[Senate Hearing 115-342]
[From the U.S. Government Publishing Office]
S. Hrg. 115-342
BUSINESS TAX REFORM
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HEARING
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 19, 2017
__________
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COMMITTEE ON FINANCE
ORRIN G. HATCH, Utah, Chairman
CHUCK GRASSLEY, Iowa RON WYDEN, Oregon
MIKE CRAPO, Idaho DEBBIE STABENOW, Michigan
PAT ROBERTS, Kansas MARIA CANTWELL, Washington
MICHAEL B. ENZI, Wyoming BILL NELSON, Florida
JOHN CORNYN, Texas ROBERT MENENDEZ, New Jersey
JOHN THUNE, South Dakota THOMAS R. CARPER, Delaware
RICHARD BURR, North Carolina BENJAMIN L. CARDIN, Maryland
JOHNNY ISAKSON, Georgia SHERROD BROWN, Ohio
ROB PORTMAN, Ohio MICHAEL F. BENNET, Colorado
PATRICK J. TOOMEY, Pennsylvania ROBERT P. CASEY, Jr., Pennsylvania
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina CLAIRE McCASKILL, Missouri
BILL CASSIDY, Louisiana
A. Jay Khosla, Staff Director
Joshua Sheinkman, Democratic Staff Director
(ii)
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...................... 4
WITNESSES
Hodge, Scott A., president, Tax Foundation, Washington, DC....... 6
Marron, Donald B., Ph.D., institute fellow, Urban Institute and
Urban-
Brookings Tax Policy Center, Washington, DC.................... 8
Lewis, Troy K., CPA, CGMA, immediate past chair, Tax Executive
Committee, American Institute of Certified Public Accountants,
Provo, UT...................................................... 9
DeBoer, Jeffrey D., president and chief executive officer, The
Real Estate Roundtable, Washington, DC......................... 11
ALPHABETICAL LISTING AND APPENDIX MATERIAL
DeBoer, Jeffrey D.:
Testimony.................................................... 11
Prepared statement........................................... 41
Responses to questions from committee members................ 50
Hatch, Hon. Orrin G.:
Opening statement............................................ 1
Prepared statement........................................... 57
Hodge, Scott A.:
Testimony.................................................... 6
Prepared statement........................................... 59
Responses to questions from committee members................ 64
Lewis, Troy K., CPA, CGMA:
Testimony.................................................... 9
Prepared statement........................................... 69
Responses to questions from committee members................ 74
Marron, Donald B., Ph.D.:
Testimony.................................................... 8
Prepared statement........................................... 75
Responses to questions from committee members................ 82
Wyden, Hon. Ron:
Opening statement............................................ 4
Prepared statement........................................... 86
Communications
A Call To Invest in Our Neighborhoods (ACTION) Campaign.......... 89
American Farm Bureau Federation.................................. 92
American Forest and Paper Association (AF&PA).................... 96
Beer Institute et al............................................. 97
Biotechnology Innovation Organization (BIO)...................... 98
BUILD Coalition.................................................. 104
Business Roundtable.............................................. 107
Center for Fiscal Equity......................................... 110
Coalition to Preserve Cash Accounting............................ 113
CVS Health....................................................... 117
Davis, Dwight J.................................................. 118
Enterprise Community Partners.................................... 118
Like-Kind Exchange Stakeholder Coalition......................... 123
National Association of Realtors................................. 125
National Mining Association (NMA)................................ 127
National Multifamily Housing Council and National Apartment
Association.................................................... 129
National Retail Federation (NRF)................................. 137
Nonprofit Data Project........................................... 138
Reforming America's Taxes Equitably (RATE) Coalition............. 140
R&D Credit Coalition............................................. 141
Retail Industry Leaders Association (RILA)....................... 145
Small Business Council of America (SBCA)......................... 147
Small Business Legislative Council (SBLC)........................ 151
Tax Ag Coalition................................................. 154
Tax Innovation Equality (TIE) Coalition.......................... 161
BUSINESS TAX REFORM
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TUESDAY, SEPTEMBER 19, 2017
U.S. Senate,
Committee on Finance,
Washington, DC.
The hearing was convened, pursuant to notice, at 10:06
a.m., in room SD-215, Dirksen Senate Office Building, Hon.
Orrin G. Hatch (chairman of the committee) presiding.
Present: Senators Grassley, Crapo, Roberts, Thune, Portman,
Toomey, Heller, Scott, Cassidy, Wyden, Stabenow, Cantwell,
Carper, Cardin, Brown, Bennet, Casey, Warner, and McCaskill.
Also present: Republican Staff: Mark Prater, Deputy Staff
Director and Chief Tax Counsel; Tony Coughlan, Senior Tax
Counsel; Eric Oman, Senior Policy Advisor for Tax and
Accounting; and Jeff Wrase, Chief Economist. Democratic Staff:
Joshua Sheinkman, Staff Director; Michael Evans, General
Counsel; Tiffany Smith, Chief Tax Counsel; and Chris Arneson,
Tax Policy Advisor.
OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM
UTAH, CHAIRMAN, COMMITTEE ON FINANCE
The Chairman. During this morning's hearing, we will
discuss ways to improve the business provisions of the U.S. tax
code with an eye toward creating jobs and boosting wages for
American workers and improving our country's overall business
climate.
This hearing is part of our ongoing effort--following years
of tax hearings and last week's hearing on individual reform--
to draft and report comprehensive tax reform legislation later
this year. Members of both parties recognize the need to reform
the way we tax businesses in the United States.
As former President Obama noted when discussing his own
framework for business tax reform, the current system, quote,
``does too little to encourage job creation and investment in
the United States while allowing firms to benefit from
incentives to locate production and shift profits overseas,''
unquote.
As we all know, many elements of a particular business's
tax burden depend on the company's organizational form. For
example, C corporations are taxed at the corporate tax rate.
According to a recent report by the Congressional Budget
Office, the top Federal statutory corporate income tax rate has
been 35 percent since 1993, and with State taxes added, the
United States' average corporate statutory rate is the highest
in the industrialized world, at more than 39.1 percent.
And, while some have noted that not all corporations pay
the full statutory rate, the average effective tax rate of U.S.
corporations is the fourth highest among G20 countries.
According to a recent analysis by Ernst and Young, when you
integrate corporate-level taxes and investor-level taxes, such
as those on dividends and capital gains, U.S. tax rates are the
second highest among developed countries. That last one is
important, given that the United States taxes most corporate
earnings that are distributed to shareholders twice--both at
the corporate and the shareholder levels.
For the past few years, I have been working on a corporate
integration proposal that, among other things, would allow
businesses to deduct their dividends paid to help alleviate the
double taxation problem. I view this as a complement to a
statutory corporate tax rate reduction, not a substitute.
We held a few hearings on this topic last year, so I will
not delve too deeply into the details at this time. For now, I
will just say I continue to believe this idea, whether it
applies fully or in some other limited way, can help address a
number of the problems we are trying to solve with
comprehensive tax reform. I look forward to continuing this
conversation as the process moves forward.
It is also important to note that, while the U.S. corporate
tax rate has remained unchanged for decades, the trend among
our foreign competitors has been to lower corporate rates,
making American businesses increasingly less competitive. This
is not just a Republican talking point. This problem is widely
acknowledged on both sides of the aisle. Even former President
Bill Clinton, who signed into law the rate increase to 35
percent, recently argued the rate should now be lowered. I
agree.
Our current business tax system--and the disparity between
the U.S. corporate rate and our foreign competitors' corporate
rates--has created a number of problems and distortions. For
example, the current system slows economic growth by impeding
capital formation, hindering wage growth and job creation,
reducing productive capacity, and lowering the standard of
living in the United States, all of which directly harm middle-
class families and individuals.
The current system lowers returns on investment, creating a
bias against savings and investment. This hinders the creation
of wealth for Americans across the economic spectrum, including
the middle class. The current system encourages corporations to
finance operations using debt rather than equity, which
increases the risks, particularly during times of economic
weakness. The current system gives corporations incentives to
shift income production and intangible assets, like
intellectual property, from the U.S. to lower-taxed foreign
jurisdictions, thereby eroding our tax base.
In tax reform, we need to address all of these problems and
distortions, and many others as well. In particular, we need to
lower the corporate tax rate to relieve the burdens the tax
imposes on American workers, who, according to many economists,
bear a significant part of the corporate tax.
We also need to reduce the burden on pass-through
businesses whose earnings are reported and taxed on individual
tax returns. These types of businesses include sole
proprietorships, limited liability companies, partnerships, and
S corporations. And we need to fix our international tax system
so that American businesses can compete in the global
marketplace without facing significant disadvantages simply
because they are headquartered in the United States.
Each of these propositions is supported by people in both
parties. Of course, when politics enter the equation, the story
sounds much different. According to some, all Republicans want
to do in tax reform is give tax breaks to the super-rich, have
cushy portfolios for Wall Street bankers and more handouts for
greedy corporations, all at the expense of middle-class workers
and families. Those types of claims may play well to political
bases, but they do not align with reality.
As I noted in our hearing last week, virtually all of our
current tax reform ideas are aimed squarely at helping the
middle class as well as low-income families. Our chief goals,
particularly in business tax reform, are to increase economic
growth, create new jobs, grow wages for the employees of both
large and small businesses, expand opportunities for all
Americans, and improve standards of living for everyone in the
United States.
