges, which help farmers and ranchers upgrade and 
improve their businesses by deferring taxes when they sell business 
capital and replace it with like-kind assets. Without the ability to 
defer taxes on exchanges, some farmers and ranchers would need to incur 
debt to continue their farm or ranch businesses or, worse yet, delay 
mandatory improvements to maintain the financial viability of their 
farm or ranch.

Other Provisions Important to Farmers and Ranchers: Farm Bureau 
supports the continuation of the Domestic Production Activities 
Deduction (Section 199), farm and ranch income averaging, installment 
land sales, elimination of the UNICAP rules for plants, and the tax 
deduction for donated food and donated conservation easements.

                                 ______
                                 
                American Public Power Association (APPA)

                 Senate Committee on Finance Hearing on

                  ``Navigating Business Tax Reform'' 

                    Held on Tuesday, April 26, 2016

Introduction

The American Public Power Association (APPA) appreciates the 
opportunity to submit this statement for the record for the April 26, 
2016, Senate Committee on Finance Hearing on ``Navigating Business Tax 
Reform.''

APPA is the national service organization representing the interests of 
over 2,000 municipal and other state- and locally-owned, not-for-profit 
electric utilities (``public power utilities'') throughout the United 
States (all but Hawaii). Public power utilities serve some of the 
nation's smallest towns--roughly four out of five public power 
utilities serve 10,000 or fewer customers--and largest cities, 
including Los Angeles and San Antonio. Collectively, public power 
utilities deliver electricity to one of every seven U.S. electricity 
consumers (approximately 48 million people).

Public power utilities are operated by state and local governmental 
entities and, as a result, are exempt from federal income tax. However, 
several business tax reform proposals \1\ have included municipal bond 
related provisions to raise revenue to offset the cost of lowering 
corporate income tax rates. Arguably, doing so makes these proposals 
``revenue-neutral.'' In fact, while some of these municipal bond 
provisions relate to the taxation of business income, others impose new 
taxes on individuals or limit the purpose for which a municipal bond 
may be issued. More importantly, all would increase the cost of 
borrowing for state and local governments and, so, increase costs paid 
by state and local residents or lead to a reduction in services 
provided to these residents. As a result, including these provisions in 
a business tax reform proposal would shift costs from corporate 
taxpayers to individual taxpayers and state and local residents. APPA 
believes such proposals are particularly poorly timed when the nation 
faces crushing demand for critical infrastructure investments needed 
for economic growth and our citizens' well-being.
---------------------------------------------------------------------------
    \1\ See, e.g., H.R. 1 , the ``Tax Reform Act of 2014'' by 
Representative Dave Camp (R-MI).
---------------------------------------------------------------------------

Municipal Bonds

Municipal bonds are the largest source of financing for core 
infrastructure in the U.S.,\2\ and are the single most important 
financing tool for public power, given the capital-intensive and long-
lived nature of assets needed by the electric industry. Each year, on 
average, public power utilities make $11 billion in new investments 
financed with municipal bonds. Power-related municipal bonds account 
for roughly 5 percent of municipal bond issuances every year.\3\ (See 
Appendix A for tabulation of power-related bond issuances, by state, 
over the last decade).
---------------------------------------------------------------------------
    \2\ Cong. Budget Office, J. Comm. on Taxation, ``Subsidizing 
Infrastructure Investment with Tax-Preferred Bonds'' (Oct. 2009) 
(showing that for education, water, and sewer, nearly all capital 
investments are made by state and local governments and that for 
transportation most investments are made by state and local 
governments).
    \3\  The Bond Buyer and Thomson Reuters ``2014 Yearbook'' (2014); 
The Bond Buyer and Thomson Reuters ``2009 Yearbook'' (2009).

Municipal bonds long predate the modern income tax, having been used 
for more than 200 years by state and local governments to finance a 
wide range of public infrastructure. However, as the nation 
transitioned from dependence on excise taxes to an income tax as a 
primary source of revenue, a series of mid-19th Century Supreme Court 
decisions carved out the doctrine of reciprocal immunity, under which 
state and local bond issuances are exempt from federal taxation, while 
federal bonds are exempt from state and local tax. The federal tax 
exemption for municipal bonds was part of the original federal income 
tax enacted in 1913 and is codified today at 26 U.S.C. Sec. 103. The 
state and local tax exemption for federal bonds was not codified until 
---------------------------------------------------------------------------
1982 (at 31 U.S.C. Sec. 3124).

Because interest on municipal bonds is exempt from federal income tax, 
investors accept a lower rate of return than they would otherwise 
demand from issuers of taxable debt. Investors are also attracted to 
municipal bonds because of the stability of the municipal bond market 
and the extremely low rate of default for municipal bonds compared to 
comparably rated corporate bonds. Historically, interest rates demanded 
by investors for tax-exempt municipal bonds have been an estimated 
average 200 basis points lower than comparable taxable corporate bonds. 
Savings to the issuer from this reduced cost in borrowing allow 
additional infrastructure investments or are passed through to 
taxpayers in the form of lower taxes or, in the case of public power 
customers, reduced utility rates.\4\
---------------------------------------------------------------------------
    \4\ American Public Power Association ``2012-2013 Public Power 
Annual Directory and Statistical Report'' 51 (2012).
---------------------------------------------------------------------------

Proposals to Alter Tax Exempt Municipal Bonds

Several recent proposals to reform federal taxation of business rely on 
revenue raised from bond-related provisions to offset the cost of 
lowering marginal corporate income tax rates. While some of these 
provisions would directly affect corporations holding municipal bonds, 
others would also increase taxes on individual bondholders or save 
federal revenue by limiting the purposes for which municipal bonds can 
be issued. As a result, these proposals would use individual income tax 
revenue to finance corporate tax rate reductions.

Additionally, while the Joint Committee on Taxation will score these 
provisions as raising revenue from bondholders, we believe the after-
tax effect on bondholders, whether businesses or an individuals, will 
be negligible. Instead, state and local governmental issuers will pay 
the price of these tax increases, either because bondholders are 
demanding a higher rate of return to compensate for additional taxes 
paid, or because potential bondholders have exited the market for 
municipal bonds. The additional costs paid by state and local residents 
is important because revenue neutrality is being discussed as one way 
to ensure rough justice in business tax reform. The argument goes that 
every dollar of additional tax paid because of lost deductions, 
exclusions, or credits, will be returned in the form of lower marginal 
tax rates or other more simple deductions and exclusions. Using bond-
related provisions to pay-for corporate tax rate reductions clearly 
violates this principle, pulling money out of the pockets of individual 
bondholders and state and local taxpayers (and utility customers) to 
the benefit of corporations, partnerships, and the like benefiting from 
business tax reform.

Finally, in so far as Congress feels that there is merit to some of 
these bond-related provisions beyond simply their ability to raise 
federal revenue, it would make more sense (and better bolster 
infrastructure investments) to marry them with provisions improving and 
updating the federal tax treatment of municipal bonds.\5\
---------------------------------------------------------------------------
    \5\ See, for example, American Public Power Association, Large 
Public Power Council, Transmission Access Policy Study Group, 
``Statement to the Senate Finance Committee Tax Reform Working Groups 
on Community Development and Infrastructure and Saving and Investment'' 
10-11 (April 15, 2015).
---------------------------------------------------------------------------

Conclusion

Thank you for the opportunity to provide input as the Committee 
considers business tax reform. While bond-related provisions can be 
used as ``pay-fors'' to meet a federal budgetary or revenue neutrality 
goal on paper, new taxes and limitations on tax-exempt bonds will 
simply shift federal costs to state and local residents while 
permanently impairing the ability of public power utilities and state 
and local governments to meet their critical, public purpose 
infrastructure needs.

For more information please contact:

John Godfrey

Senior Government Relations Director
American Public Power Association
2451 Crystal Dr. Suite 1000
Arlington, VA 22202

[email protected]
(202) 467-2929

                               Appendix A

                A Decade of Power-Related Municipal Bonds
 Power-related municipal bonds issued in each state from 2004-2013  (By
             total dollar volume and number of bonds issued)
------------------------------------------------------------------------
                                                      $ Volume    Bonds
                       State                         (millions)   Issued
------------------------------------------------------------------------
Alabama...........................................        1,739     (33)
Alaska............................................          436      (9)
Arizona...........................................        6,210     (20)
Arkansas..........................................          244     (15)
California........................................       38,306    (237)
Colorado..........................................          726     (23)
Connecticut.......................................          266      (9)
Delaware..........................................          196      (5)
Florida...........................................       14,757    (134)
Georgia...........................................       10,071     (52)
Hawaii............................................          481      (4)
Idaho.............................................           82      (1)
Illinois..........................................        2,928     (42)
Indiana...........................................        1,985     (41)
Iowa..............................................          340     (99)
Kansas............................................          364     (45)
Kentucky..........................................        2,574     (42)
Louisiana.........................................        1,428     (18)
Maine.............................................            7      (2)
Maryland..........................................          122      (1)
Massachusetts.....................................          382     (21)
Michigan..........................................          532     (26)
Minnesota.........................................        1,762    (112)
Mississippi.......................................          911     (15)
Missouri..........................................        2,541     (41)
Montana...........................................           22      (6)
Nebraska..........................................        8,510    (282)
Nevada............................................          154      (5)
New Hampshire.....................................            0      (0)
New Jersey........................................          174      (9)
New Mexico........................................           56      (1)
New York..........................................        9,963     (46)
North Carolina....................................        5,091     (37)
North Dakota......................................          352      (4)
Ohio..............................................        6,969     (54)
Oklahoma..........................................        2,325     (19)
Oregon............................................          922     (42)
Pennsylvania......................................          777     (10)
Rhode Island......................................            0      (0)
South Carolina....................................        8,703     (47)
South Dakota......................................           55     (13)
Tennessee.........................................        8,646     (73)
Texas.............................................       13,921     (91)
Utah..............................................        2,688     (31)
Vermont...........................................           91      (9)
Virginia..........................................          465      (8)
Washington........................................       14,646    (188)
West Virginia.....................................           11      (1)
Wisconsin.........................................        1,384     (64)
Wyoming...........................................          403      (7)
Guam..............................................          207      (3)
Puerto Rico.......................................        8,511     (15)
Virgin Islands....................................          227      (6)
U.S.TOTAL.........................................     $177,401    2,149
------------------------------------------------------------------------
Sources: The Bond Buyer/Thomson Reuters 2009, 2014 Yearbooks.


                                 ______
                                 
            Cash to Accrual Accounting Stakeholder Coalition
Dear Chairman Hatch and Ranking Member Wyden:

    In connection with the Senate Finance Committee's recent hearing on 
``Navigating Business Tax Reform,'' we are submitting as a statement 
for the record the attached letter which was sent to the Committee's 
Business Income Tax Bipartisan Tax Working Group in April 2015. As 
discussed in the letter, we urge you preserve the current availability 
of the cash method of accounting as part of any business tax reform. 
Thank you for your consideration and your leadership on tax policy 
issues.

            Sincerely,

            The Cash to Accrual Accounting Stakeholder Coalition

                             April 15, 2015

The Honorable Orrin G. Hatch        The Honorable Ron Wyden
Chairman                            Ranking Member
Senate Committee on Finance         Senate Committee on Finance
219 Dirksen Senate Office Building  219 Dirksen Senate Office Building
Washington, DC 20510                Washington, DC 20510

Dear Chairman Hatch and Ranking Member Wyden:

    We are writing in response to your invitation to stakeholders to 
submit ideas to the Committee's tax reform working groups on how best 
to reform the nation's tax code to make it simpler, fairer and more 
efficient. We applaud your efforts to improve the tax code and 
strengthen U.S. businesses, and we appreciate the opportunity to 
provide comments.

    Specifically, we are writing to ask that you preserve the cash 
method of accounting for service pass-through entities, including 
partnerships and Subchapter S corporations, farmers and ranchers, and 
personal service corporations. The cash method of accounting is the 
foundation upon which these types of businesses have built their 
businesses for decades. Because these businesses are taxed at the owner 
level, forcing them to switch to the accrual method of accounting would 
result in an effective tax increase on their thousands upon thousands 
of individual owners that generate jobs and are integral to the 
vitality of local economies throughout our nation.

    Under current law, there are two primary methods of accounting for 
tax purposes: cash and accrual. Under cash basis accounting, taxes are 
paid on cash actually collected and bills actually paid. Under accrual 
basis accounting, taxes are owed when the right to receive payment is 
fixed, even if that payment will not be received for several months or 
even several years. Internal Revenue Code section 448 allows the use of 
cash accounting for service pass-throughs; qualified personal service 
corporations; farmers and ranchers; and entities with average annual 
gross receipts of $5 million or less.

    Proposals in the last Congress would have required any business 
with average annual gross receipts greater than $10 million to use the 
accrual method of accounting. By raising the threshold from $5 to $10 
million, the proposals were intended to reduce recordkeeping burdens on 
small businesses. However, this expansion was paid for by forcing all 
other businesses currently using cash accounting to switch to accrual 
accounting. We do not oppose expanding the allowable use of cash 
accounting, but it is unfair and inconsistent with generally agreed 
upon tax reform principles to pay for good policy with bad policy that 
has no other justification than raising revenues. Further, there have 
been no allegations that the businesses affected by the proposals are 
abusing the cash method of accounting.

    Pass-through entities account for more than 90 percent of all 
business entities in the United States and are represented across a 
diverse range of business professions and sectors. A substantial number 
of these businesses are service providers, farmers and ranchers that 
currently qualify to use cash accounting. These are businesses 
throughout America--farms, trucking, construction, engineers, 
architects, accountants, lawyers, dentists, doctors and other essential 
service providers--on which communities rely for services and jobs. 
These are not just a few big businesses and a few well-to-do owners. 
According to IRS data, there are over 60,000 Subchapter S corporations, 
25,000 partnerships and at least 2,000 sole proprietors that wouldhave 
to switch from cash to accrual accounting.