The proof, I suppose, will be in the pudding. As the
committee works through this process with those goals in mind,
I believe we will be able to demonstrate why those in the
middle class should feel as though they have a stake in this
discussion and how these ideas to reform our current system
will help. Let us keep in mind that the status quo--sluggish
economic growth, stagnant wages, and decreased workforce
participation--has not exactly been doing the middle class any
favors. The case for tax reform should therefore be easy to
make.
I want to reiterate what I said last week, namely that this
committee will be the starting point for any tax reform
legislation that is considered in the Senate. While I expect we
will continue to hear more arguments about secret tax plans
written behind closed doors, this committee is going to
consider tax reform through regular order. That applies to both
the drafting and the reporting of any tax reform bills.
As I also said last week, I hope this process is
bipartisan. As with individual tax reform, there are many areas
of business tax reform where thoughts and interests of both
Republicans and Democrats overlap. There is fertile ground for
bipartisan agreement on this, and I hope we can take advantage
of this historic opportunity together.
I know that my friend Ranking Member Wyden shares these
broad objectives, and I appreciate that. In fact, he has put
forward his own tax reform proposals in the past, likely with
these same goals in mind. And at the end of the day, we should
all at the very least agree that the current tax system is
broken and the current state of our economy should not be
accepted as the new normal.
I look forward to a robust discussion of these issues here
today as well as some acknowledgments of the bipartisan
agreement that exists on these matters.
So with that, I will turn to Senator Wyden for his opening
remarks.
[The prepared statement of Chairman Hatch appears in the
appendix.]
OPENING STATEMENT OF HON. RON WYDEN,
A U.S. SENATOR FROM OREGON
Senator Wyden. Thank you very much, Mr. Chairman. I am
going to have to do a little committee-hopping here in the next
hour, so I am going to be brief. And before I get to the
substance of today's hearing, I just need to talk briefly about
what is coming down the pike for this committee, both here and
on the floor.
And as I told you, Mr. Chairman, the remarks I am going to
make now do not in any way affect my admiration for you, our
friendship, and the fact that we just moved ahead on a very
important CHIP bill, the Children's Health Insurance Program
bill. I just want to set out my comments about what happened
last night.
Last night the majority announced, without consulting the
minority, that the Finance Committee is going to hold a hearing
on the Graham-Cassidy-Heller health-care bill. I want to make
clear: I believe that this is an abomination. It is an
abomination of the process, it is an abomination of the
substance, and it is an abomination of the history of this
storied committee.
First of all, this bill is a prescription for suffering and
disastrous consequences for millions of our people. Second, the
Budget Office has informed Congress that it will be several
weeks at the very least before it can provide real estimates
for the bill. So this means the majority is going to charge
ahead with a radical, destructive transformation of American
health care with the American people in the dark.
This bill is going to be a few roll-call votes away from
the President's desk. And yet, Republicans here in the Senate
do not have answers to the key questions: What is going to
happen to the premiums paid by the American people? What is
going to happen to their coverage?
The idea, the proposition that a bill this destructive,
this far-reaching, can swing through the Senate Finance
Committee for a single hearing on a Monday morning and hit the
Senate floor a day or two later makes a mockery of the
legislative process that Senator McCain so eloquently urged us
to return to.
Furthermore, this abomination of a process stands in sharp
contrast to what we have been able to achieve with respect to
the Children's Health Insurance Program. What a sad commentary
on the times, that when the committee ought to be celebrating a
big victory for something like 9 million kids, for millions of
families, the Graham-Cassidy-Heller bill threatens the health
care of millions of children and families.
Second point: reconciliation relies on secrecy, brute
power, and speed to ram purely partisan bills through the
Senate. And it is a train wreck to do it on health care.
I think we have to note, as we start this hearing, that
Leader McConnell is committed to Reconciliation Round Two on
tax reform when we want, on this side of the aisle, to have
colleagues working together in a bipartisan way. And as the
chairman noted graciously, I have written two full bipartisan
bills. Leader McConnell says we are going to have another
partisan bill, another completely partisan bill, with respect
to tax reform. And I think that too is a prescription for
trouble.
So the details that leak out of these ``Big Six'' meetings,
in my view, suggest that what is under way is an unprecedented
tax giveaway for the most fortunate and the biggest
corporations in the country. The centerpiece could be a $2-
trillion loophole dealing with something called pass-through
status.
Now, pass-through status is supposed to be all about small
businesses, you know, the person who is running a cleaners or
running a restaurant. There is no question those small
businesses fuel local economies and hire the most workers. They
surely need a boost in tax reform. But any tax change that
allows tax cheats to abuse pass-through status by self-
declaring to avoid paying their fair share and dodge Social
Security taxes would be worse than what is on the tax books
today.
The day the pass-through loophole bill becomes law would be
Christmas morning in America for the tax cheats. It would make
a mockery of the Trump pledge that, quote, ``The rich are not
going to gain at all with this plan.'' And that is just one
element of what is on offer.
The bottom line for me as we move to this crucial
discussion is, it is time for the Congress to take the lies out
of the corporate tax rate in America. Many of the biggest
corporations in the country employ armies of lawyers and
accountants who know every single one of the tax tricks. And
they use them all to winnow down their tax rates to the low
teens, to single digits, even zero. So the Congress cannot pair
a big corporate rate cut with a plan to enshrine a vast array
of loopholes that lets corporations off the hook for paying
their fair share. That is, in my view, a surefire way to heap
an even heavier burden on the middle class.
So I look forward to discussing these issues, Mr. Chairman.
As I indicated, I am going to have to be out for a few minutes,
but I look forward to the discussion, and I thank you for the
chance to make this statement.
The Chairman. Well, thank you, Senator Wyden.
[The prepared statement of Senator Wyden appears in the
appendix.]
The Chairman. Some of our committee members have requested
a public hearing to examine details of the Graham-Cassidy
health care proposal. A hearing will allow members on both
sides to delve deeper into the policy and gain a better
understanding of what the proposal is intended to achieve. So
we are going to have a hearing next week on this matter. I
believe that members will benefit from a public discussion and
examination of these issues.
Yet, even though their requests have been heard and a
hearing is on the schedule, some members are still unsatisfied.
I am not sure what else we can do on this matter to address
every complaint. For today, our hearing is on business tax
reform, and I hope we can focus these proceedings on that
issue.
Having said that, I would like to welcome each of our
witnesses to our hearing today. We all appreciate your
willingness to testify and answer questions today. Hearing each
of your perspectives on tax reform will be critical to our
process.
First, we will hear from Mr. Scott A. Hodge, the president
of the Tax Foundation in Washington, DC, where he has worked
for the past 25 years. Before joining the Tax Foundation, Mr.
Hodge was director of tax and budget policy at Citizens for a
Sound Economy. He also spent 10 years at The Heritage
Foundation as a fellow analyzing budget and tax policy. Before
that, Mr. Hodge started his career in Chicago, where he helped
found the Heartland Institute in 1984. He holds a degree in
political science from the University of Illinois at Chicago.
Second, we will hear from Dr. Donald B. Marron, an
institute fellow and director of economic policy initiatives at
the Urban Institute. From 2010 to 2013, Dr. Marron led the
Urban-Brookings Tax Policy Center. Prior to joining Urban, Dr.
Marron served as a member of the President's Council of
Economic Advisers and Acting Director of the Congressional
Budget Office. He has also taught at the Georgetown Public
Policy Institute and the University of Chicago's Graduate
School of Business. Dr. Marron studied mathematics at Harvard
College and received his Ph.D. in economics from the
Massachusetts Institute of Technology.
Next, we will hear from Mr. Troy K. Lewis, the immediate
past chair of the Tax Executive Committee of the American
Institute of Certified Public Accountants in Washington, DC.
Mr. Lewis currently teaches at Brigham Young University in
Provo, UT. He is in practice as a managing member of Lewis and
Associates CPAs, LLC in Draper, UT. He obtained his master's of
accountancy and bachelor's of science in accountancy from
Brigham Young University. He is also a certified public
accountant and a chartered global management accountant.
Last but not least, we will hear from Mr. Jeff DeBoer, the
founding president and CEO of the Real Estate Roundtable, where
he has served since 1997. Mr. DeBoer also serves as the
chairman of the Real Estate Industry Information Sharing and
Analysis Center as well as chairman of the National Real Estate
Organizations. Mr. DeBoer has also served as co-chairman of the
advisory board of the RAND Corporation Center for Terrorism
Risk Management Policy and was a founding member of the
steering committee of the Coalition to Ensure Against
Terrorism. Mr. DeBoer holds degrees from Washington and Lee
University School of Law and from Yankton College. He is a
member of the Virginia Bar Association and the American Bar
Association.
We want to thank all of you again for coming today, and I
look forward to hearing your remarks.
Mr. Hodge, we will begin with you, so if you will please
begin, that will be great.
STATEMENT OF SCOTT A. HODGE, PRESIDENT,
TAX FOUNDATION, WASHINGTON, DC
Mr. Hodge. Well, thank you, Mr. Chairman and Ranking Member
Wyden. It is good to see you and all the members of the
committee.
I commend you for taking on the challenge of reforming
America's business tax code, especially the task of overhauling
our corporate tax system. The most important thing that
Congress and the administration can do to boost economic
growth, lift wages, create jobs, and make the U.S. economy more
competitive globally is overhaul our business tax system.
The Tax Foundation's extensive economic research and tax
modeling experience suggest that the committee should have four
priorities in mind when you are reforming the corporate tax
system. We call these the four pillars of corporate tax reform.
First, provide full expensing for capital investments. Second,
cut the corporate tax rate to a globally competitive level,
such as 20 percent. Third, move to a competitive territorial
system. And fourth, make all three of these priorities
permanent.
And while many of you and many in the business community
may see some of these policies in conflict or competing for
space in the tax plan, we see these pieces as complementary and
essential, not in conflict. In our view, cutting the corporate
tax rate and moving to a territorial system are essential for
restoring U.S. competitiveness and reducing the incentives for
profit-shifting and corporate inversions. These measures are
also important for defining and reclaiming the U.S. tax base.
Right now, the European Union and the OECD are proposing
policies such as a new turnover tax on digital companies that
are directly aimed at raising taxes on U.S. multinationals.
Expensing, we believe, is key to reducing the cost of
capital in order to revitalize U.S. capital investment, which,
in turn, will boost productivity and wages. Thus, a good tax
plan should include all three of these policies, because they
will not only boost economic growth, but they will do so in a
way that leads to higher wages and living standards for working
Americans.
However, these gains are not possible if the policies are
made temporary. Temporary tax cuts deliver temporary results,
whereas permanent tax reform delivers permanent economic
benefits.
It is hard to generate public support for corporate tax
reform, I know, because most people do not see how it benefits
them. Corporate tax reform may not put cash in people's pockets
in the same way a tax credit might, but it can have a powerful
effect on spurring economic growth while lifting after-tax
incomes and living standards.
As just an example, we used our Taxes and Growth Dynamic
Tax Model to simulate the long-term economic effects of cutting
the corporate tax rate to 20 percent and moving to full
expensing for corporations. Our model indicates that these two
policies combined would increase the level of GDP by 3.4
percent, lift wages by an average of 3.8 percent, and create
more than 860,000 new jobs. And when we account for all of
these economic factors, we find that the lower corporate tax
rate and full expensing combined would boost the after-tax
incomes of all Americans by an average of 5.2 percent. Pretty
good.
And one last thing to consider about expensing. It does
something that no rate cut can. It eliminates pages and
sections from the tax code, saving businesses more than 448
million hours of compliance time and more than $23 billion in
compliance costs each year.
The great economist Thomas Sowell once said that there are
no solutions, there are only tradeoffs. And I am sure you are
all discovering that now in looking at corporate tax reform.
First, the math is very hard. Contrary to what some people
believe, there are not as many loopholes in the corporate tax
code as many think, and so you will likely have to think
outside the box if you want corporate tax reform to be revenue-
neutral.
Second, the economics of tax reform must be at the
forefront of your decision-making. If you make the wrong choice
in the base broadeners you choose to offset your tax cuts, you
can neutralize all the benefits that you are trying to achieve
through the reforms.
These are the challenges, and there will be hard choices
ahead of you. But corporate tax reform done right is key to
growing the economy, boosting family incomes, and making the
U.S. a better place to do business in and do business from.
So remember the four pillars of corporate tax reform: full
expensing, lower corporate tax rate, a territorial system, and
permanence. Those are the right policies to make this tax
reform effort a lasting success.
So, Mr. Chairman, thank you very much for the opportunity
to share these ideas. I look forward to any questions that you
may have.
The Chairman. Well, thank you.
[The prepared statement of Mr. Hodge appears in the
appendix.]
The Chairman. Dr. Marron, we will turn to you.
STATEMENT OF DONALD B. MARRON, Ph.D., INSTITUTE FELLOW, URBAN
INSTITUTE AND URBAN-BROOKINGS TAX POLICY CENTER, WASHINGTON, DC
Dr. Marron. Great, thank you. Chairman Hatch, Ranking
Member Wyden, members of the committee, thank you very much for
inviting me to discuss business tax reform.
America's business tax system is needlessly complex and
economically harmful. Thoughtful reform can make our tax code
simpler, it can boost American competitiveness, it can create
better jobs, and it can promote shared prosperity.
But tax reform is hard. Meaningful reforms create winners
and losers, and you will likely hear more complaints from the
latter than praise from the former. I feel your pain. But at
the risk of adding to it, my testimony today makes eight points
about business tax reform.
First, thoughtful reform can promote economic growth, but
we should be realistic about how much. More and better
investment boosts economic activity over time. The largest
effects will occur beyond the 10-year budget window. If reform
is revenue-neutral,
revenue-raisers may temper future growth. If reform turns into
tax cuts, deficits may crowd out private investment. Either
way, the boost in the near term may be modest, and dynamic
scoring will thus play only a small role in paying for tax
reform.
Second, the corporate income tax makes our tax system more
progressive. The corporate income tax falls on shareholders,
investors more generally, and workers. Economists debate how
much each group bears. Workers are clearly the most
economically diverse, but they include highly paid executives,
professionals and managers, as well as rank-and-file employees.
The bulk of the corporate tax burden thus falls on people with
high incomes, even if workers bear a substantial portion.
Third, workers would benefit from reforms that encourage
more and better investment in the United States. In the long
run, wages, salaries, and benefits depend on worker
productivity. Reforms that encourage investment and boost
productivity would thus do more to help workers than those that
merely increase shareholder profits.
Fourth, taxing pass-through business income at preferential
rates would inspire new tax avoidance. When taxpayers can
switch from a high tax rate to a lower one, they often do so.
Kansans did so when their State stopped taxing pass-through
income. Professionals use S corporations to avoid payroll
taxes. Investment managers convert labor income into long-term
capital gains. Congress and the IRS can try to limit tax
avoidance, but the cost will be new complexities, arbitrary
distinctions, and new administrative burdens.
Fifth, capping the top tax rate on pass-through business
income would benefit only high-income people. To benefit,
taxpayers must have qualifying business income and be in a high
tax bracket. Creating a complete schedule of pass-through rates
could reduce this inequity, but it would expand the pool of
taxpayers tempted by tax avoidance.
Sixth, taxing pass-through business income at the corporate
rate would not create a level playing field. Pass-through
income faces one layer of tax, but corporate income faces two,
at the company level and again at taxable shareholders. Taxing
pass-throughs and corporations at the same rate would favor
pass-throughs over corporations. To get true tax parity, you
could apply a higher tax rate on pass-through business income,
you could levy a new tax on pass-through distributions, or you
could get rid of shareholder taxes.
Seventh, it is difficult to pay for large tax cuts and
business tax rates by limiting business tax breaks and
deductions. Eliminating all corporate tax expenditures, except
for deferral, for example, might be able to get a corporate
rate down to 26 percent. You could try to go lower by cutting
other business deductions, such as interest payments, but
deductions lose their value as tax rates fall. To pay for large
rate reductions, you will need to raise other taxes or
introduce new ones. Options include raising taxes on
shareholders, a value-added tax or close variant like the
destination-based cash-flow tax, or a carbon tax.
Finally, making business tax cuts retroactive to January 1,
2017 would not promote growth. Retroactive tax cuts would give
a windfall to profitable businesses. That does little or
nothing to encourage productive investment. Indeed, it could
weaken growth by leaving less budget room for more pro-growth
reforms. Another downside is that all the benefits would go to
shareholders, not workers.
Thank you again. I look forward to your questions.
The Chairman. Thank you. Thank you so much.
[The prepared statement of Dr. Marron appears in the
appendix.]
The Chairman. Okay. We will go next to Mr. Lewis.
STATEMENT OF TROY K. LEWIS, CPA, CGMA, IMMEDIATE PAST CHAIR,
TAX EXECUTIVE COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC
ACCOUNTANTS, PROVO, UT
Mr. Lewis. Chairman Hatch, Ranking Member Wyden, members of
the Committee on Finance, thank you for the opportunity to
testify on behalf of the AICPA.
As the committee tackles this rare opportunity to enact
bold, pro-growth business tax reform, we urge Congress to take
a holistic approach to provide tax reform to all of America's
businesses. Fair and equitable tax reform will drive economic
growth and enhance the competitiveness of all types of American
businesses, not only in the U.S., but also abroad.
The AICPA is a longtime advocate for an efficient and pro-
growth tax system based on principles of good tax policy. We
need a tax system that is fair, stimulates economic growth, has
minimal compliance costs, and allows taxpayers to understand
their tax obligations. These features of a tax system are
achievable if principles of good tax policy are considered.
Today I would like to highlight a few tax reform issues
that directly impact businesses and their owners. First, we are
concerned with and oppose any new limitations on the use of the
cash method of accounting. The cash method is simpler in
application, has fewer compliance costs, and does not require
taxpayers to pay tax before receiving their income. Forcing
businesses to switch to the accrual method unnecessarily
discourages business growth, increases compliance costs, and
imposes financial hardship on cash-strapped businesses.
Next, tax relief should not mean a rate reduction for only
C corporations. Congress should encourage or at least not
discourage the formation of pass-through entities. Inequities
would also arise from having significantly different income tax
rates for business income based on an overly simplistic
approach, such as one centered solely around the structure,
sector, or the general nature of the business's activities.
For example, excluding professional service firms from the
benefit of a lower business rate reflects a view of the service
industry that does not represent the current global
environment. In today's economy, professional service firms are
increasingly competing on an international level with
businesses organized as corporations. They also require a
significant investment and rely on the contribution of
employees to generate a substantial portion of the revenue.