    The negative impact of such a move would be significant:

        Cash flow would be severely impaired. Businesses could be 
        forced into debt to finance truces, including accelerated 
        estimated tax payments, on money they may never receive. Many 
        cash businesses operate on very small profit margins, so 
        accelerating the recognition of income could be the difference 
        between being liquid and illiquid. Many cash businesses have 
        contracts with the government, which is known for long delays 
        in making payments that already stretch their working capital. 
        Structured settlements and alternative fee arrangements can 
        result in substantial delays in collections, sometimes over 
        several years; taxes owed in the year a matter is resolved 
        could potentially exceed the cash actually collected.

        A bad crop year could make a farm go under. For farmers and 
        ranchers, cash accounting is crucial due to the number and 
        enormity of up-front costs and the uncertainty of crop yields 
        and market prices. A heavy rainfall, early freeze or sustained 
        drought can devastate an agricultural community. Farmers and 
        ranchers need the flexibility and simplicity of cash accounting 
        to manage their tax burden by evening out annual revenues that 
        can fluctuate greatly from one year to the next.

        Recordkeeping burdens would escalate, in cost, staff time and 
        complexity. Cash accounting is simple--cash in/cash out. 
        Accrual accounting is much more complex, requiring 
        sophisticated analyses of when the right to collect income or 
        to pay expenses is fixed and determinable. In order to comply 
        with the more complex rules, businesses currently handling 
        their own books and records may feel like they have no other 
        choice than to hire outside help or buy expensive software.

    These impacts are not about the size of a business or its gross 
receipts. Whether large or small, a business can have small profit 
margins, rely on government contracts, generate business through 
deferred fee structures or be wiped out through the vagaries of the 
weather. Cash diverted toward interest expense, taxes and higher 
recordkeeping costs is capital unavailable for use in the actual 
business, including paying wages, buying capital assets or investing in 
growth.

    Proposals to limit the use of cash accounting are counterproductive 
to agreed-upon principles of tax reform. Tax reform should strengthen 
our economy, foster job growth, enhance U.S. competitiveness, and 
promote fairness and simplicity in the tax code. Accrual accounting 
does not make the system simpler, but more complex. Increasing the debt 
load of American businesses runs contrary to objectives to move toward 
equity financing instead of debt financing and will raise the cost of 
capital, creating a drag on economic growth and job creation. Putting 
U.S. businesses in a weaker position will put them at further 
disadvantage compared to foreign competitors. American businesses and 
their individual owners should not be asked to pay a significant price 
for reforms that will leave them in a worse position than when they 
started.

    As discussions on tax reform continue, the undersigned respectfully 
request that the Committee and the working groups take our concerns 
into consideration and not propose to change the ability to use cash 
accounting. We would be happy to discuss any of these items further. 
Please feel free to contact Mary Burke Baker (mary.
[email protected]) or any of the signatories for additional 
information.

    Thank you for your consideration of this important matter.

    Sincerely,

 
                                                      --
 
American Council of Engineering      Investment Adviser Association
 Companies
American Farm Bureau Federation      Jackson Walker LLP
American Institute of Architects     K&L Gates LLP
Americans for Tax Reform             Littler Mendelson PC
American Institute of CPAs           Miles and Stockbridge PC
Baker Botts LLP                      Mitchell Silberberg and Knupp LLP
Baker Donelson Bearman Caldwell and  Morrison and Foerster LLP
 Berkowitz PC
Debevoise and Plimpton LLP           Nelson Mullins Riley and
                                      Scarborough LLP
Dorsey and Whitney LLP               Ogletree, Deakins, Nash, Smoak and
                                      Stewart PC
Dykema Gossett PLLC                  Perkins Coie LLP
Farmers for Tax Fairness             Richards, Layton and Finger PA
Federal Communications Bar           Ropes and Gray LLP
 Association
Foley and Lardner LLP                State Bar of South Dakota
Hunton and Williams LLP              Steptoe and Johnson LLP
 


    cc:
    The Honorable John Thune, Co-Chair, Business Income Tax Working 
Group
    The Honorable Benjamin Cardin, Co-Chair, Business Income Tax 
Working Group
    The Honorable Pat Roberts, Member, Business Income Tax Working 
Group
    The Honorable Debbie Stabenow, Member, Business Income Tax Working 
Group
    The Honorable Richard Burr, Member, Business Income Tax Working 
Group
    The Honorable Tom Carper, Member, Business Income Tax Working Group
    The Honorable Johnny Isakson, Member, Business Income Tax Working 
Group
    The Honorable Bob Casey, Member, Business Income Tax Working Group
    The Honorable Rob Portman, Member, Business Income Tax Working 
Group
    The Honorable Mark Warner, Member, Business Income Tax Working 
Group
    The Honorable Pat Toomey, Member, Business Income Tax Working Group
    The Honorable Robert Menendez, Member, Business Income Tax Working 
Group
    The Honorable Dan Coats, Member, Business Income Tax Working Group
    The Honorable Bill Nelson, Member, Business Income Tax Working 
Group

                                 ______
                                 
                            CRANE Coalition

                    c/o Ogilvy Government Relations

                      1111 19th St. NW, Suite 1100

                          Washington, DC 20036

                      Senate Committee on Finance

             Hearing on ``Navigating Business Tax Reform''

                             April 26, 2016

    Last year, during the Finance Committee's working group process on 
tax reform, the CRANE Coalition (``Cost Recovery Advances the Nation's 
Economy'') submitted comments to the committee making the case for the 
preservation of accelerated depreciation in tax reform. We showed that 
cuts in accelerated depreciation are an unworkable budget offset for 
permanent tax reforms because the substantial early-year revenue gains 
from such cuts do not persist for the long term. Through a paper 
prepared by former revenue estimators from the staff of the Joint 
Committee on Taxation, we showed that reliance on such cuts to offset 
the cost of a tax reform measure in the first decade could lead to 
burgeoning revenue shortfalls for the government thereafter. Such 
revenue shortfalls would come just when baby-boom retirements are 
forecasted to create unsustainable budget deficits; the shortfalls 
could readily lead to the reversal of the very tax reforms for which 
the cuts in accelerated depreciation were enacted!

    We also explained in our comments that cuts in accelerated 
depreciation would increase the cost of capital for domestic investment 
in plant and equipment. We pointed out that according to the Joint Tax 
Committee staff's assessment of the tax reform proposal of former House 
Ways and Means Committee chair Dave Camp, on an overall basis the 
proposal would result in reduced capital stocks after 10 years because 
of cuts in accelerated depreciation and other cost-recovery mechanisms. 
It is axiomatic that investment is the key determinant of future 
growth; for Congress to consider a tax reform plan that would tend to 
dampen investment in plant and equipment would be to turn the idea of 
tax reform on its head.

    After submitting our comments to the committee last year, we 
released another paper by the former Joint Committee economists, 
precisely on the economic effect of cuts in accelerated depreciation. 
The paper shows that the repeal of accelerated depreciation would 
increase the cost of capital by more than 10 percent for capital-
intensive industries. The curtailment of other cost-recovery 
mechanisms, as in the Camp plan, would add to the increase, as would 
the elimination of bonus depreciation, also assumed in the Camp plan. 
The inevitable effect would be reduced investment and growth.

    What CRANE members understand well is that accelerated depreciation 
is fundamentally about cash flow and that, for most companies, cash 
flow is a key determinant of investment. While some U.S. companies may 
be in a position to freely access the capital markets for all their 
capital needs, most are not--for financial, prudential, or other 
reasons. For most companies, if cash flow declines because of cuts in 
accelerated depreciation, investment inevitably will decline along with 
it.

    In short, as we argued last year, accelerated depreciation promotes 
domestic investment and economic growth. Its repeal has no logical 
place in a tax reform measure meant to help get the tax code out of the 
way of the country's economic growth.

    If Congress is to consider tax reform, the key driver of the 
measure should be to spur faster economic growth for the benefit of all 
Americans. A tax reform measure that does not meet that test should not 
advance in Congress.

                       The Historical Perspective

    For today's hearing record, we believe it is important to consider 
accelerated depreciation from a broader historical perspective. From 
that point of view, we believe Congress would be making a serious 
mistake in turning its back on the tax code's current system of 
accelerated depreciation when the system has taken so long to develop. 
The budgetary and political obstacles today to shifting the tax system 
in the direction of investment and growth are daunting by any measure, 
requiring nearly impossible political maneuvering over issues of 
progressivity, revenue levels, and the public perception of fairness. 
Especially given the budgetary constraints posed by the retirement of 
the baby boom generation, if Congress decides to turn back the clock on 
accelerated depreciation now for sake of tax reform, the likelihood 
that Congress would be able to correct the mistake in coming years 
could be minimal.

    The federal income tax was in place for four decades before the 
first permanent allowances for accelerated depreciation were added into 
the tax code, in 1954. The Internal Revenue Code of 1954 authorized the 
use of the double declining balance method and sum of the years' digits 
method of depreciation for assets with a useful life of more than three 
years. In adopting those provisions, this committee explained that the 
provision would boost investment and economic growth:

        More liberal depreciation allowances are anticipated to have 
        far-reaching economic effects. . . . The acceleration in the 
        speed of the tax-free recovery of costs is of critical 
        importance in the decision of management to incur risk. The 
        faster tax write-off would increase available working capital 
        and materially aid growing businesses in the financing of their 
        expansion. For all segments of the American economy, 
        liberalized depreciation policies should assist modernization 
        and expansion of industrial capacity, with resulting economic 
        growth, increased production, and a higher standard of 
        living.\1\
---------------------------------------------------------------------------
    \1\ See U.S. Treasury Department, Office of Tax Analysis, ``A 
History of U.S. Tax Depreciation Policy,'' OTA Paper 64 (May 1989), p. 
13.

    Over the decades from 1954 to the present, accelerated depreciation 
has gradually become more deeply embedded in federal tax policy. In 
1958 and again in 1962, Congress liberalized the rules in a number of 
ways, such as by enacting section 179, which then, as today, was meant 
to provide rapid write-offs for smaller businesses. During the 1960s 
and 1970s, the administrative rules and regulations under which 
taxpayers determined the depreciable lives for assets moved steadily 
toward shorter lives.\2\ The asset depreciation range (ADR) system 
prescribed by the Treasury Department in 1971 explicitly allowed 
taxpayers to select depreciable lives shorter than the Treasury's 
calculation of industry average.
---------------------------------------------------------------------------
    \2\ Id., at 12-19.

    In the 1980s, Congress further embedded accelerated depreciation in 
the tax law by enacting the accelerated cost recovery system (ACRS) and 
its scaled-back version, the modified accelerated cost recovery system 
(MACRS). As the rules settled out in 1986, most types of equipment were 
depreciable over either five years or seven years. Depreciation periods 
longer than five years applied to real property, public utility 
property, some transportation property, and certain other long-lived 
assets, but those periods were shorter than the periods applicable in 
the 1970s. Accelerated methods of depreciation (such as the double 
declining balance method) continued to apply to most types of assets 
other than real property. The accelerated depreciation rules adopted in 
---------------------------------------------------------------------------
the 1980s have persisted to the present day.

    During the last 15 years, rapid recovery of capital costs has 
become even more central to the U.S. tax system as Congress has 
provided an add-on system of bonus depreciation during most of those 
years. Bonus depreciation has allowed taxpayers to deduct in the first 
year a prescribed portion of the cost of assets, ranging from 30 
percent to 100 percent, depending on the particular year. The regular 
depreciation allowance (computed with respect to portion of the cost 
basis, if any, remaining after the bonus depreciation deduction) has 
remained applicable. Most depreciable assets other than public utility 
property and other such long-lived assets are eligible for bonus 
depreciation.

    The determination by Congress in 1954 that liberal depreciation 
rules foster economic growth was reconfirmed more recently in a 
comprehensive 2007 Treasury Department study of the U.S. system for 
taxing business income. The study stated flatly that the repeal of 
incentives for domestic investment, including primarily accelerated 
depreciation ``would discourage investment and have a detrimental 
effect on economic growth.'' Reduced incentives to invest, explained 
the report, ``can hurt labor productivity, which is central to higher 
living standards for workers in the long run.'' \3\ The report went on 
to forecast that a budget-neutral tax reform measure preserving 
accelerated depreciation would boost economic growth better than a 
budget-neutral tax reform measure repealing it and, further, that a tax 
reform measure expanding accelerated depreciation would boost economic 
growth even more.\4\
---------------------------------------------------------------------------
    \3\ U.S. Department of the Treasury, Approaches to Improve the 
Competitiveness of the U.S. Business Tax System for the 21st Century, 
Dec. 20, 2007, p. 48.
    \4\ Id., at 49-50.

    In sum, accelerated depreciation represents a slow, evolutionary 
process by the federal government over more than six decades to tilt 
the federal tax system in a direction that promotes investment and 
long-term economic growth. Any tax writers considering tilting the 
system in the other direction today by curtailing accelerated 
depreciation should consider realistically the length of the road to 
restore robust investment and growth incentives to the tax code in the 
future. For most of the 30 years since the tax reform act of 1986, tax 
reformers have continually laid out tax proposals for boosting 
investment and growth--proposals like corporate integration, full 
expensing of capital equipment, consumption taxes or business activity 
taxes as a replacement for income taxes, and others. But such tax 
initiatives have proven to be dead ends, over and over, as Congress has 
reliably chosen to devote available resources to other forms of tax 
cuts or to new programs like Medicare prescription drugs and the 
---------------------------------------------------------------------------
Affordable Care Act.