Artificially limiting the use of a lower business rate,
regardless of the industry, would penalize a business for
operating as a pass-through entity. Professional service firms
are an important sector in our economy and heavily contribute
to the Nation's goals of creating jobs and better wages.
Without the benefit of a fair and consistent rate reduction for
all businesses, including pass-through entities, the incentive
to start or grow a business is diminished, with a corresponding
loss of jobs and reduction in wages.
We recognize that providing a reduced rate on active
business income will place additional pressure on the
distinction between profits of the business and compensation of
the owner operators. We recommend codifying traditional
definitions of reasonable compensation and provide, if
necessary, additional guidance from Treasury and the IRS.
If Congress moves forward with a fixed percentage split for
business income, such as treating 70 percent of pass-through
earnings as employment income and 30 percent as return of
capital, we recommend making the proposal a safe harbor rather
than a hard-and-fast rule. A safe harbor would promote
simplicity for many businesses without sacrificing fairness for
others. It would also provide a uniform treatment among closely
held business entity types.
Another important issue is the ability to deduct interest
expense. Business owners borrow to fund operations, working
capital needs, equipment acquisition, and even to build credit
for future loans. These businesses rely on financing to
survive. Equity financing for many startup businesses is simply
not available. At a minimum, we should not take away or limit
this critical deduction for many small and mid-sized businesses
that, with little or no access to equity capital, are often
forced to rely on debt financing.
Finally, we encourage you to enact mobile workforce
legislation, such as the bill introduced by Senator Thune. The
burden of tracking and complying with all the different State
payroll tax laws is complex and costly, particularly for small
employers. The mobile workforce legislation provides a uniform
national standard for non-resident State income tax withholding
and a de minimis exemption from State income tax for non-
resident employees.
Thank you for the opportunity to testify, and I will be
happy to answer any questions you may have.
The Chairman. Well, thank you. We are grateful for your
testimony.
[The prepared statement of Mr. Lewis appears in the
appendix.]
The Chairman. Let us go to our final witness, Mr. DeBoer,
and we will listen to you.
STATEMENT OF JEFFREY D. DeBOER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, THE REAL ESTATE ROUNDTABLE, WASHINGTON, DC
Mr. DeBoer. Good morning. Tax reform's impact on the
commercial real estate industry will have wide-ranging effects
on the economy, job creation, and the overall GDP. And I am
honored to be here today to talk with you about this issue.
But it is not the first time that our industry has been
before this committee and talked about tax reform. In 1981,
Congress provided our industry with very aggressive tax
incentives. These tax incentives spawned a robust tax shelter
industry and resulted in the development of millions of
buildings that had no tenants.
In 1986, Congress rightly eliminated these tax shelter
provisions; however, the combination of these actions caused
severe dislocation in real estate markets nationwide, caused
great numbers of lost jobs, resulted in countless bankruptcies,
and many people believe that it ultimately led to the demise of
the savings and loan industry.
It took years for the economic pain to work through the
system. Our industry steadily has recovered. And with
congressional assistance, the Federal taxation of real estate
investment today is much closer to matching the economics of
the investment. As a result, the commercial real estate
industry today is estimated to provide about 20 percent of the
Nation's GDP. Our industry now employees millions of Americans,
provides local governments with their largest revenue source,
and plays a key role in the retirement savings and wealth
creation of Americans. Importantly, commercial real estate
markets today are largely in balance, where supply only
modestly exceeds demand.
Now, despite our industry's relatively positive health, we
know the underlying economy can and should grow more rapidly.
Properly designed tax reform can spur overall job creation,
encourage more robust business expansion, improve the standard
of living for all Americans, and result in sustainable GDP
increase.
The first step should be reducing the tax on all job-
creating businesses. This action should not be limited to
corporate income but should also include income from pass-
through businesses. And I want to pledge to Senator Wyden that
our industry and our organization will work very hard to make
sure that there are not games played on compensation earned.
Pro-growth tax reform should also encourage and reward risk
through capital gain. And capital gain should continue to
recognize that it is not just cash that is put in an investment
that should be rewarded. Some concepts, however, may have
unintended consequences. For example, our capital markets today
are the envy of the world. Entrepreneurs are able to access
debt amounts needed to provide their businesses with
flexibility to build, operate, and grow their businesses. We
should continue that and not end the deduction for business
expenses.
The proposal to expense assets is troubling to us, because
it is suggested to apply to structures. We think that carries
great potential negative consequences. Expensing structures
would obviously encourage a lot of development, but we are
concerned that this development would not be supported by
underlying demand. And such un-economic development is a false
indicator of economic strength and will badly distort markets.
This is not to say, however, that the current cost recovery
system is correct for our industry. We think it should be
shortened. And MIT has reviewed a wealth of data regarding
buildings, and their findings suggest that the proper economic
life of buildings is 20 years. We believe a 20-year life
twinned with the continuation of the interest deduction will
spur sustainable development and sustainable GDP expansion.
The deduction for Federal, State, and local property tax
payments should continue. We think that repeal will cause many
businesses to leave our urban areas, and we reject that idea.
We believe the like-kind exchange rules also should be
continued. We think they are a positive part of the economy.
I would like to say that in 2015 Congress took a very
positive step in the PATH Act regarding the taxation of foreign
investment in U.S. real property. We urge you to now take
another step and repeal that entirely.
There is one final item that I would like to add, and that
is that we would urge you to consider an infrastructure
initiative of some type in tax reform. Action in this area is
badly needed. It would create jobs. And if it is done
correctly, and by correctly I mean to understand the
transportation revolution that is going on in our country and
where we will be going as far as transportation needs and
mobility in the future, and if we do it, if Congress and
policymakers do it the correct way, it not only would create
jobs but increase productivity for workers and our businesses.
We have submitted a detailed statement, and I would be
happy to respond to any questions about it or my comments
today. Thank you.
The Chairman. Well, thank you.
[The prepared statement of Mr. DeBoer appears in the
appendix.]
The Chairman. Thank you so much, all four of you. We really
appreciate you taking the time and putting in the effort to
come and testify to us today. And we will pay strict attention
to your statements.
I might add that today is Senator Tim Scott's birthday. I
do not think he looks a day over 29 and makes the rest of us
look pretty old, I will tell you.
Senator Scott. I am very appreciative, sir.
The Chairman. Well, we are grateful to have you on the
committee. You add a great deal to our committee, as do the
other members.
Well, let me start with you, Mr. Hodge. In your testimony,
you note that the Tax Foundation is generally supportive of
corporate integration. Of course, corporate integration is an
idea that I, along with my staff, have been exploring for
several years now.
In your written testimony, you note that reducing the
corporate tax rate to 20 percent increases economic growth in
the long run by 3.1 percent and results in 592,000 full-time-
equivalent jobs. And corporate-only expensing achieves a very
similar result: an increase in economic growth by 3 percent,
resulting in 575,000 full-time-equivalent jobs. Now, these
projections are impressive.
What struck me as very interesting is that in the Tax
Foundation's 2016 book Options for Reforming America's Tax
Code, almost identical economic growth and job projections
occur with corporate integration, that is, allowing a
corporation to deduct dividends.
The Tax Foundation estimated economic growth of almost 3
percent in the long run, 2.9 percent to be precise, and 535,000
full-time-equivalent jobs. And of course, corporate integration
would eliminate the two levels of tax on corporate earnings and
bring the tax treatment of debt and equity closer into
alignment, which would reduce, if not eliminate, a lot of the
distortions and inefficiencies of the current system.
Would you share with us the Tax Foundation's views on
corporate integration in general and the dividends paid
deduction approach in particular?
Mr. Hodge. Well, thank you, Mr. Chairman. You know, I was
looking through the Tax Foundation's archives and came across a
1977 Tax Foundation publication by Marty Feldstein--whom I
think you know well--on corporate integration. And since that
time, there have been no fewer than a dozen corporate
integration proposals that have come out of either Congress or
the White House. And this is an issue of longstanding study
and, unfortunately, we have yet to see the kind of action that
I think is necessary to remove the double taxation of corporate
income and make business taxation more equitable.
We believe that business income should be taxed only once
and at the same rate. And as you noted, in our analysis it has
the dramatic effect of lowering the effective corporate tax
rate and having a substantial impact on long-term economic
growth. But as you mentioned, rightly I think, it also improves
or equalizes the treatment of debt and equity financing and, as
a result, makes the economy much, much more efficient.
And I think a dividends paid deduction is a very thoughtful
way to approach this. After all, companies get to deduct their
interest costs; why should they not get to deduct the dividends
that they pay to shareholders?
And I think it is certainly an approach that ought to
deserve the attention and consideration of the committee, but
also, as you move forward on fundamental tax reform, ought to
be a nice complement to the broader corporate tax reform
efforts.
The Chairman. Well, thank you.
Mr. Lewis and Mr. DeBoer, you both included in your written
statements concerns regarding limitations on the deductibility
of interest expense. Mr. Lewis, your testimony laid out
concerns for small businesses and services businesses. Mr.
DeBoer, your testimony laid out the potential and significant
negative effects on the real estate industry of such a
limitation.
However, we frequently hear how the current tax treatment
of debt and equity financing leads to overleveraging of
businesses, and limiting the deductibility of interest expense
brings the tax treatment of the two more in sync.
I would like your respective thoughts on that, Mr. Lewis
and Mr. DeBoer, if you could do that for us.
Mr. Lewis. Okay, I will take a crack at it first. Equity
financing for many startups and small, mid-sized businesses is
simply not available. I think you have to start with that
notion. So, while the points that you just made are there, the
combination of those and taking away an interest expense
deduction will put more burden on those small businesses.
I mean, the reality is that large businesses have access to
the equity markets, the capital markets, and small businesses
do not. So many of our businesses, particularly the growth
businesses, the entrepreneurial businesses, are those
businesses that rely on debt financing.
Tax laws should not discourage the formation of businesses.
The formation of new businesses is one of the best aspects that
we have in the U.S. economic system, and I think it should
continue.
The Chairman. Thank you.
Sir?
Mr. DeBoer. Mr. Chairman, the issue of overleverage, I
think, is really one that should be examined on an individual-
by-
individual basis. If there is overleverage, it is a problem
with the regulators who were supposed to be determining whether
someone had too much leverage, and we would prefer that the
issue be dealt with there, not through the tax code.
The use of debt is very, very important for all businesses,
not just startup businesses and not just small businesses, but
all businesses that need this kind of flexibility to use debt.
Debt, by the way, allows entrepreneurs to retain more
control over their business operation. If they have equity,
they give up control of some of their business. They retain
more control over their business operations by using debt. It
is something that historically has been recognized as a cost of
doing business, like other costs of doing business. And we
really see no reason to adjust it through the tax code.
That is not to say that we think that people should be
overleveraged or that businesses should be overleveraged. They
should not be. There should be governors on that. And there are
other parts where the government should act.
By the way, in the real estate industry, from a macro point
of view, I believe our industry is now levered at about 60
percent. Publicly traded REITs, for example, are levered at
even lower amounts, 40 or 45 percent on average.
So we are very mindful of the problems with overleverage,
but it is really a problem of whether the borrower itself is
able to repay the amount, and it might be a low amount of
leverage that they cannot handle while others can handle higher
amounts.
Thank you for the question though, sir. It is very, very
important to have access to debt for the economy to continue to
grow.
The Chairman. Well, thanks to both of you.
Senator Grassley?
Senator Grassley. For anybody or all of you: as part of a
pro-growth tax reform, there has been considerable debate over
what is more important, lower rates or expensing.
Mr. Hodge and Dr. Marron, especially you two, could you
both elaborate on how you see the tradeoff between expensing of
depreciation and lower rates? For example, do you view it as
acceptable to lengthen depreciation to help finance lower
rates?
Mr. Hodge. Well, I will start out with the first part of
that, Mr. Grassley. We see expensing as the most powerful
policy change that you can make to improve economic growth.
And, on an apples-to-apples basis, our models show that full
expensing delivers twice the economic growth than a comparable
rate cut, and that is because it really affects new investment
whereas a rate cut, a corporate rate cut, affects both new and
old capital, new and old investment, and so its benefits get
distributed a little more broadly.
But to the second point, I think we have to look back at
the tax reform proposal that Chairman Camp put forward a few
years ago, which lengthened depreciation lives in order to
finance or offset the revenue lost from a corporate rate cut.
And what we found--all the models, the Joint Committee on
Taxation model, the Tax Foundation model, showed that
lengthening depreciation lives raised the cost of capital to
such an extent that it offset the benefits of a lower corporate
tax rate on the other hand. And it ended up as an economic
wash.
And I think you need to be extremely careful in looking at
your offsets when you are looking to offset the corporate rate
cut.
Dr. Marron. So my thoughts are going to be very, very
similar, that if you focus on expensing, what you are doing is,
you are providing incentives for new investment, which is the
thing that is going to be most beneficial for the economy--and
I want to emphasize it is also going to be most beneficial for
workers.
The research that my colleagues at the Tax Policy Center
have done suggests that if you focus on reductions that
encourage investment, you get more of the benefits flowing to
workers and relatively less of it being focused on
shareholders.
That said, with a 35-percent top rate, you could make very
good arguments for bringing that down as well, as part of the
concerns about the competitiveness of our tax system.
But as Scott just said, if your strategy is to reduce the
corporate rate and then make depreciation and write-offs less
favorable, what you are going to see in all the macro models is
that that is going to very much limit any growth benefit you
get.
Senator Grassley. Okay. I am going to ask the same two
people something that Senator Hatch discussed with the others,
because I want your opinions on it, and that is consideration
of restrictions, whether they should be imposed on the ability
to deduct interest.
As you know, the House Blueprint generally eliminates
interest as a business expense in exchange for going to a full
expensing on capital assets.
So for the two of you, should any restriction on the
deductibility of interest be considered to finance lower rates
or faster depreciation?
Dr. Marron. I will go first on this one. There are two
great schools of how you should tax, right? There is the income
tax school and the consumption tax school. So in the income tax
school, interest is an expense--you ought to be able to deduct
it--and then depreciation ought to follow the economic
depreciation of assets over time. In the consumption tax view
of the world, you should be able to expense everything
immediately, and you should not get any write-off for interest.
We have a system that is somewhere in between those, where
we have accelerated depreciation, but we allow interest
deductibility. And the challenge you have there is that you can
actually over-
encourage investment. You can create negative effective tax
rates on investment. You can have some of the problems that
Jeff mentioned that happened in the 1980s. If you go too far in
making investment favorable, but allow full deduction of
interest, you can end up with excessive investment in certain
sectors.
And so I am very, very open to reducing interest
deductibility if it is being paired with making depreciation
more favorable. That moves in the direction of a consumption
tax; that is a logical and consistent way to design a tax
system.
Mr. Hodge. I would echo much of what Donald has said. And I
think that our models show that when you eliminate interest
deductibility, it not only raises about $1.2 trillion, but it
does so in perhaps a less-harmful way than other options. And
thus, when paired with a corporate rate cut or full expensing,
you get the maximum amount of benefits from those policies with
the least amount of harm on the other side.
There are also other advantages to eliminating the interest
deductibility when it comes to perhaps reducing the amount of
earnings stripping that we see, where foreign multinationals
load up debt here on their domestic subsidiaries and then strip
income out of the U.S. tax base.
There are other issues that we have talked about in terms
of overleveraging and so forth, so there are many advantages to
it. But we do understand that some industries are perhaps over-
reliant on it and it could be disruptive. But it is one of the
tradeoffs that will have to be made in order to get economic
growth on the other side of the equation.
Senator Grassley. Thanks to both of you.
Thank you, Mr. Chairman.
The Chairman. Thank you, Senator.
Senator Carper?
Senator Carper. Thanks, Mr. Chairman.
I want to add to your birthday wishes to Tim Scott. It is
great to serve with you, Tim, and happy, happy birthday.
You are too young to remember a great song by Conway
Twitty, and this last weekend I just happened to be listening
to the radio driving around, and I heard a song by Conway
Twitty I have not heard in years. It goes, ``It's only make
believe.'' And I was trying to think what he was singing about.
He was singing about a relationship with another person, but it
could just have easily been dynamic scoring. [Laughter.]
I just want to say, we have been down this road before. We
did it in early 1981 with tax cuts for the higher-income
people; it did not work. We did it in 2001; we ended up with
more debt and, frankly, not the kind of economic growth that we
had hoped for.
And the idea of trying it again--there is a saying that
says, ``third time's a charm.'' I am not sure the first two
times were charmed, and I would have us be careful about going
down this road again.
So my question is, Dr. Marron, could you just lay out for
our committee what effect a largely debt-financed tax cut would
have on long-term economic growth for the U.S. and on our
deficits? Thank you.
Dr. Marron. Sure; my pleasure. Thanks. So if you look at
the CBO baseline forecasts of where we are in fiscal terms
today, we are on track over the next decade in round numbers to
spend around $50 trillion and to bring in tax revenue around
$40 trillion, and therefore to have deficits that accumulate
over the decade of about $10 trillion. So that will build the
debt from around 75 percent of GDP today up to around 90
percent of GDP by the end of the budget window.
That is problematic in its own way. We ought to be on a
trajectory where the debt is not rising faster than the
economy, right? We want it to flatten out and eventually come
down.
If you did deficit-financed tax cuts today, what you would
have is--we would have more of that. So you would have,
depending on the scenario people have discussed, you would have
another $1 trillion, $2 trillion of additional debt over the
decade. So adding, say, $12 trillion to the debt over that
period.
And the financing of that would have to come from
somewhere. And one way it might be financed is by reducing the
amount of private investment we see in the United States, and
that would, therefore, weaken the amount of growth you would
get from a tax reform.
You should always think about these tax reform proposals as
being a race between the effects you get from the tax changes
you are doing and any effect they have on the budget balance.
And if you are increasing deficits over this time period, there
is going to be an offset. And in the models I have seen,
typically the offset ends up overwhelming eventually, so you
end up losing your growth effects.
There are some scenarios in which that does not happen,
where foreign capital is very widely available. It comes in and
offsets the hit to private investment, but then you are left in
a situation where, yes, the U.S. economy is being more
productive, but more of the benefits are going overseas rather
than staying here. And so either way, there is a cost to debt
financing.
Senator Carper. All right. Let me ask a related question,
again of you, Dr. Marron, if I could.