    There is simply no apparent reason to think that tax writers will 
have an easier time in winning approval of pro-growth tax changes in 
coming years, given political and budget realities. The system of 
accelerated depreciation has evolved over more than six decades as a 
means of promoting investment and growth The repeal or curtailment of 
the system by Congress at this time would likely end up effectively 
amounting to a permanent change in tax law. In other words, If Congress 
were to decide to repeal or curtail the system today, there would 
probably be little realistic chance of turning back.

    Accelerated depreciation works. It is well understood by taxpayers. 
Tax writers would be abandoning six decades of evolution--much of it 
spawned by their own efforts--in abandoning accelerated depreciation 
now. The CRANE coalition urges Congress to preserve accelerated 
depreciation in any tax reform measure.

                                 ______
                                 
                Financial Executives International (FEI)

                        1250 Headquarters Plaza

                         West Tower, 7th Floor

                          Morristown, NJ 07960

                    973-765-1000 | Fax 973-765-1018

   Financial Executives International's Committee on Private Company 
                                 Policy

                      Senate Committee on Finance

             Hearing on ``Navigating Business Tax Reform''

                             April 26, 2016

Financial Executives International (FEI) represents over 10,000 Chief 
Financial Officers, Vice Presidents of Finance, Corporate Treasurers, 
Controllers and other senior financial executives from 74 chapters 
across the United States. Nearly 60% of our members work for private 
companies, and the Committee on Private Company Policy (CPC-P) focuses 
on these members' policy concerns. The following summarizes the CPC-P 
urges the Finance Committee to consider the following recommendations 
with respect to current efforts in Congress to reform the U.S. Tax 
Code.

Tax Reform

Private Companies in the U.S. Economy: Pass-through entities play a 
critical role in the U.S. economy, serving as a key source of jobs, 
wages and tax revenue in the United States. In 2011, pass-through 
entities accounted for 94% of all businesses, 64% of total net business 
income, 55% of all private sector employment, and paid more than $1.6 
trillion in wages and salaries.\1\ In 2010, private companies generated 
53% of fixed non-residential investment, and are, on average, 4 times 
more responsive to investment opportunities than public companies.\2\ 
In 2012, pass-through entities contributed nearly $840 billion in 
business AGI to individual returns.\3\ If tax reform is to have a 
meaningful impact on business investment, productivity growth and job 
creation, privately-held businesses cannot be left out of the equation.
---------------------------------------------------------------------------
    \1\ Kyle Pomerleau, ``An Overview of Pass-through Businesses in the 
United States,'' Tax Foundation, January 2015.
    \2\ John Asker et al., ``Corporate Investment and Stock Market 
Listing: A Puzzle?'', NBER, October 4, 2014.
    \3\ Joseph Rosenberg, ``Flow-Through Business Income as a Share of 
AGI,'' Tax Facts, Urban Institute, Sept. 29, 2014.

Unfairness of Current System: While pass-throughs play a critical role 
in fueling U.S. economic activity, current tax rates place them at 
competitive disadvantage that could be deepened if recent ``corporate-
only'' tax reform proposals are enacted. Since 2013, pass-throughs have 
been subjected to a higher marginal tax rate on business income than C-
corporations. Currently, the top tax rate on individuals is 39.6% while 
the top corporate tax rate is 35%. Some recent business tax reform 
proposals would lower the corporate tax rate to 25%, while leaving the 
tax rate for pass-throughs unchanged. The disparity puts privately-held 
and family-owned businesses which operate as pass throughs at a huge 
competitive disadvantage, limiting their ability to create jobs and 
invest in their businesses. For example, a C-corporation that earns $1 
million would pay nearly $350,000 in taxes at current rates. If that 
same business were organized as a partnership, it could pay as much as 
$444,000 in taxes, a difference of 27%. If corporate tax rates were 
---------------------------------------------------------------------------
lowered to 28%, that difference would grow to 59%.

Tax Rate Equivalency: To level the playing field, restore fairness to 
the tax code, and better position pass throughs to create jobs and 
increase investment, any comprehensive tax reform bill should include 
provisions that permit the bifurcation of business and other income on 
an individual's tax return, and the application of a business rate 
equivalent to the highest corporate rate.

      Congress should create an elective business equivalency rate 
(BER) on qualified active trade or business income that would ensure 
that all active business income, whether earned in a pass-through or in 
a corporation (C Corp), is taxed at a rate no higher than the maximum 
corporate rate. BER would be implemented in a two-step process:
        The pass-through entity would report qualified trade or 
business income on Schedule K-1;
        Taxpayers would report qualified business income on a new 
schedule similar to Schedule D (for capital gains) that automatically 
determines tax using the BER.
      In order to retain equivalency between pass-through and C-Corp 
rates, qualified business income would not be used when calculating 
AMT.

Territorial Tax System Access: Increasingly, large and medium-sized 
pass-throughs are net exporters, i.e., they have real business activity 
offshore. Broadly, tax reform legislation should create a territorial 
system that puts U.S. companies on an even footing with their foreign 
competition, removes disincentives for capital mobility and earnings 
repatriation, and brings U.S. rates in line with other developed 
countries.

      Current territorial tax proposals are limited to C-Corps. 
Congress should grant pass-throughs access to any new territorial tax 
regime if they are willing to pay tolling charges on retained foreign 
earnings.
      Pass-throughs have very complex international structures because 
they don't get 902 indirect credits even though they have exposure to 
Subpart F income. Some have CFCs for offshore deferral, but most use a 
combination of check the box and hybrid entities to manage tax 
exposure. A territorial system could reduce the need for this 
complexity.
      Under a territorial system, pass-throughs could establish 
specified accumulated adjustment accounts (AAA) for offshore earnings 
and the entity could make distributions comprised of proportionate 
shares of foreign and domestic earnings as disclosed in the K-1.

S-Corp Gains Recognition Period: Make permanent the reduced recognition 
period, 5 years, for built-in gains for S corporations.

Other Tax Issues

Estate Tax: While FEI supported most of the estate tax provisions in 
the American Taxpayer Relief Act of 2012, we continue to believe that 
repeal is the best solution to protect all family-owned businesses from 
the serious transition challenges posed by estate taxes, and thus 
support H.R. 1105 and S. 860.

      The estate tax is one of the largest drains on resources for 
privately held and family-owned businesses in the United States. The 
death of a shareholder in a closely held business creates a liquidity 
and tax event for the entity. To preserve the continuity of the 
business, companies often deploy techniques that pull capital out of 
the business while the principals are living to prepay the death tax 
liability. This inhibits companies from hiring workers and expanding 
their businesses. It adds significant costs for lawyers, accountants, 
life insurance contracts and management's time, in addition to funding 
the tax itself. Banks, one of the principal funding sources for private 
companies, are reluctant to lend companies money for the purpose of 
satisfying the shareholder's death tax resulting in forced sales or 
liquidations.
      It is difficult to know the value of a privately held business 
for estate tax purposes (which is often audited and ``negotiated''); 
this makes planning for the tax amount highly problematic. In many 
cases, the owners are faced with the difficult decision of selling 
their business while alive or risking them going out of business after 
their deaths.
      Consequently, if repeal is not forthcoming, in order to 
alleviate these pressures, FEI supports facilitating the election to 
allow the estate to pay the death taxes and provide a step up in basis 
to the heirs or defer the tax but keep a carry-over basis into the next 
generation.

For additional information please contact:

Brian Cove
Managing Director, Technical Activities
Financial Executives International
973-765-1092
[email protected]

                                 ______
                                 
                Like-Kind Exchange Stakeholder Coalition

May 10, 2016

The Honorable Orrin G. Hatch        The Honorable Ron Wyden
Chairman                            Ranking Member
Senate Committee on Finance         Senate Committee on Finance
219 Dirksen Senate Office Building  219 Dirksen Senate Office Building
Washington, DC 20510                Washington, DC 20510

Dear Chairman Hatch and Ranking Member Wyden:

    As the Senate Finance Committee considers ways to create jobs, grow 
the economy, and raise wages, we strongly urge you to retain current 
law regarding like-kind exchanges under section 1031 of the Internal 
Revenue Code (``Code''). Like-kind exchanges are integral to the 
efficient operation and ongoing vitality of thousands of American 
businesses, which in turn strengthen the U.S. economy and create jobs. 
Like-kind exchanges allow taxpayers to exchange their property for more 
productive like-kind property, to diversify or consolidate holdings, 
and to transition to meet changing business needs. Specifically, 
section 1031 provides that firms and investors do not immediately 
recognize a gain or loss when they exchange assets for ``like-kind'' 
property that will be used in their trade or business. They do 
immediately recognize gain, however, to the extent that cash or other 
``boot'' is received. Importantly, like-kind exchanges are similar to 
other non-recognition and tax deferral provisions in the Code because 
they result in no change to the economic position of the taxpayer.

    Since 1921, like-kind exchanges have encouraged capital investment 
in the United States by allowing funds to be reinvested in the 
enterprise, which is the very reason section 1031 was enacted in the 
first place. These investments not only benefit the companies making 
the like-kind exchanges, but also suppliers, manufacturers, and others 
facilitating them. Like-kind exchanges ensure both the best use of real 
estate and a new and used personal property market that significantly 
benefits start-ups and small businesses. Eliminating them or 
restricting their use would have a contraction effect on our economy by 
increasing the cost of capital. In fact, a recent macroeconomic 
analysis by Ernst and Young found that limitations on like-kind 
exchanges could lead to a decline in U.S. GDP of up to $13.1 billion 
annually.\1\
---------------------------------------------------------------------------
    \1\ Economic Impact of Repealing Like-Kind Exchange Rules, Ernst 
and Young (March 2015, revised November 2015), at (iii), available at 
http://www.1031taxreform.com/wp-content/uploads/EY-Report-for-LKE-
Coalition-on-macroeconomic-impact-of-repealing-LKE-rules-revised-2015-
11-18.pdf.

    Companies in a wide range of industries, business structures, and 
sizes rely on the like kind exchange provision of the Code. These 
businesses--which include construction, industrial, and farm equipment; 
vehicle manufacturers and lessors; and real estate--provide essential 
products and services to U.S. consumers and are an integral part of our 
economy. A study by researchers at the University of Florida and 
Syracuse University supports that without like-kind exchanges, 
businesses and entrepreneurs would have less incentive and ability to 
make real estate and capital investments. The immediate recognition of 
a gain upon the disposition of property being replaced would impair 
cash flow and could make it uneconomical to replace that asset.\2\ As a 
result, requiring the recognition of gain on like-kind exchanges would 
hamper the ability of businesses to be competitive in our global 
marketplace. The reduced investment in real estate and capital would 
also have significant upstream and downstream impacts on economic 
reactivity and employment in industries as diverse as real estate, 
agriculture, construction, tourism, hospitality, trucking, and 
equipment supply.
---------------------------------------------------------------------------
    \2\ David Ling and Milena Petrova, The Economic Impact of Repealing 
or Limiting Section 1031 Like-Kind Exchanges in Real Estate (March 
2015, revised June 2015), at 5, available at http://
www.1031taxreform.com/wp-content/uploads/Ling-Petrova-Economic-Impact-
of-Repealing-or-Limiting-Section-1031-in-Real-Estate.pdf.

    In summary, there is strong economic rationale, supported by recent 
analytical research, for the like-kind exchange provision's nearly 100-
year existence in the Code. Limitation or repeal of section 1031 would 
deter and, in many cases, prohibit continued and new real estate and 
capital investment. These adverse effects on the U.S. economy would 
likely not be offset by lower tax rates. Finally, like-kind exchanges 
promote uniformly agreed upon tax reform goals such as economic growth, 
---------------------------------------------------------------------------
job creation and increased competitiveness.

    Thank you for your consideration of this important matter.

    Sincerely,


 
                                                     --
 
American Car Rental Association     American Farm Bureau Federation
American Truck Dealers              American Trucking Associations
Asian American Hotel Owners         Associated General Contractors of
 Association                         America
Avis Budget Group, Inc.             CCIM Institute
C.R. England, Inc.                  Equipment Leasing and Finance
                                     Association
Federation of Exchange              Hertz Global Holdings, Inc.
 Accommodators
Idaho Dairymen's Association        Institute of Real Estate Management
National Apartment Association      National Association of Real Estate
                                     Investment Trusts
National Association of Realtors   National Automobile Dealers
                                     Association
National Multifamily Housing        National Stone, Sand, and Gravel
 Council                             Association
National Utility Contractors        The Real Estate Roundtable
 Association
Realtors Land Institute            South East Dairy Farmers Association
Truck Renting and Leasing           Western United Dairymen
 Association
 


                                 ______
                                 
                National Conference of CPA Practitioners

                     22 Jericho Turnpike, Suite 110

                           Mineola, NY 11501

                            T: 516-333-8282

                            F: 516-333-4099

May 6, 2016

The Honorable Orrin G. Hatch        The Honorable Ron Wyden
Chairman                            Ranking Member
Senate Committee on Finance         Senate Committee on Finance
219 Dirksen Senate Office Building  219 Dirksen Senate Office Building
Washington, DC 20510                Washington, DC 20510

RE: Importance of Maintaining Cash Method of Accounting

Dear Chairman Hatch and Ranking Member Wyden,

The National Conference of CPA Practitioners (NCCPAP) writes to you 
today regarding the April 26, 2016 hearing by the Senate Finance 
Committee on ``Navigating Business Tax Reform.'' NCCPAP commends your 
ongoing efforts on tax reform and strongly encourages the importance of 
maintaining the cash method of accounting, as it is currently 
permitted, as part of the Internal Revenue Code. NCCPAP is a 
professional organization that advocates on issues that affect 
Certified Public Accountants in public practice and their small 
business and individual clients located throughout the United States. 
NCCPAP members serve more than one million business and individual 
clients and are in continual communication with regulatory bodies to 
keep them apprised of the needs of the local CPA practitioner. Below is 
a copy of testimony submitted to the House Small Business Committee in 
July 2014.