Can you lay out for us what the evidence shows regarding
who really bears the cost of corporate tax and your assessment
of the assumptions used in models claiming that a rate cut
would allegedly help workers?
Dr. Marron. Certainly. So this is an area that economists
have studied a lot in recent decades. I would say the consensus
that you see--from CBO and JCT and the Office of Tax Analysis
and what my friends at the Tax Policy Center do--is that,
clearly, workers pay some of the corporate income tax. The one
unfortunate side effect of the corporate income tax is to
discourage investment in the United States: workers have less
capital to work with, they are less productive, wages are
lower.
The mainstream estimates of that are around 20 percent,
kind of in the 20- to 25-percent range for the corporate tax
system as a whole.
At the Tax Policy Center, my colleagues emphasize that it
differs depending on what tax provision you look at. And if you
are talking about just provisions focused really directly on
investment, you can make an argument that about 50 percent of
that is borne by workers. But for the corporate tax system as a
whole, kind of the mainstream view is around 20, 25.
Senator Carper. All right. Let me just say I am all for
reducing the corporate tax rate. We are not competitive with
the rest of the world. There needs to be a reduction. I hope
that as we address that concern, we will keep in mind four
questions as we address more broadly comprehensive tax reform.
Number one, the proposal that has come before us, is it
fair? Number two, does it foster economic growth or impede it?
Number three, does it make the tax code more complex or less
complex? And number four, what is the fiscal impact?
We are 6, 7 years into the longest-running economic
expansion in the history of our country. And usually at this
point in time, I would think we would be interested in
addressing the corporate tax problem so we are competitive with
the rest of the world, but do so in a way that is fiscally
sustainable.
This year's deficit is going to exceed $700 billion, that
is 7 years into an economic expansion. The economics I studied
as an undergraduate and graduate student said you deficit-spend
when you are trying to stimulate the economy, deficit-spend
when you are in a recession or something like that, or in a
war.
But when you are 6, 7 years into an economic expansion, the
idea of somehow doing it all over again and increasing the
deficit further, I do not think we should do that. I do not
think we should do that.
Thank you so much.
The Chairman. Thanks, Senator.
Senator Toomey?
Senator Toomey. Thank you very much, Mr. Chairman.
I just want to follow up briefly on the Senator from
Delaware's comments. But let me start with a question.
Is there anybody on the panel who believes that economic
growth and output are completely unaffected by all incentives
and penalties in the tax code, that they are completely
independent and the economy is uninfluenced by good or bad tax
policy? Does anybody hold that view?
Okay, nobody holds that view. So does it not follow
logically that if you have better incentives and fewer
penalties and you have a tax code that creates the right
incentives for growth, you have more growth than you would
otherwise?
And if we achieve that, then it is not a question of
whether or not the economy grows more, it is a legitimate
question about how much. And I think we all agree that if we
have a bigger economy than we would otherwise have, then there
is more economic activity to tax. So the logic behind
dynamically scoring tax policy, it seems to me, can only be a
question of the extent, but not whether or not we do it.
Now, if you think that the tax reform is actually
counterproductive to growth, if you think it is going to create
disincentives and penalties for growth, then it should be
scored accordingly.
But isn't there a basic--Mr. Hodge, I will throw it to
you--is there not a fundamental kind of unavoidable logic that,
if you get the incentives right, you will have more growth, and
if you have more growth, you can generate more revenue and it
is just a question of magnitude?
Mr. Hodge. That is correct. And what we try to tell people
about dynamic scoring is that, by and large, most tax cuts do
not pay for themselves. But depending on the type of tax cut,
it can have macroeconomic effects which will have feedback
effects on revenues and will minimize their long-term costs.
Senator Toomey. Thank you.
There are a couple of other things I want to get to
quickly.
Mr. DeBoer, you seem to be skeptical about the wisdom of
allowing full expensing for structures, but that skepticism, I
did not hear that applied to other kinds of assets like
vehicles, equipment, machinery, other sorts of things. And you
acknowledge that expensing of those types of things, non-
structures, can be beneficial for economic growth, is that
correct?
Mr. DeBoer. Well, I do not necessarily disagree with that.
But the facts are, I believe, that under the current law of
depreciation and bonus depreciation that is in place, I believe
roughly 60 percent of all business investments today are
recovered within 18 months.
Senator Toomey. Yes; I have very limited time, and I
appreciate that.
Mr. DeBoer. And so I am a little skeptical about the bump
that you would get from that.
Senator Toomey. I appreciate your skepticism. Okay, that
was not my question, though. I appreciate that, sir.
Mr. DeBoer. And the Tax Foundation's own study does show
that 70 percent of the increase in GDP would come from
expensing structures.
Senator Toomey. It would be nice if we could move on, sir.
Thank you very much.
Mr. Lewis, you had made a point about the accrual method
versus the cash method of accounting. Is it true that a fast-
growing company that is investing significantly in capital and
maybe growing its inventory could be in a position where their
tax liability actually exceeds their free cash flow under an
accrual system?
Mr. Lewis. Certainly, they could.
Senator Toomey. And so allowing companies to take the cash
method has the great virtue of tremendous simplicity, but it
also tends to align their cash flow better with their tax
obligations. Is that true?
Mr. Lewis. Yes. Cash method accounting tends to be simpler,
like you said, and it does provide a lot of incentive, fewer
compliance costs, and they put more money into doing what they
do best, which is not accounting, but growing their business.
Senator Toomey. Yes. Would you be supportive of raising the
threshold that is currently in law that allows for a cash basis
for tax purposes?
Mr. Lewis. Yes. The AICPA has supported Senator Thune's
INVEST Act that had a provision in there to increase it, to
make it more available to smaller businesses.
Senator Toomey. Thanks.
Mr. Hodge, you had mentioned that dollar-for-dollar
expensing has more impact on growth than lower marginal rates,
maybe than most of the other ideas we have been talking about.
Could you briefly explain how that benefit translates to
workers? How does that help average workers? How does that help
wages?
Mr. Hodge. The key point here is, by lowering the cost of
capital, you are improving the opportunities for businesses to
invest in tools which make their workers much more productive.
Much more productive workers earn more over their lifetimes,
and their standard of living rises as a result. So the key here
is to incentivize new investment, to increase productivity,
which ultimately makes everyone better off in the long run.
Senator Toomey. Thanks very much.
Thank you, Mr. Chairman.
Senator Roberts [presiding]. Senator Cantwell?
Senator Cantwell. Mr. Chairman, thank you.
I know my colleagues and the panel have been discussing
dynamic scoring and the deficit. So I guess I definitely
believe, as we had our last hearing, that dynamic scoring does
not definitely lead to dramatic growth. It might, it might not.
And, Mr. DeBoer, one of the things that I am most
interested in is, before we launch into this discussion about
the tax code, just as any businessperson would do--they take an
assessment of the environment and what are the needs and
opportunities of that company and what are the needs and
opportunities of our Nation.
One of those things that I think has been missing in this
equation as it relates to our discussion is, what are those
needs and opportunities as it relates to housing? Could you
comment on that as it relates to the tax code and what we need
to be doing?
Mr. DeBoer. Certainly. I think, you know, most people, most
businesspeople who operate certainly in urban areas, recognize
that there is a tremendous and growing shortage of what we
would call workforce housing. And so people who are middle-
American citizens--firemen, teachers, what have you, combined
incomes, working very, very hard--are being priced out of our
Nation's cities.
And we need to focus on ways to incentivize affordable
housing, not just low-income housing, which is obviously
needed, but workforce housing as well. And we should not lose
sight of that.
I do not have any solutions to share with you, but it is
certainly a growing and troubling problem. And as we go
forward, that part of our Nation has to be included in whatever
is done in economic growth.
Senator Cantwell. So do you think just cutting the
corporate tax rate gets us affordable housing?
Mr. DeBoer. Well no, I do not think it really will have
anything to do with affordable housing. It would put,
hopefully, more people to work, and it would provide more money
in people's paychecks, and perhaps they would have more money
to buy workforce housing, but it would not directly stimulate
workforce housing.
Senator Cantwell. Do you think affordable housing is a
crisis in America?
Mr. DeBoer. I am not sure I would call it a crisis. I think
there is an awful lot of multifamily housing being constructed
today, meeting a demand for it, but it is not meeting that
segment of the economy. And people need to understand, land is
land, and it is going to cost the same thing regardless of its
use almost. And construction costs are quite high.
And so when people construct assets--multifamily, retail,
office buildings, what have you--they are paying roughly the
same cost to construct them. And so it is hard to understand
why they would then provide low-income housing or workforce
housing, because it does not pencil out for them from an
economic point of view. So there does have to be assistance
there, we think, whether that is zoning assistance or local tax
break assistance or something from the Federal Government.
Senator Cantwell. Or expansion of the Low-Income Housing
Tax Credit?
Mr. DeBoer. Well, keep in mind, as tax reform goes forward
and rates lower--and I certainly am not suggesting that we do
not want lower rates--but the market for the low-income tax
credit is made more robust and more positive because of what
rates are. As rates go down, those will become less valuable.
And again, I am not suggesting that rates should not come
down. I am simply suggesting that if you keep the low-income
housing program as it is, the incentive will naturally be
reduced, and perhaps a rethinking of that incentive is in
order.
Senator Cantwell. Well, I think you said something very
important there, but I am not sure everybody understood it.