Discussions surrounding the proper basis of accounting most likely 
began the moment a second basis was developed. Today, we not only have 
the two primary bases--cash and accrual--but also others including tax, 
regulatory and ``other.'' Any basis other the accrual method is 
referred to as an ``Other Comprehensive Basis of Accounting (OCBOA).'' 
For purposes of this testimony, I will be discussing the cash and 
accrual bases of accounting.

To further complicate the discussion, there are two distinct cash bases 
of accounting--cash and modified cash. Pure cash presentations in 
financial statements are very rare because cash receipts would not only 
include sales receipts but also proceeds from debt and fixed asset 
sales, and cash disbursements would include expenses, purchases of 
fixed assets, and loan repayments. This approach does not provide 
useful or realistic financial statements. Rather, a modified 
presentation. has evolved to address these concerns. Therefore, when 
the term ``cash basis of accounting'' is used, the presenter is truly 
using the modified cash basis of accounting. As such, when discussing 
the cash basis of accounting, it is really a Modified Cash Basis, but 
hereinafter will be referred to as ``cash basis.''

Under the cash basis of accounting, a taxpayer can defer income until 
cash is received but must also wait to deduct expenses until the 
amounts have actually been paid. Currently the cash basis of accounting 
is available for businesses operating as sole proprietors, S 
Corporations, partnerships that do not have a ``C'' Corporation as a 
partner, and personal service corporations (PSCs). A PSC performs 
activities in the fields of health, law, engineering, accounting, etc. 
whereby substantially all of the stock of the corporation is owned by 
employees performing services for the corporation in connection with 
those activities. In addition, some C Corporations and partnerships 
with C Corporation as partners can use the cash method if their average 
annual sales for the previous three years are less than $5 million.

Accrual accounting is considered to be the standard accounting method 
for most other companies. The accrual method provides a more accurate 
picture of the company's current financial condition, but its relative 
complexity makes it more expensive to implement. Generally, a small 
business that receives income from producing, purchasing or selling 
merchandise must compute its inventory and use the accrual method of 
accounting. However, a small business with average annual receipts of 
$1 million or less can still use the cash method and account for 
inventory as materials and supplies. The costs for these materials and 
supplies would be deducted in the year the business sells the 
merchandise or pays for the items, whichever is later. Resellers with 
gross receipts of $10 million or less are not required to use the 
accrual method of accounting.

Currently, if a small business has sales that require an accrual method 
of accounting or if the business simply wishes to convert from the cash 
method to the accrual method they must file IRS Form 3115, Application 
for Change in Accounting Method. The filing of this form is a request 
for a change in accounting method, not a guarantee. In preparing this 
form, the taxpayer must take into account any and all changes required 
to convert to an accrual basis as well as pay a filing fee.

The need for the accrual method arose out of the increasing complexity 
of business transactions and a desire for more accurate financial 
information. Selling on credit and projects that provide revenue 
streams over a long period of time affect the company's financial 
condition at the point of the transaction. Therefore, it usually makes 
sense that such events should also be reflected on the financial 
statements during the same reporting period that these transactions 
occur.

The form to request a Federal Employer ID number (EIN) requires that an 
accounting method for the business must be selected. This form is 
completed prior to the business opening. Often, the primary 
understanding of accounting and record keeping of the business owner(s) 
falls under the cash basis of accounting. Throughout their adult lives, 
as individuals they have received W2s, 1099s, 1098s, and/or real estate 
bills. All of these documents were prepared under the cash basis of 
accounting. In fact, almost all personal tax returns are prepared on a 
cash basis of accounting. Therefore, when opening a business or even 
purchasing a rental property, the cash basis of accounting is the 
initial thought that comes to mind for the taxpayer.

In establishing a business, hopefully the business owners have 
consulted with professionals--attorneys to incorporate the entity, if 
applicable, and CPAs to ensure the proper business structure. Part of a 
CPA's job is to ensure that taxpayers comply with the tax codes so that 
they pay their fair share of taxes. Many business owners want to 
incorporate their business believing that there are special tax 
advantages, such as fewer tax audits. They don't realize that there are 
other considerations including keeping separate books and records, 
paying themselves a salary as an incorporated business is required to 
do, additional tax files, and the list goes on.

In recent years, Limited Liability Companies (LLCs) have become a 
common choice of business structure of the new small business. Often, 
however, the business owner is not aware of the various tax 
ramifications. If there is only one owner, the business is taxed as a 
sole proprietor and all of the business activity will be reported on 
Schedule C of the owner's individual tax return. With multiple owners, 
the entity would be taxed as a partnership. The entity can elect to be 
taxed as an S-Corporation regardless of the number of owners provided 
that none of the owners are corporations. Under the rules of S 
Corporations, owners with greater than a five percent ownership 
interest are required to draw reasonable compensation in the form of a 
salary where the tax withholdings can be sufficient to remove the 
burden of making quarterly estimated tax payments as individuals.

Regardless of whether the entity is taxed as an S corporation or 
partnership, the owners are subject to pass-through income based upon 
their ownership interest or partnership agreement. Often, this income 
relates to funds that are not always immediately available for 
distribution to the owner(s), which may be another challenge to 
taxpayers who have to follow accrual based accounting as this may 
trigger phantom income. Owner(s) may choose to keep the net income in 
the business to help fund expansion, debt service or unpaid bills. 
Countless times during tax season after the owner(s) receive Form K-1 
from their partnership or S corporation, we have to explain to business 
owners why they are paying taxes on business income that they have not 
received. This is what is referred to as pass-through income of the 
business and is taxed at the individual level--frequently at lower tax 
rates than if taxed at corporate levels. Further complicating pass-
through income is the fact that most partnership income is also subject 
to self-employment taxes.

Many small businesses still operate under the cash basis for tax 
purposes but opt to prepare accrual basis financial statements, as this 
may show them in a better financial position. This is often the case 
when there is a need for financing. In addition, many banks prefer an 
accrual basis as it provides them a more comprehensive view of the 
financial position of the entity because of the inclusion of accounts 
receivable and accounts payable in the financial statements.

Often business owners do not have the accounting background to properly 
and adequately track and report revenue and expenses in any manner 
other than cash basis without the assistance of CPAs, EAs, accountants 
and bookkeepers. Many owners simply think on the basis of cash in and 
cash out and give their accountants their bank statements, check stubs 
and invoices to prepare their financial books which are used solely to 
prepare their tax returns. Many small business owners do not have 
systems in place to fully track accounts receivable or accounts 
payable. Once the financial activity is recorded, small business owners 
would then need to adjust these statements into an accrual basis. These 
adjustments can include uncollected revenue, unpaid payroll and related 
liabilities, prepaid expenses, inventory, etc. Not only will the owners 
be responsible for knowing what adjustments need to be made, they also 
must be able to determine the valuation of these adjustments.

Despite the business owner's reliance on accounting professionals, the 
fiscal responsibility still falls on the owners. The business owners 
are and will remain responsible for all of the information that appears 
on their tax returns. The fact that their tax returns are 
professionally prepared does not alleviate the taxpayer responsibility 
for the accuracy of the data contained in the tax returns, but many 
business owners may not have the financial background to make this 
determination using the accrual basis of accounting.

If small businesses were required to convert their accounting method to 
the accrual basis, the overall impact might simply be a ``one-time'' 
hit. Meaning, once the conversion is complete, the annual effect might 
not be as significant as one might expect. The ``one-time'' hit, 
however, could be very significant depending on the business. Newer 
entities or entities with minimal accounts receivable or accounts 
payable would likely have a small tax increase and possibly even a tax 
decrease. Entities with a larger receivable base, however, would not be 
so fortunate. To properly convert, they would need to report all open 
receivables as current income and all unpaid bills as current expenses. 
The impact of this added income could propel the owners into higher tax 
brackets, which in turn could lead to the phase-outs of itemized 
deductions and personal exemptions, phase-outs of other deductions and 
credits including tuition and student loans when the increased income 
is reported on their individual income tax returns. In addition, 
taxpayers may find themselves subject to the 3.9% Net Investment Income 
surtax that became effective last year.

These tax increases will not just affect the taxpayer's federal income 
tax. Rather, additional state and local taxes may also be due because 
state and local tax returns usually have to be filed on the same basis 
as the federal tax returns. Further, many municipalities also impose a 
tax on gross receipts of all businesses.

As discussed throughout the testimony, taxpayers often are unaware of 
the differences in accounting methods. If they were required to 
convert, this obviously creates a major business opportunity for CPAs, 
EA, bookkeepers, etc. Unfortunately, this will also open the door for 
unregulated preparers to take advantage of unknowing taxpayers and 
utilize creative accounting.

Over the last few years, I have attended many IRS meetings, including 
National Public Liaison (NPL) and Working Together Forums. If there is 
one common thread that has been resonating from the IRS, it has been to 
reduce taxpayer burden. While this can mean many things, ultimately I 
believe that the IRS realizes that business and taxes in today's 
economy have gotten even more complicated. The current tax code makes 
compliance even more complicated. In working to reduce the tax 
compliance burden, the IRS representatives have stressed the importance 
of e-Filing tax returns and have improved upon every tax season, added 
additional features to their website such as ``where's my amended 
return'' that allows taxpayers to track the processing of amended tax 
returns. Further, discussions have also centered on what can be done to 
ease the stress of taxpayers from regular tax filings and to respond to 
IRS notices that are sent. Requiring taxpayers to change their 
accounting methods without any specific reasons would truly be in 
conflict to what the IRS has been working to achieve.

In conclusion, after reviewing the facts surrounding the differences 
between cash and accrual basis accounting, I feel that the use of cash 
basis for small firms remains of great importance and should be 
continued. It is a method that is consistent with how the owners have 
been taxed throughout their lives on their personal tax returns and how 
they realistically live. Converting to an accrual basis would add an 
additional burden onto them--financial. They would need to retain 
accounting professionals to guide them in this process. The Federal 
Government would achieve what can best be described as a ``one-time'' 
boost of tax revenue from the conversion. Taxpayers would be paying 
taxes on net income that neither they nor the business has received and 
this tax increase will include federal, state and local taxes. If the 
taxpayer has uncollectable aged accounts receivable, the taxpayer will 
be able to then write off this revenue and potentially send 
cancellation of debt notices (a 1099C) to those who owe money to the 
business. If the business subsequently pays the old accounts 
receivable, the income would be reported at that time and a method 
would have to be developed to reverse the cancellation of debt notice. 
The end result would be that the taxpayer has reduced his or her tax 
burden and the effect of the conversion to accrual basis is further 
diminished.

All businesses have the opportunity to elect to track their accounting 
on an accrual basis. Not all have the opportunity to account on a cash 
basis. Some larger entities and many of those with inventory are 
required to account on an accrual basis. However, the majority of 
businesses are permitted to choose their accounting method. With the 
guidance of financial professionals, they are able to elect the most 
appropriate accounting method for their specific business. Forcing a 
business to use the accrual basis not only complicates their business 
but also requires the owners to take time away from operations to focus 
on changing an accounting method. Ultimately, one does not start a 
business to focus on accounting. Forcing this change will do just that.

Sincerely,

Stephen F. Mankowski, CPA, CGMA
Executive, VP, NCCPAP
                                 ______
                                 
              National Multifamily Housing Council (NMHC) 
                  National Apartment Association (NAA)
The National Multifamily Housing Council (NMHC) and National Apartment 
Association (NAA) respectfully submit this statement for the record for 
the Senate Finance Committee's April 26, 2016, business tax reform 
hearing titled ``Navigating Business Tax Reform.''

For more than 20 years, NMHC and NAA have partnered in a joint 
legislative program to provide a single voice for America's apartment 
industry. Our combined memberships are engaged in all aspects of the 
apartment industry, including ownership, development, management and 
finance. NMHC represents the principal officers of the apartment 
industry's largest and most prominent firms. As a federation of nearly 
170 state and local affiliates, NAA encompasses over 69,000 members 
representing more than 8.1 million apartment homes throughout the 
United States and Canada.

Background on the Multifamily Housing Sector

Prior to addressing the multifamily housing industry's recommendations 
for tax reform, it is worthwhile to take a moment and note the 
fundamental role multifamily housing plays in providing safe and decent 
shelter to millions of Americans, as well as the sector's considerable 
impact on our nation's economy.

Today, 110 million Americans, over one-third of all Americans, rent 
their housing (whether in an apartment home or single-family home).\1\ 
There are 18.3 million renter households, or over 15 percent of all 
households, who live in apartments (properties with five or more 
units).\2\ On an aggregate basis, the value of the entire apartment 
stock is $3.3 trillion.\3\ Our industry and its 37.8 million residents 
contributed $1.3 trillion to the national economy in 2013 while 
supporting 12.3 million jobs.\4\
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    \1\ 2014 American Community Survey, 1-Year Estimates. U.S. Census 
Bureau, ``Total Population in Occupied Housing Units by Tenure.''
    \2\ 2014 American Community Survey 1-Year Estimates, U.S. Census 
Bureau, ``Tenure by Units in Structure.''
    \3\ NMHC estimate based on a report by Rosen Consulting. Updated 
June 2014.
    \4\ National Apartment Association and National Multifamily Housing 
Council.

The U.S. is on the cusp of fundamental change in our housing dynamics 
as shifting demographics and housing preferences drive more people away 
from the typical suburban house. Rising demand is not just a 
consequence of the bursting of the housing price bubble. In the 5 years 
ending in 2015, the number of renters was up by 6.6 million; the number 
of homeowners was up by less than 400,000. Compared with 10 years ago, 
there were 10.8 million new renter households and just 605,000 new 
owner households. In other words, the growth in renter households 
precedes the 2008 housing crisis.\5\
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    \5\ NMHC tabulations of 2015, 2010, and 2005 Current Population 
Survey, Annual Social and Economic Supplement, U.S. Census Bureau.

Changing demographics are driving the demand for apartments. Married 
couples with children now represent only 21 percent of households. 
Single-person households (28 percent), single parent households (9 
percent) and roommates (6 percent) collectively account for 43 percent 
of all households, and these households are more likely to rent.\6\ 
Moreover, the surge toward rental housing cuts across generations. In 
fact, fully 75 million Baby Boomers (those born between 1946 and 1964), 
as well as other empty nesters, have the option of downsizing as their 
children leave the house and many will choose the convenience of 
renting.\7\ Over half (57.5 percent) of the net increase in renter 
households from 2005 to 2015 came from householders 45 years or 
older.\8\
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    \6\ 2015 Current Population Survey, Annual Social and Economic 
Supplement, U.S. Census Bureau, ``America's Families and Living 
Arrangements: 2015: Households'' (H table series), table H3/Family 
groups (FG series), table FG6.
    \7\ Annual Estimates of the Resident Population by Single Year of 
Age and Sex for the United States: April 1, 2010 to July 1, 2014, U.S. 
Census Bureau. Baby Boomers are defined as those born 1946 through 
1964.
    \8\ NMHC tabulations of 2015 Current Population Survey, Annual 
Social and Economic Supplement, U.S. Census Bureau.

Unfortunately, the supply of new apartments is falling well short of 
demand. An estimated 300,000 to 400,000 units a year must be built to 
meet expected demand; yet, on average, just 208,000 apartments were 
delivered from 2011-2015.\9\ Furthermore, according to Harvard's 
America's Rental Housing, the number of renter households could rise by 
more than 4.4 million in the next decade (depending upon the rate of 
immigration).\10\
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    \9\ U.S. Census Bureau, New Residential Construction, updated 
February 2016.
    \10\ Harvard Joint Center for Housing Studies, ``America's Rental 
Housing'' (2015).
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Key Priorities for Tax Reform

Owners, operators, and developers of multifamily housing, who favor 
pro-growth tax reform that does not disadvantage multifamily housing 
relative to other asset classes, have a considerable stake in the 
outcome of the debate over how to reform and simplify the nation's tax 
code. Industry participants pay federal tax at each stage of an 
apartment's lifecycle. Put another way, federal taxes are paid when 
properties are built, operated, sold or transferred to heirs.

In providing our recommendations, which we respectfully make below, we 
are guided by the principle that real estate relies on the free-flow of 
capital and that investment decisions are driven by after-tax rates of 
return rather than solely on statutory tax rates. Thus, the number of 
layers of taxation, the marginal rate of tax imposed on income, cost 
recovery rules, investment incentives and taxes imposed when properties 
are sold, exchanged or transferred to heirs are all critical in 
assessing the viability of an investment. In developing reform 
proposals, we recommend that Congress certainly consider--but also look 
well beyond--lowering statutory tax rates and focus on the ability of a 
reformed system to efficiently allocate capital and drive job-creating 
business investment. As is outlined in the pages below, NMHC/NAA 
believe that any tax reform proposal must:

      Protect Pass-Through Entities from Higher Taxes or Compliance 
Burdens;
      Ensure Depreciation Rules Avoid Harming Multifamily Real Estate;
      Retain the Full Deductibility of Business Interest;
      Preserve the Ability to Conduct Like-Kind Exchanges;
      Maintain the Current Law Tax Treatment of Carried Interest;
      Preserve and Strengthen the Low-Income Housing Tax Credit;
      Maintain the Current Law Estate Tax;
      Reform the Foreign Investment in Real Property Tax Act to 
Promote Investment in the Domestic Apartment Industry; and
      Improve Incentives for Energy Efficiency in Commercial Buildings 
and Multifamily Properties

Priority 1: Tax Reform Must Not Harm Pass-Through Entities

The multifamily industry is dominated by ``pass-through'' entities 
(e.g., LLCs, partnerships and S corporations) instead of publicly held 
corporations (e.g., C corporations). Indeed, over three-quarters of 
apartment properties are owned by pass-through entities.\11\ This means 
that a company's taxable income is passed through to the partners, who 
pay taxes on their share of the income on their individual tax returns. 
This treatment contrasts with the taxation of large publicly held 
corporations that generally face two levels of tax. Those entities 
remit tax at the corporate level under the corporate tax system. 
Shareholders are then taxed upon the receipt of dividend income.
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    \11\ U.S. Census Bureau and U.S. Department of Housing and Urban 
Development, Rental Housing Finance Survey, 2012.

The multifamily industry opposes any tax reform effort that would lead 
to higher taxes or compliance burdens for pass-through entities. For 
example, given that Congress raised marginal tax rates on ordinary 
income to as high as 39.6 percent as part of the American Taxpayer 
Relief Act of 2012 (Pub. L. 112-240), rates should certainly not be 
increased once again. Additionally, while many are calling for a 
reduction in the nation's 35 percent corporate tax rate, flow-through 
entities should not be called upon to make up the lost revenue from 
this change. Finally, a corporate rate cut should not be financed by 
denying flow-through taxpayers credits and deductions.

Priority 2: Ensure Depreciation Rules Avoid Harming Multifamily Real 
                    Estate

Enabling multifamily developers to recover their investment through 
depreciation rules that reflect underlying economic realities promotes 
apartment construction, economic growth and job creation. Tax reform 
should ensure that depreciation tax rules match the economic life of 
assets by taking into account natural wear and tear and technological 
obsolescence.

NMHC/NAA note that while we support depreciation periods that are set 
prospectively and reflect the economic lives of underlying assets, a 
retroactive cost-recovery proposal made in the 113th Congress by the 
staff of former Senate Finance Committee Chairman Baucus would have had 
a devastating effect on the apartment industry's ability to construct 
new apartment buildings, particularly when, as noted above, supply 
continues to fall short of demand. Former Chairman Baucus' staff 
discussion draft proposed to retroactively extend the tax recovery 
period for multifamily buildings from 27.5 years to 43 years \12\ (a 
period well beyond economic life). The Baucus staff discussion draft 
also would have increased the 25 percent tax rate on recaptured 
depreciation to the ordinary income rate.\13\ As with the change to 
depreciation rules, this proposal would also have been applied 
retroactively. We are extremely pleased that the cost recovery 
legislation proposed by current Finance Committee Ranking Member Wyden 
on April 26, 2016, would leave the depreciation of multifamily property 
at 27.5 years.\14\
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    \12\ United States Senate Committee on Finance, Cost Recovery and 
Accounting Staff Discussion Legislative Language, November 21, 2013. 
Section 11, Pooled asset cost recovery system and depreciation of real 
property.
    \13\ United States Senate Committee on Finance, Cost Recovery and 
Accounting Staff Discussion Legislative Language, November 2013, 
Section 12, Rules related to treatment of gains from depreciable 
property.
    \14\ Senator Wyden, Cost Recovery Reform and Simplification Act of 
2016, Section 2, Pooled Asset Cost Recovery System and Depreciation of 
Straight Line Property.

Extending the straight-line recovery period for residential rental 
property from 27.5 years to 43 years would reduce a multifamily 
operator's annual depreciation deduction by 36 percent. By creating an 
arbitrary and discriminatory cost recovery system that does not reflect 
the economic life of actual structures, the proposal would diminish 
investment and development in multifamily properties, drive down real 
estate values and stifle the multifamily industry's ability to continue 
creating new jobs. Put another way, the proposal would significantly 
impact cash flows and investment returns that are at the heart of a 
developer's analysis of whether a particular project is economically 
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viable.

Furthermore, it is not just property owners who would suffer the 
consequences of depreciation periods that do not reflect the economic 
life of underlying assets. For example, pension plans and life 
insurance companies, which provide retirement and income security to 
millions of working Americans and retirees, could be harmed as their 
real estate investments lose value. Local governments would also see 
lower revenues as the value of multifamily properties decline, leaving 
a smaller amount of property taxes to finance core services, including 
law enforcement and schools. In this regard, the Tax Foundation in 2013 
found that at 35 percent of total revenues collected:

        Property taxes were the most prominent source of state and 
        local tax revenues in Fiscal Year 2010. This category includes 
        both commercial and residential real estate in addition to 
        personal property tax revenues obtained from taxes on cars, 
        boats, etc. Residential and commercial real estate are often a 
        source of local tax revenue, while personal property taxes are 
        often a source of state tax revenues.\15\
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    \15\ Liz Malm and Ellen Kant, Tax Foundation, The Sources of State 
and Local Tax Revenues, January 28, 2013.

As noted above, the apartment industry supports depreciation periods 
that match the economic life of assets. We believe that Congress must 
use credible and contemporary research to set depreciation periods and 
should do so on a prospective basis. NMHC/NAA note that to arrive at a 
43-year depreciation schedule for real property, former Chairman 
Baucus' staff relied on assistance from the Congressional Budget Office 
that used data that is 40 years to 50 years old.\16\ In particular, the 
estimates for the economic rate of depreciation for structures come 
from a Treasury study published in 1975 and a study by the National 
Bureau of Economic Research from 1963. These outdated studies do not 
reflect current economic realities, the degree of obsolescence caused 
by increasingly sophisticated technology now commonly found in 
buildings or the manner in which contemporary buildings are designed.
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    \16\ The Congressional Budget Office released a letter in November 
2013 that states, ``CBO was asked [by Finance Committee staff] to 
estimate the length of the period under the straight-line approach that 
would generate the same value of depreciation deductions for real 
property as would applying the average economic depreciation rate after 
adjusting for inflation. CBO estimates that period to be 43 years.'' 
Letter from CBO Director Douglas W. Elmendorf to Chairman Max Baucus, 
Information on the Depreciation of Assets (November 21, 2013), http://
www.cbo.gov/publication/44911. A footnote in the CBO letter states: 
``The U.S. Bureau of Economic Analysis (BEA) computes economic 
depreciation rates for most asset types, which occasionally vary by 
industry (see BEA Depreciation Estimates, 2004, www.bea.gov/national/
FA2004/Tableandtext.pdf).'' The data on which BEA relies is from 
National Bureau of Economic Research and Treasury Department studies 
conducted in the 1960s and 1970s.

NMHC/NAA recommend that the Finance Committee consider a recent study 
that suggests the depreciation of multifamily buildings should 
certainly be no longer than the current-law 27.5-year period and 
perhaps shorter. In particular, David Geitner and Sheharyar Bokhari of 
the MIT Center for Real Estate in November 2015 published a paper, 
Commercial Buildings Capital Consumption in the United States, which 
represents the first comprehensive study on this topic in nearly 40 
years.\17\ By including capital improvement expenditures, the MIT study 
finds that residential properties net of land depreciate at 7.3 percent 
per year on average, which is a significantly faster rate than 
previously understood. Translated into tax policy terms, we believe 
this data shows that the current-law 27.5-year depreciation period 
overstates the economic life of an underlying multifamily asset.
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    \17\ David Geitner and Sheharyar Bokhari, MIT Center for Real 
Estate, Commercial Buildings Capital Consumption in the United States, 
November 2015.

Finally, a note is warranted regarding so-called deprecation recapture. 
Under current law, when a multifamily property is sold, there are two 
types of taxes that apply. First, gain from the sale of the property is 
taxed as a capital gain, typically at a rate of 20 percent for a 
general partner. Second, the portion of the gain attributable to prior 
depreciation deductions is generally subject to a 25 percent tax. This 
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second tax is referred to as depreciation recapture.

Former Chairman Baucus's staff discussion draft proposed to 
retroactively repeal the 25 percent depreciation recapture rate and tax 
all depreciation recapture as ordinary income, potentially at rates of 
up to 39.6 percent.\18\ NMHC/NAA believe that depreciation recapture 
taxes as they stand today already can have a pernicious effect on 
property investment and should, at the very least, be left at current 
law rates.
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    \18\ Chairman Baucus's staff discussion draft proposal did not set 
new and potentially lower rates for ordinary income, but the current-
law top rate is 39.6 percent.

After decades of operations, many multifamily owners have a very low 
tax basis in their properties. If they were to sell them, they, even 
under current law, would have to pay large depreciation recapture 
taxes. To avoid this huge tax bill, many current owners will not only 
avoid selling their properties, but they will also be reluctant to make 
additional capital investments in properties with little value. The 
result is deteriorating properties that are lost from the stock of 
safe, affordable housing. The other alternative is for the long-time 
owners to sell their properties to an entity that is able to pay a 
large enough sales price to cover the recapture taxes. To make their 
investment pay off, however, the new owner will likely convert the 
property to higher, market-rate rents, meaning a loss of our nation's 
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affordable housing stock.

Therefore, either scenario can have the same result: the possible loss 
of hundreds of thousands of affordable housing units. Increasing 
depreciation recapture taxes will exacerbate this result and further 
discourage owners from selling these properties to entities that can 
retain them as affordable housing.

Priority 3: Retain the Full Deductibility of Business Interest

Under current law, business interest is fully deductible. However, 
deduction for business interest expenses should be curtailed. 
Unfortunately, curtailing this deductibility would greatly increase the 
cost of debt financing necessary for multifamily projects, curbing 
development activity.