Basically, what you said----
Mr. DeBoer. I may not have understood it, but it was fun
saying it. [Laughter.]
Senator Cantwell. I think what you said is technically
correct. But the translation is that, basically, because a lot
of people who have invested in affordable housing as we have
given them incentives for investing in it through the LIHTC
program, as they are sitting there waiting to see what is going
to happen with the corporate tax rate or tax rates overall,
they are sitting on capital and we are actually suppressing the
amount of available investment in affordable housing at the
same time that we have a crisis.
So to me, as we ponder this big question, particularly as
it relates to this issue of dynamic scoring and whether you are
going to get dynamic growth from it, I want to make sure
everybody clearly understands that housing somehow has lost its
way.
It used to be in the 1960s, 1970s, 1980s you would say,
when you wanted to stimulate our economy, the cheer would go up
for housing, but you have not heard that cheer in a long time.
And it is time for us to focus on the fact that affordable
housing is a crisis, and it is certainly a crisis in my State;
it is certainly a crisis in Seattle. And we need to make sure
that we are putting the right incentives in place. This is just
as important as the rest of the discussion we are having here.
So thank you, Mr. DeBoer.
Mr. DeBoer. Senator, if I may just add one thing. It was
referenced how long we are into the economic recovery--forget
about affordable or low-income housing--and home-building in
general is off where it typically would be at this point in the
recovery anyway. And if it was only where it should normally
historically be, our GDP would be a point higher, some suggest.
And I just throw that out.
Senator Cantwell. Thank you.
Mr. DeBoer. And again, those solutions----
Senator Cantwell. Thank you. No, I call that growth. Thank
you.
Thank you, Mr. Chairman.
Senator Roberts. I appreciate that.
Senator Scott?
Senator Scott. Thank you, Mr. Chairman.
I will make my questions quick, because I have to go vote
before we close that vote out.
I was a small business owner for about 15 to 16 years. And
I will tell you that the question that seems to be unanswered--
I thought Senator Toomey did a very good job of delineating the
importance of, from a competitive perspective, how lower rates
equal a better competitive position against folks in other
countries.
A lower rate also will encourage economic activity in a way
that can be scored dynamically. The question is, can we score
dynamically accurately? The fact of the matter is, there is no
question that the dynamic impact will be measurable, which
means that it will be positive.
Another very important factor is the complexity of the code
and the amount of time that small business owners spend
preparing for the dreaded season of March 15th to August 15th
and the times when the extensions run out.
Can you, Mr. Lewis and Mr. Hodge, speak for a few minutes
on the compliance costs borne by U.S. small businesses under
the current code and what that means long-term for our
competitive position and the ability to grow jobs and make
future investments?
Mr. Hodge. Well, I can just give you some overviews. We
have looked at the overall complexity of the U.S. code and
tried to measure it. Americans spend close to 9 billion hours
complying with the U.S. tax system. The corporate part of that
code is the most complex and the most costly. Things like
depreciation schedules among that, as I mentioned earlier in my
testimony, cost U.S. businesses about $23 billion a year in
compliance costs. This is money that is not only drained from
businesses, but it is time taken away from entrepreneurs.
So instead of writing computer code, they are complying
with the tax code. This is wasted energy, wasted time, wasted
resources that go to, well, complying with the IRS rather than
trying to build a business, and that is simply unfair.
Senator Scott. Thank you, sir.
Mr. Lewis?
Mr. Lewis. Thank you for the question. The AICPA has 12
guiding principles that we believe should be considered as part
of any tax reform discussion. There are many of them, but you
hit on a couple of them that I think are important. The first
one is equity and fairness on the one side. On the other side
is simplicity.
The thing about it is, often one principle in these 12
guiding principles has to be compromised at the expense of
another to achieve the common objective. So it is that tradeoff
that you all are debating now where the rubber hits the road.
Reconciling the competing interests of each of the guiding
principles can be difficult.
You know, the thing about it is, the code will probably
never be simple, but, man, it sure could be a lot less complex.
And so anything that you can do along those lines to make it
less complex would benefit all businesses in our country.
Senator Scott. Thank you, sir.
Thank you, Mr. Chairman.
Senator Roberts. Unlike Shane in the movie sometime back--I
realize that two-thirds of the audience do not even know what I
am talking about--but at least Shane never came back, but
Chairman Hatch will come back. [Laughter.]
I remember 1986, the last time we did tax reform. We have
pictures of the gentlemen who were in charge: Senator Packwood,
Senator Dole, others. When I reviewed the tax proposal at that
particular time, farmers in my district--I was then a member of
the House--said they were going to take a pretty big hit. Real
estate also said, listen, this is really not what we think is
appropriate.
And then the S&L business was very worried, rightly so--
they went out of business. One of my very best friends went
broke who had a cow/calf operation.
So I listened to those people, and I voted ``no.'' I was
the only one in a several-State area who did that. I think the
most important thing that happened in that regard was that Bob
Dole did not speak to me for 6 months. That was not all bad,
but that was probably a very good relationship. [Laughter.]
I have a theory. We are all wrapped around the axle with
regards to offsets and revenue, so on and so forth. You all
have been talking about expensing, depreciation, State and
local taxes. You have not mentioned--I am surprised you have
not--the deduction of interest for various things, your health
insurance, so on and so forth.
When you do that, I have a red ant theory. Every time you
touch something that is in the tax code, it has been there on
purpose even though it is 9 feet tall, and we have to do
something. But I would prefer to see us do the big things, not
worry so much about the dynamic scoring--although that is a big
issue for many--just for my personal preference.
Lower the corporate rate, we have to do that, the business
rate, but I would prefer we call it a business rate. And then
also go from 7 to 3 on the brackets, same with the middle
class.
I would fix AMT. I would do something with the estate tax.
There is one more that I am missing. Oh, repatriation; but
obviously, if you lower that rate, why, that supposedly takes
care of that. And call it good and not go into all these other
details.
I know some members in the House do not buy that argument
at all, but it sure would save us a lot of time. And all these
other things that I have mentioned--you have various interest
groups coming in, and it is the red ant theory, based on an
experience when a Senator from Kansas tried to give a speech
when he was standing on a hill of red ants. That did not work
out very well. They crawl up your leg and bite you pretty good.
How do you feel about that, more especially with the 1986
example? Does anybody want to take that on?
And the chairman is back, and I will yield to him, but I
will listen. But not for very long, because I have to go vote.
Mr. Hodge. Very quickly.
Senator Roberts. Very quickly.
Mr. Hodge. The 1986 act has gotten a lot of mythology over
the years. We actually went back and modeled the economic
effects of the 1986 act. We found that it actually raised the
cost of capital, mainly by shifting the tax burden onto
businesses at the expense of giving tax cuts to individuals. As
a consequence, we found it had the effect of actually slowing
economic growth, not boosting growth.
Senator Roberts. Well, and 4 years later our friends across
the aisle simply raised taxes, and there was a lot of blood on
the ground. And I do not see the need for doing that again, so
I hope we can stick to the big items.
And I note that the distinguished chairman is back. Thank
you.
The Chairman. Thanks, Senator.
Senator Cardin?
Senator Cardin. Thank you, Mr. Chairman.
I thank all the witnesses.
Mr. DeBoer, I am sorry I was not here when you were talking
about incentives for energy efficiency. We are strongly going
to work to make sure we can preserve those issues.
I want to ask a question about the pass-throughs, as to
what is a fair way to handle this. Pass-through companies do
not have to pay double taxation, that is true; however, when
you look at global competition, they are still paying a much
higher rate than their global competitors because of the
marginal tax rates in the United States. And the overwhelming
majority of American businesses do not pay the C rate. I think
the C rate now amounts to about 5 percent of the companies,
somewhere in that level.
So as we look for reform in order to make our business tax
structure more competitive, if that is one of our goals for
growth, what do we do about making sure we do not have the
unintended consequences of hurting those companies that have
the current status as pass-throughs? How do we protect them if
the rates do not change, if we just do the C rate? How do you
deal with that issue?
Mr. DeBoer. Senator Cardin, I will take the first swing at
that. And we do appreciate your work on energy efficiency for
buildings. It is a very, very important topic going forward,
and hopefully it can be included.
Pass-throughs--certainly for our industry, very, very few
real estate businesses are operated in corporate format. Almost
all are LLCs, publicly traded or privately traded REITs, or
partnerships. In fact, real estate consists of almost half of
all partnerships in America, so we are highly concerned and
focused on how we can achieve a lower tax rate for those
entities.
Right now, there is a 5-percent spread between the
corporate and the ordinary rate. We see no reason that if the
corporate rate is coming down that a comparable spread should
not be the result of tax reform this time, or you are going to
put pass-through entities, which really drive the economy in
many ways in the United States, at a disadvantage, not only
globally, but vis-a-vis their competitors in the corporate
world here. So we want to work on that very, very much.
Senator Cardin. I agree with that.
Mr. DeBoer. And I mentioned to Senator Wyden, Senator, that
we share the concern about potential shifting of what is
service-
related income in a pass-through into that lower bucket. And we
have worked very, very hard internally to try to come up with a
way to deal with that.
Senator Cardin. Well, I thank you for that response. I
think we all have to keep our eyes on this issue, because it
could get lost in some of the proposals that are being made.
And I agree with the point that you made: particularly in the
real estate sector, the pass-throughs are critically important.