As mentioned above, over three-quarters of multifamily properties are 
owned by pass-through entities. Although such entities can access 
equity from investors, they must generally borrow a significant portion 
of the funds necessary to finance a multifamily development. In fact, a 
typical multifamily deal might consist of 65 percent debt and 35 
percent equity. Because such entities often look to debt markets, which 
lend money at a rate of interest, to garner capital, the full 
deductibility of interest expenses is critical to promoting investment. 
Indeed, according to the Federal Reserve, as of December 31, 2015, 
total multifamily debt outstanding was $1,098.8 billion.\19\ Reducing 
the full deductibility of interest would undoubtedly increase 
investment costs for owners and developers of multifamily housing and 
negatively impact aggregate construction.
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    \19\ Board of Governors of the Federal Reserve System, Mortgage 
Debt Outstanding, By type of property, multifamily residences, 2015Q4, 
March 2015.

In addition to harming the multifamily industry, it is also instructive 
to note that modifying the full deductibility of business interest 
would be precedent setting. In fact, Drs. Robert Carroll and Thomas 
Neubig of Ernst and Young LLP concluded in their analysis, Business Tax 
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Reform and the Tax Treatment of Debt:

        The current income tax generally applies broad income tax 
        principles to the taxation of interest. Interest expenses paid 
        by borrowers are generally deductible as a business expense, 
        while interest income received by lenders is generally 
        includible in income and subject to tax at applicable recipient 
        tax rates. With this treatment, interest income is generally 
        subject to one level of tax under the graduated individual 
        income tax rates. This is the same manner in which most other 
        business expenses, such as wages payments to employees, are 
        taxed, and also follows the practice in other developed 
        nations.\20\
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    \20\ Drs. Robert Carroll and Thomas Neubig, Business Tax Reform and 
the Tax Treatment of Debt: Revenue neutral rate reduction financed by 
an across-the-board interest deduction limit would deter investment, 
Ernst and Young LLP, May 2012, p. 3.
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Priority 4: Preserve the Ability to Conduct Like-Kind Exchanges

Since 1921, the Internal Revenue Code has codified the principle that 
the exchange of one property held for business use or investment for a 
property of a like-kind constitutes no change in the economic position 
of the taxpayer and, therefore, should not result in the imposition of 
tax. This concept is codified today in section 1031 of the Internal 
Revenue Code with respect to the exchange of real and personal 
property,\21\ and it is one of many non-recognition provisions in the 
Code that provide for deferral of gains.\22\ The Obama Administration's 
Fiscal Year 2017 budget targeted section 1031 by substantially 
restricting the provision with respect to real property by limiting the 
amount of gain that may be deferred to $1 million annually.\23\ Former 
Senate Finance Committee Chairman Baucus' November 2013 staff 
discussion draft proposal sought to repeal the ability to undertake 
like-kind exchanges.\24\ Notably, however, Ranking Member Wyden's cost 
recovery proposal released on April 26, 2016, would appropriately 
retain current-law like-kind exchange rules for real property.\25\
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    \21\ Section 1031 permits taxpayers to exchange assets used for 
investment or business purposes, including multifamily properties, for 
other like-kind assets without the recognition of gain. The tax on such 
gain is deferred, and, in return the taxpayer carries over the basis of 
the original property to the new property, losing the ability to take 
depreciation at the higher exchange value. Gain is immediately 
recognized to the extent cash is received as part of the like-kind 
exchange, and the taxes paid on such gain serve to increase the newly 
acquired property's basis. Congress has largely left the like-kind rule 
unchanged since 1928, though it has narrowed its scope.
    The like-kind exchange rules are based on the concept that when one 
property is exchanged for another property, there is no receipt of cash 
that gives the owner the ability to pay taxes on any unrealized gain. 
The deferral is limited to illiquid assets, such as real estate, and 
does not extend to investments that are liquid and readily convertible 
to cash, such as securities. Furthermore, the person who exchanges one 
property for another property of like-kind has not really changed his 
economic position; the taxpayer, having exchanged one property for 
another property of like-kind is in a nearly identical position to the 
holder of an asset that has appreciated or depreciated in value, but 
who has not yet exited the investment.
    \22\ Under the tax code, the mere change in value of an asset, 
without realization of the gain or loss does not generally trigger a 
taxable event. In such situations, the proper tax treatment is to defer 
recognition of any gain and maintain in the new property the same basis 
as existed in the exchanged property. This is similar in concept to 
other non-recognition tax deferral provisions in the tax code, 
including property exchanges for stock under Section 351, property 
exchanges for an interest in a partnership under section 721, and stock 
exchanges for stock or property under section 361 pursuant to a 
corporate reorganization.
    \23\ Department of the Treasury, General Explanations of the 
Administration's Fiscal Year 2017 Revenue Proposals, Modify Like-Kind 
Exchange Rules, p. 107.
    \24\ United States Senate Committee on Finance, Cost Recovery and 
Accounting Staff Discussion Legislative Language, November 2013, 
Section 15, Repeal of like-kind exchanges.
    \25\ Senator Wyden, Cost Recovery Reform and Simplification Act of 
2016, Section 2, Pooled Asset Cost Recovery System and Depreciation of 
Straight-Line Property.

Like-kind exchanges play a significant role and are widely used in the 
multifamily industry. Current-law like-kind exchange rules enable the 
smooth functioning of the multifamily industry by allowing capital to 
flow more freely, which, thereby, supports economic growth and job 
creation. Multifamily property owners use section 1031 to efficiently 
allocate capital to optimize portfolios, realign property 
geographically to improve operating efficiencies and manage risk. By 
increasing the frequency of property transactions, the like-kind 
exchange rules facilitate a more dynamic multifamily sector that 
supports additional reinvestment and construction activity in the 
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apartment industry.

According to recent research by Drs. David C. Ling and Milena Petrova 
regarding the economic impact of repealing like-kind exchanges for real 
estate and the multifamily industry in particular:\26\
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    \26\ David C. Ling and Milena Petrova, The Economic Impact of 
Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate, 
June 2015.

      Assuming a typical 9-year holding period, apartment rents would 
have to increase by 11.8 percent to offset the taxation of capital 
gains and depreciation recapture income at rates of 23.8 percent and 25 
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percent, respectively.

      Whether based on the number of transactions or dollar volume, 
multifamily properties, both large and small, are the property type 
most frequently acquired or disposed of with an exchange.

      Governments collect 19 percent more taxes on commercial 
properties sold following a like-kind exchange than by an ordinary 
sale.

      Nearly 9 in 10 (88 percent) of commercial properties acquired by 
a like-kind exchange result in a taxable sale in the very next 
transaction. Thus, like-kind exchange rules are not used to 
indefinitely defer taxes.

Additional recent research suggests that like-kind exchanges play such 
a critical role in driving investment that repealing the ability to 
conduct them would harm the economy even if the resulting revenue were 
used to reduce tax rates. Indeed, Ernst and Young LLP, in a March 2015 
analysis, estimates that repealing like-kind exchange rules and using 
the resulting revenue to enact a revenue-neutral corporate income tax 
rate reduction or a revenue-neutral business sector income tax 
reduction (i.e., encompassing both C corporations and flow-through 
entities) would reduce Gross Domestic Product (GDP) by $8.1 billion 
each year and $6.1 billion each year, respectively.\27\ Put another 
way, a tax rate reduction financed by repealing like-kind exchange 
rules would, on a net basis, harm the economy.
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    \27\ Ernst and Young LLP, Economic impact of repealing like-kind 
exchange rules, March 2015.

One of the main reasons that GDP would decrease if the like-kind 
exchange rules were repealed is that such a policy would increase the 
cost of capital and, therefore, negatively impact investment, a key 
ingredient of economic growth. Indeed, Ernst and Young LLP data shows a 
repeal of like-kind exchange rules would cause overall investment in 
the economy to decline by $7.0 billion per year if revenue from repeal 
were used to reduce corporate tax rates and by $4.8 billion per year if 
revenue from repeal were used to reduce business sector income tax 
rates.\28\
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    \28\ Ibid.

Ernst and Young LLP summed up its analysis of how repealing like-kind 
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exchanges would impair investment by concluding:

        While repealing like-kind exchange rules could help fund a 
        reduced corporate income tax rate, its repeal increases the tax 
        cost of investing by more than a corresponding revenue neutral 
        reduction in the corporate tax rate. That is, rather than 
        making the United States a more attractive place to invest, 
        these results suggest this policy shift would leave the United 
        States a less attractive place to invest.\29\
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    \29\ Ibid.

This result, of course, moves in the opposite direction of one of the 
stated goals for tax reform put forward by many of its proponents.

Priority 5: Maintain the Current Law Tax Treatment of Carried Interest

NMHC/NAA would also like to use this opportunity to underscore our 
strong opposition to proposals to change the current law governing the 
tax treatment of carried interest. If enacted, this proposal would 
significantly reduce the ability to develop or rehab apartments across 
the nation.

A carried interest, also called a ``promote,'' has been a fundamental 
part of real estate partnerships for decades. Investing partners grant 
this interest to the general partners to recognize the value they bring 
to the venture as well as the risks they take. Such risks include 
responsibility for recourse debt, litigation risks and cost overruns, 
to name a few.

Current tax law, which treats carried interest as a capital gain, is 
the proper treatment of this income because carried interest represents 
a return on an underlying long-term capital asset, as well as risk and 
entrepreneurial activity. Extending ordinary income treatment to this 
revenue would be inappropriate and result in skewed and inconsistent 
tax treatment vis-a-vis other investments. Notably, any fees that a 
general partner receives that represent payment for operations and 
management activities are today properly taxed as ordinary income.

Taxing carried interest at ordinary income rates would adversely affect 
real estate partnerships. At a time when the nation already faces a 5.3 
million unit shortage of affordable rental housing, increasing the tax 
rate on long-term capital gains would discourage real estate 
partnerships from investing in new construction. Furthermore, such a 
reduction would translate into fewer construction, maintenance, on-site 
employee and service provider jobs during a period in which the 
unemployment rate remains abnormally high.

Notably, former House Ways and Means Committee Chairman Camp recognized 
the devastating impact that a change in the manner in which carried 
interest is taxed would have on commercial real estate when he 
specifically exempted real estate from a change he sought to the 
taxation of carried interest in his Tax Reform Act of 2014.\30\ 
Moreover, in 2010, both the U.S. Conference of Mayors and the National 
Association of Counties passed resolutions opposing the carried 
interest proposal as it relates to real estate partnerships and urged 
Congress to maintain the current law capital gains treatment of carried 
interest, noting that any change would bring extremely negative 
consequences to communities throughout the country.\31\
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    \30\ H.R. 1, Tax Reform Act of 2014, Section 3621, Ordinary income 
treatment in the case of partnership interest held in connection with 
performance of services.
    \31\ Resolutions Adopted by the Members of the U.S. Conference of 
Mayors, Carried Interest, 78th Winter Meeting, Washington, DC, 2010, 
http://www.usmayors.org/resolutions/78th_
Winter_Conference/res_Carriedinterest.pdf.
    National Association of Counties, Resolution Urging Congress to 
Maintain the Current Capital Gains Tax Treatment of ``Carried 
Interest'' Used by Real Estate Partnerships, Adopted March 8, 2010. 
https://www.novoco.com/hottopics/resource_files/naco_carried-
interest_030910.pdf

Finally, some in Congress see the tax revenue generated by the carried 
interest proposal as a way to offset the cost of other tax changes. 
Enacting a bad tax law, such as changing the taxation of carried 
interest, merely to gain revenue to make other tax changes, is a 
distorted view of good tax policy, which demands that each tax proposal 
be judged on its individual merits.

Priority 6: Preserve and Strengthen the Low-Income Housing Tax Credit

The Low-Income Housing Tax Credit (LIHTC) has a long history of 
successfully generating the capital needed to produce low-income 
housing while also enjoying broad bipartisan support in Congress. This 
public/private partnership program has led to the construction of 
nearly 2.8 million units since its inception in 1986.\32\ The LIHTC 
program also allocates units to low-income residents while helping to 
boost the economy. In fact, according to a December 2014 Department of 
Housing and Urban Development study, Understanding Whom the LIHTC 
Program Serves: Tenants in LIHTC Units as of December 31, 2012, the 
median income of a household residing in a LIHTC unit was $17,066 \33\ 
with just under two-thirds of residents earning 40 percent or less of 
area median income.\34\ Finally, the National Association of Home 
Builders reports that, in a typical year, LIHTC development supports 
approximately: 95,700 jobs; $3.5 billion in federal, state and local 
taxes; and $9.1 billion in wages and business income.\35\
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    \32\ National Council of State Housing Agencies, 2015 Housing 
Credit Q&A, February 25, 2015, https://www.ncsha.org/resource/2015-
housing-credit-qa.
    \33\ Department of Housing and Urban Development, Understanding 
Whom the LIHTC Program Serves: Tenants in LIHTC Units as of December 
31, 2012, December 2014, p. 23.
    \34\ Ibid, p. 24.
    \35\ Robert Dietz, The Economic Impact of the Affordable Housing 
Credit, National Association of Home Builders, Eye on Housing, July 15, 
2014, http://eyeonhousing.org/2014/07/the-economic-impact-of-the-
affordable-housing-credit/.

Maintaining and bolstering the LIHTC's ability to both construct and 
rehab affordable housing is critical given acute supply shortages. 
Indeed, the Harvard Joint Center for Housing Studies estimated that 
there were only 58 affordable units for every 100 very low-income 
households (those earning up to 50 percent of area median income) in 
the United States in 2013.\36\
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    \36\ Harvard Joint Center for Housing Studies, ``The State of the 
Nation's Housing 2015: Housing Challenges'' (2015), available at http:/
/www.jchs.harvard.edu/sites/jchs.harvard.edu/files/jchs-sonhr-2015-
ch6.pdf.

The LIHTC has two components that enable the construction and 
redevelopment of affordable rental units. The so-called 9 percent tax 
credit supports new construction by subsidizing 70 percent of the 
costs. In contrast, the 4 percent tax credit can be used to subsidize 
30 percent of the unit costs in an acquisition of a project or new 
construction of a federally subsidized project and can be paired with 
---------------------------------------------------------------------------
additional federal subsidies.

Developers receive an allocation of LIHTCs from state agencies through 
a competitive application process. They generally sell these credits to 
investors, who receive a dollar-for-dollar reduction in their federal 
tax liability paid in annual allotments, generally over 10 years. The 
equity raised by selling the credits reduces the cost of apartment 
construction, which allows the property to operate at below-market 
rents for qualifying families; LIHTC-financed properties must be kept 
affordable for at least 15 years, but, in practice, a development 
receiving an allocation must commit to 30 years. Property compliance is 
monitored by state allocating agencies, the Internal Revenue Service, 
investors, equity syndicators and the developers.

First and foremost, Congress should retain the LIHTC as part of any 
effort to overhaul the nation's tax code. NMHC/NAA reminds Congress 
that tax-exempt private activity multifamily housing bonds are often 
paired with 4 percent tax credits to finance multifamily development, 
and that such tax-exempt bonds should be retained in any tax reform 
legislation as they play a critical role in making deals viable to 
investors.

Second, Congress should also look to strengthen the credit by both 
increasing program resources so that additional units can be developed 
or redeveloped and making targeted improvements to the program to 
improve its efficiency.

Congress could increase program authority by allocating additional tax 
credits or enabling states to exchange private activity bond volume cap 
into housing tax credits. A part of the LIHTC that could benefit from a 
targeted adjustment involves program rules that require owners to 
either rent 40 percent of their units to households earning no more 
than 60 percent of area median income (AMI) or 20 percent to those 
earning no more than 50 percent of AMI. If program rules were revised 
to allow owners to reserve 40 percent of the units for people whose 
average income is below 60 percent of AMI, it could serve a wider array 
of households. Notably, President Obama included a version of this 
proposal in his Fiscal Year 2017 Budget.\37\
---------------------------------------------------------------------------
    \37\ Department of the Treasury, General Explanations of the 
Administration's Fiscal Year 2017 Revenue Proposals, Reform and Expand 
the Low-Income Housing Tax Credit. Encourage mixed income occupancy by 
allowing LIHTC-supported projects to elect a criterion employing a 
restriction on average income, p. 67.
---------------------------------------------------------------------------

Priority 7: Preserve the Current Law Estate Tax

As part of the American Taxpayer Relief Act of 2012 (Pub. L. 112-240), 
Congress in January 2013 enacted permanent estate tax legislation. The 
Act sensibly made permanent the $5 million exemption level (indexed for 
inflation) enacted as part of the Tax Relief, Unemployment Insurance 
Reauthorization and Job Creation Act of 2010 (Pub. L. 111-312) and set 
a top tax rate of 40 percent. Crucially, it also retained the stepped-
up basis rules applicable to inherited assets. As many apartment 
executives prepare to leave a legacy to their heirs, it is vital to 
have clarity and consistency in the tax code with regard to estate tax 
rules. For this reason, the apartment industry remains supportive of 
the permanent estate tax legislation passed in early 2013.

There are three key elements to the estate tax: (1) the exemption 
level; (2) the estate tax rate; and (3) the basis rules. While all 
three elements can be important for all types of estates, estates with 
significant amounts of depreciable real property are especially 
concerned with how various types of basis rules may affect them.

      Exemption Levels: The estate tax exemption level is, in 
simplified terms, the amount that a donor may leave to an heir without 
incurring any federal estate tax liability. In 2016, there is a $5-45 
million exemption.

      Tax Rates: The estate tax rate applies to the value of an estate 
that exceeds the exemption level. The maximum rate is 40 percent.

      Basis Rules: The basis rules determine the tax basis to the 
recipient of inherited property. There are generally two different ways 
that basis is determined-stepped-up basis and carryover basis. The 
estate tax today features stepped-up basis rules, and under this 
regime, the tax basis of inherited property is generally reset to 
reflect the fair market value of the property at the date of the 
decedent's death. By contrast, under carryover basis, the tax basis of 
the inherited properties is the same for heirs as it was for the donor. 
This includes any decreases in tax basis to reflect depreciation 
allowances claimed by the donor in prior years. Retaining a stepped-up 
basis rule is critical for estates that contain significant amounts of 
depreciated real property as it helps heirs reduce capital gains taxes 
and maximize depreciation deductions.

Priority 8: Reform the Foreign Investment in Real Property Tax Act to 
                    Promote Investment in the Domestic Apartment 
                    Industry

Enacted in 1980 to prevent foreign investors from harming family 
farmers by putting upward pressure on the price of U.S. farmland, the 
Foreign Investment in Real Property Tax Act (FIRPTA) (Pub. L. 96-499) 
serves as an impediment to investment in U.S. commercial real estate, 
including multifamily housing. The FIRPTA regime is particularly 
pernicious because it treats foreign investment in real estate 
differently than investment in other economic sectors and, thereby, 
prevents commercial real estate from securing a key source of private-
sector capital that could be used to develop, upgrade, and refinance 
properties. Congress should enact tax reform that either repeals FIRPTA 
or, at the very least, further mitigates its corrosive effect on 
foreign investment in U.S. real estate.

Under current law, the U.S. does not generally impose capital gains 
taxes on foreign investors who sell interests in assets sourced to the 
U.S. unless those gains are effectively connected with a U.S. trade or 
business. This means that a foreign investor generally incurs no U.S. 
tax liability on capital gains attributable to the sale of stocks and 
bonds in non real estate U.S. companies.

FIRPTA, however, serves as an exception to the general tax rules and 
imposes a punitive barrier on foreign investment in U.S. real estate. 
Under FIRPTA, when a foreign person disposes of an interest in U.S. 
real property, the resulting capital gain is automatically treated as 
income effectively connected to a U.S. trade or business. Thus, the 
foreign investor is required to suffer a withholding tax on the 
proceeds of the sale only because it is associated with an investment 
in U.S. real estate.

In addition to levying tax, FIRPTA also mandates onerous administrative 
obligations that further deters foreign investment in U.S. real estate. 
First, the buyer of a property must withhold 15 percent of the sales 
price of a property sold by a foreign investor so as to ensure taxes 
are collected. Second, if they overpay tax through the withholding, 
foreigners investing in U.S. real estate must file tax returns with the 
IRS to receive a refund of the overpayment.

The taxes and administrative burdens FIRPTA imposes have negative 
consequences for U.S. commercial real estate and the multifamily 
industry. Because foreign investors can avoid U.S. tax and reduce their 
worldwide tax burden tax by investing in U.S. securities or in real 
estate outside of the U.S., they may simply choose not to invest in 
U.S. real estate. This is particularly harmful to an apartment industry 
that relies on capital to finance and refinance properties. 
Furthermore, because it is the sale of a U.S. property interest that 
triggers FIRPTA, foreign investors may hold on to U.S. real estate due 
solely to tax considerations.

Repealing FIRPTA would ensure that tax considerations will not prevent 
capital from flowing to the most productive investments. Such reform 
could unlock billions in foreign capital that could help to both drive 
new investment and refinance real estate loans. If outright repeal 
proves impossible, Congress should consider additional targeted reforms 
to the FIRPTA regime. NMHC/NAA were particularly pleased that Congress 
in late 2015 enacted legislation to both provide a partial exemption 
from FIRPTA for certain stock of real estate investment trusts and 
exempt from the application of FIRPTA gains of foreign pension funds 
from the disposition of U.S. real property interests.\38\
---------------------------------------------------------------------------
    \38\  Public Law 114-113, Consolidated Appropriations Act, 2016, 
Division Q, Protecting Americans from Tax Hikes Act of 2015.
---------------------------------------------------------------------------

Priority 9: Improve Incentives for Energy Efficiency in Commercial 
                    Buildings and Multifamily Properties

As the Finance Committee considers how the tax code could be used to 
facilitate national priorities in the energy sector, we wish to call 
your attention to the Energy Efficient Commercial Buildings Tax 
Deduction (Sec. 179D of the Internal Revenue Code of 1986) and the New 
Energy Efficient Home Credit (Section 45L of the Internal Revenue 
Code). The Energy Efficient Commercial Buildings Deduction lets owners 
of buildings with four or more stories deduct between $0.60 and $1.80 
per square foot when they install certain energy efficient systems, 
including HVAC, lighting, and, or building envelope. The New Energy 
Efficient Home Credit enables developers of new low-rise multifamily 
properties (three stories or less) to claim a $2,000 per-unit tax 
credit if those residences achieve a 50 percent energy savings for 
heating and cooling over the 2006 International Energy Conservation 
Code (IECC).

These incentives help to achieve improved environmental quality, 
reinforce our national security, create jobs in the construction and 
manufacturing sector and increase housing affordability by decreasing 
utility expenses for millions of Americans who live in apartment homes. 
We ask that both of these provisions be made permanent and not allowed 
to lapse at the end of 2016 as is scheduled under current law.

Additionally, we believe that Title I of the Energy Efficiency Tax 
Incentives Act (S. 2189), which was introduced in the 113th Congress by 
Finance Committee Senator Cardin, provides a responsible plan for 
enhancing the current Sec. 179D to assist property owners to make 
meaningful improvements in the energy performance of their 
properties.\39\ Many older properties have been unable to fully utilize 
179D because they have had difficulty in achieving the requisite 50 
percent improvement in building energy performance over the level 
specified in the 2007 version of the American Society of Heating, 
Refrigerating and Air-Conditioning Engineers (ASHRAE) 90.1 code. While 
S. 2189 includes updated energy code references against which whole 
building performance will be measured for many properties, it also 
includes a pathway for older properties to qualify for incentives that 
will assist property owners in making building system upgrades that 
will yield significant energy savings.
---------------------------------------------------------------------------
    \39\ S. 2189, Energy Efficiency Tax Incentives Act, Title I--
Commercial Building Modernization

Older building structures face technical limitations in achieving the 
energy performance metrics specified by the current code, let alone 
reaching the incremental ``above-code'' performance characteristics 
required to claim the 179D deduction. S. 2189 establishes a sliding 
scale of energy improvements, using the property's current energy 
performance as the baseline. This pathway of significant improvement in 
energy performance relative to the property's own baseline performance 
will provide a much-needed financial tool for property owners who want 
---------------------------------------------------------------------------
to make these types of investments but have not been able to do so.

Advances in residential construction methods have improved the energy 
use profile of new buildings; however, the majority of the nation's 
building stock predates the use of highly energy efficient products and 
techniques. The U.S. Department of Energy (DOE) reports that housing 
built after 2000 used 14 percent less energy per square foot than 
housing built in the 1980s and 40 percent less than housing built 
before 1950.\40\ As such, there is considerable room for improvement in 
energy performance even among well designed, constructed and maintained 
properties. A recent study conducted by CNT Energy and the American 
Council for an Energy-Efficient Economy finds that ``[b]uilding owners 
often need financial incentives to adopt new technologies or equipment 
with higher upfront costs. Despite this, studies have documented that 
affordable housing, often multifamily, receives a disproportionately 
small share of available energy efficiency funding.'' \41\
---------------------------------------------------------------------------
    \40\ U.S. Department of Energy, 2011 Buildings Energy Data Book, 
March 2012, Chapter 2.
    \41\ CNT Energy and American Council for an Energy-Efficient 
Economy, Engaging as Partners in Energy Efficiency: Multifamily Housing 
and Utilities, January 2012, http://www.cntenergy.
org/media/Engaging-as-Partners-in-Energy-Efficiency-MF-Housing-and-
Utilities-Final-012512.
pdf, p. 4.

According to the American Housing Survey (2009), almost 81 percent of 
the nation's stock of apartment properties (with 5 or more units) was 
constructed prior to 1990, which marks the decade in which the first 
building energy codes were implemented. This older stock of housing, 
which is an important source of affordable housing, represents a 
significant opportunity for achieving energy savings while at the same 
time adding to the available spending capacity of individuals who live 
in these apartment homes. This is a significant consideration given 
that in 2010 approximately 70 percent of renter households had incomes 
below the national median and more than 40 percent had incomes in the 
bottom quartile.\42\ Furthermore, ``energy costs as a share of gross 
rents rose from 10.8 percent to 15.0 percent between 2001 and 2009. 
Lowest income renters saw the largest increase in their utility share, 
a jump from 12.7 percent to 17.4 percent.'' \43\
---------------------------------------------------------------------------
    \42\ Joint Center for Housing Studies of Harvard University, 
America's Rental Housing-Meeting Challenges, Building on Opportunities, 
2011, p. 17, http://www.jchs.harvard.edu/sites/jchs.
harvard.edu/files/americasrentalhousing-2011.pdf; U.S. median household 
income fell from $51,144 in 2010 to $50,502 in 2011 according to the 
United States Census, American Community Survey Briefs, September 2012, 
Appendix Table 1, p. 5.
    \43\ Ibid.

There is often a relationship between the age of a residential building 
and energy expenditures. The per-square-foot energy costs of housing 
constructed from 1980 to 1989 is 16 percent higher than that of a 
building constructed after 2000. Those expenditures soar to a 28 
percent increase in residential buildings built between 1970 and 1979 
over post-2000 properties.\44\ Energy efficiency in multifamily 
properties could be economically improved by 30 percent with a savings 
of $9 billion in averted energy costs not to mention the substantial 
savings in greenhouse gas emissions.\45\
---------------------------------------------------------------------------
    \44\ U.S. Department of Energy, supra note 1, at pp. 2-20 derived 
from Table 2.3.12.
    \45\ Joint Center for Housing Studies of Harvard University, supra 
note 2, at p. 33.

NMHC/NAA believe that a sound national tax policy can be used to 
catalyze a market transformation marked by significant improvements in 
building energy performance. A meaningful and predictable tax incentive 
would leverage private investment in qualified building retrofits and 
would have a positive effect on the economy as it would result in 
increased demand for construction services, materials and equipment.

Conclusion

In closing, NMHC/NAA look forward to working with the Senate Finance 
Committee, as well as the entire Congress, to craft tax reform 
legislation that would promote economic growth and the nation's 
multifamily housing needs. In communities across the country, 
apartments enable people to live in a home that is right for them. 
Whether it is young professionals starting out, empty nesters looking 
to downsize and simplify, workers wanting to live near their jobs, 
married couples without children or families building a better life, 
apartment homes provide a sensible choice. We stand ready to work with 
Congress to ensure that the nation's tax code helps bring apartments, 
and the jobs and dollars they generate, to communities nationwide.

                                 ______
                                 
                                NRS Inc.

                         2009 South Main Street

                          Moscow, Idaho 83843

Written Testimony Before the Committee on Finance, United States Senate

                   ``Navigating Business Tax Reform''

                             April 26, 2016

              Submitted by Bill Parks, President, NRS Inc.

Chairman Hatch, Ranking Member Wyden, and members of the committee: I 
am a retired professor of finance and the founding President of NRS, a 
100% employee-owned company, which is the largest supplier of paddle 
sports accessories in the world. I have also published numerous 
articles in respected journals, including Tax Notes.

I would like to address a critical part of our current corporate tax 
system that is failing because it discourages small business capital 
formation. The code, perhaps inadvertently, dissuades small companies 
from being taxed as corporations. Speaker Ryan has pointed out the 
corporate rate for small business is 44.6% in the U.S. versus 15% in 
Canada.\1\
---------------------------------------------------------------------------
    \1\ Ryan, Paul, Interview by Greta Van Susteren, On the Record, Fox 
News Television Network, New York, November 4, 2015.

An unintended consequence of our corporate tax system is that it 
discourages small businesses from growing. This happens because small 
businesses can easily avoid double taxation and paying any corporate 
income tax by simply organizing as ``pass-through'' entities like S 
corporations or limited liability companies. Only the C corporation can 
easily provide an incentive to reinvest in the business in the form of 
retained earnings. Therefore, while being a ``pass-through'' entity 
provides obvious tax advantages to small business owners, it 
discourages capital formation and growth. A small business organized as 
a C corporation, however, has an incentive to retain earnings not only 
directly for growth, but also because they are critical to obtaining 
loans to further finance growth. Those retained earnings will provide 
the safest, most accessible source of funds to grow the business. It is 
much more difficult for an S corporation or an LLC to reinvest its 
earnings because multiple owners will have disparate investment 
objectives and needs. Also, there is a psychological barrier to 
---------------------------------------------------------------------------
returning earnings to the company after they have been taxed.

Pass-through entities are clearly the right vehicle for most 
situations; I am not advocating their demise. However, I am urging you 
to modify the corporate tax rate structure to make the C corporation a 
more attractive option to small businesses. Here are two ways to 
accomplish this:

1. Eliminate the ``nasty notch''

The Tax Reform Act of 1986 made the C corporation even less attractive 
to small business by adding a surtax that brought the total federal 
marginal tax rate to 39% for income between $100,000 and $335,000. This 
nasty notch had the unintended consequences of not only discouraging C 
corporation formation, but also causing existing small C corporations 
to switch to S corporation or LLC status at the first opportunity.\2\ 
In doing so, small businesses have avoided the corporate tax, but at 
the same time, they have less incentive to retain the earnings that are 
critical to growing a successful business.\3\, \4\ The 39% 
marginal rate keeps all but the most stubborn entrepreneurs from 
electing C corporation status.\5\ The first step toward making C 
corporations more attractive to small business is to repeal the ``nasty 
notch.''
---------------------------------------------------------------------------
    \2\ Since 1986, while S corporations have grown at approximately 7% 
per year and LLCs multiplied many fold, C corporations have declined by 
approximately 1.5% per year.
    \3\ Bill Parks, Can Corporate Tax Reform Build on Apple's 
Proposal?, Tax Notes, April 4, 2016, p. 93.
    \4\ Edward D. Kleinbard, Why Corporate Tax Reform Can Happen, Tax 
Notes, April 6, 2015, p. 94.
    \5\ My personal stubbornness enabled NRS to grow over 40 years from 
an initial $2,000 investment to almost $40 million in sales as a C 
Corporation before recently becoming 100% employee owned.
---------------------------------------------------------------------------

2. Introduce a preferential corporate rate for small business

Over the last 30 years, the number of C corporations has plummeted. In 
1980, the White House Conference on Small Business proposed that the 
number one need for small business was more graduation in corporate 
taxes. However, this has not happened. One reason is that many experts 
have seen corporate tax graduation as a give away to ``high net worth 
individuals'' that own most small businesses.\6\ But even if it were 
true, it is of little importance compared to the need to help small 
business grow. Many small businesses, induced into becoming LLCs or S 
corporations, may not be aware of how tilted the playing field is 
against them. They lack the retained earnings that make them good 
candidates for loans needed to fuel their growth.
---------------------------------------------------------------------------
    \6\ This is ironic because The Tax Reform Act of 1986 prevented 
high income tax payers from turning themselves into corporations 
because it repealed the General Utilities Doctrine, ``that permitted a 
firm to liquidate its assets at more than book value and to pass the 
proceeds of the liquidation through to stockholders without making the 
firm pay income taxes on the gains. As a result of the repeal, any gain 
from liquidation is taxed twice: once to the liquidating firm (C 
corporation) and again to the stockholders.''

With only 2% of business income tax coming from C corporations with 
less than $50 million in sales,\7\ giving small business an incentive 
to be taxed as corporations by lowering their rate could provide great 
help to small and medium-sized businesses without seriously affecting 
revenue.
---------------------------------------------------------------------------
    \7\ Testimony of the staff of the Joint Committee on Taxation 
before the Senate Committee on Finance hearing on ``Navigating Business 
Tax Reform,'' April 26, 2016 by Thomas Barthold, 
p. 5.

Therefore, I suggest that the corporate tax rate for the first $2 
million in income be 15% and that further graduation be considered, 
perhaps up to income of $50 million.

Conclusion

Professors of tax accounting say, only partly in jest, that an 
accountant should lose his or her license for helping create a small 
business as a C corporation. Professors in law school state that an 
attorney should be disbarred for creating a small C corporation. And of 
course, many new businesses should start as S corporations or LLCs in 
order to flow through initial losses to offset other income. But after 
attaining profitability, the code should encourage growing companies to 
be taxed as corporations in order to encourage growth via retained 
earnings.

Eliminating the ``nasty notch'' and introducing preferential graduation 
for small business will stimulate growth and employment. Graduating 
corporate taxes to be far below the individual rates up to $2 million 
or more would provide a powerful incentive for small businesses to be 
taxed as C corporations.

                                 ______
                                 
Chairman Hatch, Ranking Member Wyden, and members of the committee: I 
am a retired professor of finance and the founding President of NRS, a 
100% employee-owned company, which is the largest supplier of paddle 
sports accessories in the world. I have also published numerous 
articles in respected journals including Tax Notes.

Introduction

I want to address the problem of base erosion raised by the Finance 
Committee's Bipartisan Framework for International Tax Reform, released 
in July of 2015. The framework favors a dividend exemption, or hybrid 
territorial-type system, paired with base erosion measures.

The best way to limit base erosion under a territorial system would be 
for the U.S. to use Sales Factor Apportionment (SFA) to value a 
company's taxable profit. It is the only system that places all 
companies--U.S. domestics and U.S. and foreign multinational 
enterprises--on a level playing field.

Under SFA, a company's taxable profits would be allocated in the same 
proportion as its sales. If 40 percent of a company's sales were in the 
U.S., then the U.S. could tax 40 percent of its profit. Within a 
territorial system, SFA can reduce the offshoring of U.S. jobs and the 
incidence of corporate inversions. SFA will also encourage exports and 
raise revenue without raising tax rates.

Let me explain.

Present Corporate Tax Environment

Income shifting is a common multinational tax-avoidance strategy. 
Reducing accounting income correspondingly reduces the income tax 
obligation. If a U.S. multinational enterprise (MNE) with an effective 
tax rate of 30% shifts a million dollars of U.S. earnings to a 
subsidiary in Cayman Islands, which has no corporate income tax,\1\ 
then it has reduced its U.S. tax obligation by $300,000.
---------------------------------------------------------------------------
    \1\ Pomerleau, ``Corporate Income Tax Rates Around the World, 
2014'' Tax Foundation Fiscal Fact No. 436, August 20, 2014.

There are three common strategies for income shifting: (1) Transferring 
intellectual property such as a patent or copyright to a tax haven 
subsidiary, which then charges the U.S. parent high rates for its use. 
(2) Using internal ``transfer prices'' to reduce the parent company's 
profit, when the tax haven subsidiary is part of the firm's supply 
chain. (3) Having the tax-haven subsidiary issue loans to the U.S. 
parent because interest payments on those loans are tax-deductible for 
the parent. In addition to reducing taxable income, these strategies 
also give the parent access to overseas profits without the 
repatriation tax.\2\
---------------------------------------------------------------------------
    \2\ Udell and Vashist, ``Sales-Factor Apportionment of Profits to 
Broaden the Tax Base,'' Tax Notes, July 15, 2014.

These are just the simplest and most common methods. Today there is a 
proliferation of extremely complex methods that help MNEs lower their 
effective tax rates. In addition to the tax revenue lost, these 
practices undermine the competitiveness of U.S. domestic businesses, 
which can pay 40 percent or more in federal and state taxes when 
---------------------------------------------------------------------------
competing with MNEs that pay little or no U.S. taxes.

So what can be done to fix the problem?

Most people agree that it's wrong for large MNEs to pay far less tax 
than a domestic company. Still, there is broad disagreement between 
those who want to end deferral and tax foreign income on a worldwide 
basis, and those who argue that U.S. MNEs cannot compete due to our 
current worldwide tax system. Setting aside those who want to end 
corporate taxes altogether, what should tax reform look like? One of 
the most important criterion for a more equitable tax system must be 
that a MNE, whether U.S. or foreign, pays the same tax as a domestic 
company in the same situation.

So what should be done?

Permanent Establishment Rules

The permanent establishment rules may have been appropriate in the age 
of sailing ships, but they are wildly inappropriate in today's digital 
economy. Today a foreign MNE can establish a sales office in Ontario, 
drive across the bridge to Detroit, and sell $1 billion in goods 
without ever creating a permanent establishment. With the use of Skype, 
the company could avoid a physical presence altogether. To correct this 
problem, New York State changed its rules so that every company that 
sells more than $1 million in the state is deemed to have permanent 
establishment. This should be done nationwide with $5 million in sales 
being sufficient to deem permanent establishment.

More Competitive Rates

The need for more competitive tax rates is real. If U.S. MNEs were to 
pay statutory rates on their foreign income they would be at a 
competitive disadvantage to foreign MNEs. Ending deferral will not fix 
the problem. While it would put domestic companies and U.S. MNEs on a 
more equal footing, it would do nothing to correct foreign MNEs' 
competitive advantage.

The Problem of Transfer Pricing

In this global economy, it's a fantasy that one can use a transfer 
price based on the Arms Length Price or Principle, ALP. While 
commodities can be priced this way (given the transaction between one 
buyer and one seller acting in their own self interest) that's not how 
most of today's business is done. Most products are not commodities and 
most transactions happen between related parties. Furthermore, 
companies build their transfer prices based on cost accounting. It is a 
mantra of cost accounting that there are different costs for different 
purposes. Given this, there will always be a range of acceptable 
prices, and a company will invariably choose the one that minimizes its 
total tax bill. Because of transfer pricing's inherent defect, no 
system that includes it can treat domestic companies fairly.

So what's the answer to these and other problems? I say it is Sales 
Factor Apportionment.

Sales Factor Apportionment

With SFA, a company's profits are allocated in the same proportion as 
its sales. As mentioned in the earlier example, if 40% of its sales 
were in the U.S., then the U.S. would consider 40% of its profits 
taxable. However, that would open up the system to various tax avoiding 
strategies. Therefore, to prevent abuse, all profits would be assumed 
taxable, and the company would have the responsibility to document that 
its sales remained outside the U.S. With this approach--subtraction 
method SFA--every company, including ones that have inverted, would pay 
the same taxes on its profit from sales (whether the company is 
domestic, a U.S. MNE, or a foreign MNE). The same would apply to firms 
that had inverted. And as an added bonus, states would be able to 
increase their tax revenue because MNEs would, for the first time, show 
their true domestic profits. This would end the so-called lockout 
effect.

SFA would make tax rates irrelevant to the worldwide competiveness of 
U.S. firms. Though it's always desirable to lower rates, the main 
objective must be that all MNEs, foreign and domestic, pay equal taxes 
on their U.S. sales. Only SFA can accomplish that.

SFA has been calculated to raise $46 billion annually (based on 2010 
corporate earnings). Using 2014 earnings, that comes to roughly $77 
billion in additional revenue.\3\ In my other related submission, I 
suggest using some of that revenue to support small business.
---------------------------------------------------------------------------
    \3\ Udell and Vashist, supra.
---------------------------------------------------------------------------

Conclusion

Subtraction method SFA has real economic benefits and is virtually 
foolproof. U.S. and foreign MNEs would face an appropriate corporate 
tax, which would bring billions in locked-out funds back to the U.S. 
That would raise more tax revenue even at the current tax rates.

Domestic firms that export would also see their taxes reduced, because 
profits from their exports would not be taxed. Distortions would be 
minimized because sales are the last thing a company will give up. And 
finally, because SFA taxes all companies the same, the U.S. will no 
longer be at a competitive disadvantage in world markets.

Adopting SFA would make MNE avoidance of U.S. taxes essentially 
impossible.

                                   [all]