I know they are in my State.
I know that Senator Carper talked about being fiscally
responsible. One of the worst things we could do is add to the
deficit in deficit-financed tax reform, because that will be an
anchor on our economic growth. And I know he talked about how
we score, and I hope we will use the Joint Tax traditional
scoring.
But I also raise another issue, that one of the proposals
that has been out there is talking about timing and the
Rothification of the 401(k)s. That scores as a revenue gainer,
even though over the long term it is neutral.
And I think we are just going to have to be very careful,
Mr. Chairman, as we look at these issues. There is also, of
course, the retirement security issue, which is very important,
to make sure that we not only maintain, but strengthen those
needs.
I want to get to the fundamental point, and that is, if you
really want to deal with competitive rates, if that is your
issue on the business side of tax reform, I think it is
impossible to do unless you bring different revenues into the
equation. Every industrial nation in the world except the
United States uses consumption revenues in addition to income
revenues. We are the only country that does not.
How do we expect to have competitive business rates if we
do not harmonize with the international community as to the
source of our revenues? So I have introduced a progressive
consumption tax, because one of my major objectives is to make
sure that the new tax code is at least as progressive as the
current code as it relates to middle-income families, and there
is a way of doing it. But how do you get to competitive rates
globally with industrial nations if we continue to be stubborn
and use only income revenues to the exclusion of consumption
revenues when the rest of the world is doing that?
Dr. Marron. So I think you are left with a lot of bad
choices, right? So you could run much bigger deficits as a way
to get the rate down, but that is not going to be good in the
long run.
You know, I end up mentally in the same place where you
are, which is, if you want to get down to rates below the high
20s, if you want to get lower on that rate, you are going to
need to go shopping for a new revenue source. The destination-
based cash flow tax is a species of consumption tax that has
some of those attributes, can bring in some more revenue, but
it seems to have gone by the wayside.
There are still more traditional value-added taxes you
could do. I personally am a fan of the idea of a carbon tax
which could provide significant revenue, encourage clean
energy, and help combat pollution. It would be one strategy.
And then of course, another strategy is also to look to
shareholders. If you are reducing corporate taxes, you should
keep in mind that some of the beneficiaries are going to be
taxable shareholders. And it is perfectly reasonable to look to
them to think about ways of increasing taxes on shareholders to
partly offset or fully offset the gain that they get.
Mr. Hodge. And, Mr. Cardin, I will give you credit for the
progressive tax reform that you have put forward. We modeled
your plan and found it to be exceptionally pro-growth, and not
only, I think, pro-growth, but I think it was revenue-positive.
So it is possible. And you used an offset of a value-added tax
to lower the corporate tax rate to, I believe, 17 percent, and
that had a pretty powerful effect on boosting economic growth
with that lower corporate rate.
Senator Cardin. Yes, I appreciate that. My objective is
that, since America, among industrial nations, is near the
bottom on the percentage of our economy and government, we
should have a competitive advantage, not disadvantage on our
business taxes.
The Chairman. Senator Brown?
Senator Brown. Thank you, Mr. Chairman. Thank you to all
four witnesses; good to see all of you.
My question is for Dr. Marron.
We have heard a lot of talk about what is good for large
U.S. companies. We have heard, frankly, far too much talk about
what is good for corporations and not enough talk about what is
best for American workers. And it is American workers who have
been hurt most by our tax policy and our trade policy in the
last 20 years. We need to encourage companies to invest in
their greatest asset, the American worker. We do it with a
carrot and a stick.
This month, along with Senator Durbin, I introduced the
Patriot Employer Tax Credit Act. It simply says that businesses
that pay good wages of $15 an hour and provide benefits and do
not outsource their jobs and buy American, basically, that
those companies would get a tax cut. Conversely, when
corporations pay
poverty-level wages, someone has to pick up the tab. It is
American taxpayers. Food stamps, housing vouchers, paying for
Medicaid, paying the Earned Income Tax Credit--taxpayers pick
that up.
So if you are a huge corporation under our proposal and you
choose to pay your workers so little that they are
disproportionately forced onto government assistance, you need
to reimburse American taxpayers. That is our corporate
freeloader act.
The debate over tax reform is a chance for us to reconsider
how we have been told to think about this economy. You do not
build the economy by doing a tax cut for corporations and hope
it trickles down. We know from comparing the 1990s to the next
decade, that simply does not work. You build the economy by
investing in the middle class and build the economy outward.
So, Dr. Marron, offer suggestions, if you will, for other
ways we safeguard against corporate tax reform that
overwhelmingly helps corporate America at the expense of
American workers.
Dr. Marron. Sure. So, you know, I think you want to look at
it through the lens of, if you are doing business tax reforms
and tax cuts, do they encourage more investment here? Because
that is the one channel that will have significant benefit for
workers. And you want to de-emphasize the cuts that are just
going to accrue to shareholders and not provide that sort of
competitive advantage.
I think the other thing is, you want to think about other
aspects beyond the business tax code. You know, there has been
a lot of discussion about worker credits, about expanding the
EITC, the Earned Income Tax Credit, things like that that could
provide support and encouragement to a broader array of
workers, boost their take-home pay, make them more attractive
to employers. And I think that is very worthy to consider as
part of an overall tax reform package.
Senator Brown. Thank you.
Thank you, Mr. Chairman.
The Chairman. Thank you, Senator.
Senator Heller?
Senator Heller. Mr. Chairman, thank you. Thanks for holding
this hearing, and thanks to the ranking member also. And for
those on the panel, thank you very much for taking time and
being with us today.
For too long, Nevadans and America's small-business
companies have been at a competitive disadvantage due to our
outdated and unfair tax code. A Nevada business owner recently
told me that our tax system makes it difficult for him to
compete. Another Nevadan wrote me and said that we need to fix
our tax code in order to attract businesses to our country,
drive up wages for American workers.
Our current tax code distorts the marketplace, drags down
the economy, prevents American job-creators from staying and
hiring at home. Just last month, I hosted Treasury Secretary
Mnuchin at a tax reform roundtable in my home State of Nevada.
There we met with some of the silver State's top job-creators.
And time and time again we heard the same thing: Nevada needs
lower tax rates on its businesses.
Lower rates mean a faster-growing economy, increased
international competitiveness. Lower rates will also mean more
jobs, better jobs, and higher wages, all of which the middle
class desperately needs right now.
Just last week, it was announced that Nevada leads the
Nation in private-sector job growth at 3.6 percent. And imagine
what our State, and for that matter the country, could do if we
at least delivered on tax relief.
So after 8 years of historically low growth under the
previous administration, it is time to get our economy back on
track, help our workers and small businesses win on the
international playing field. So I look forward to working with
all my colleagues here as we move forward on business tax
reform and individual tax relief.
I want to speak really briefly here on the corporate tax
rate and its impact on labor. Mr. Hodge, I missed your opening
testimony, but I assume you talked a little bit about this. The
empirical evidence suggests that workers bear a sizable
percentage, at least 45 percent, of the corporate tax burden.
Is that an accurate comment?
Mr. Hodge. Yes. In fact, we have a paper coming out in the
next week or so surveying the economic literature. And it shows
that a substantial portion of the corporate tax does fall on
workers in some fashion, roughly about half. And in some cases,
it can be as much as 100 percent.
For instance, if the factory that I work for moves from
Dublin, OH to Dublin, Ireland to take advantage of the Irish
12\1/2\-percent corporate tax rate, I have borne 100 percent of
that differential between the Irish rate and the United States
rate. So corporate taxation can have an overwhelming influence
on hiring and wages. And the economic literature shows that
pretty clearly.
Senator Heller. I have a table here that comes from your
organization. And a quote on it shows that a 20-percent
corporate tax rate would lift after-tax incomes by an average
of 3.5 percent. Do you stand behind that?
Mr. Hodge. Yes. Our model shows that, and it is because the
combination of the economic growth and the increase in
productivity will ultimately lift both wages and after-tax
income.
Senator Heller. Your model also estimates that the
combination of a 20-percent corporate tax rate and full
expensing would boost after-tax income by an average of 5.2
percent. Do you still stand behind that?
Mr. Hodge. Yes, absolutely.
Senator Heller. Can you expand on any of this information?
And what we are trying to do is get to individual tax relief.
How can we boost an individual's income, take-home income, by
perhaps a tax policy that works for all Americans? And starting
here with these numbers that you show in this model.
Mr. Hodge. Well, tax relief for individuals is important,
but if you have not had a raise in more than a decade, a tax
cut does not really benefit you. What we want to do is have
policies that lift wages, lift productivity, and ultimately
lift after-tax incomes, real living standards. And the kind of
tax reform that we have outlined here, with the lower corporate
tax rate and full expensing, will do that. And I think that
that is the strongest approach to making people better off.
Senator Heller. What would the average household prefer, a
tax cut or a raise in income?
Mr. Hodge. Well, I think, you know, most people want a tax
cut. They do not really see the connection between corporate
tax reform and the improvement in their daily lives. And we
need to convince them that, ultimately, corporate tax reform
will boost their standard of living in the long term. It is
just a hard sell.
Senator Heller. Yes. Mr. Hodges, thank you.
Mr. Chairman, thank you for my time.
The Chairman. Thank you, Senator.
Senator Thune?
Senator Thune. Thank you, Mr. Chairman. And I want to thank
each of our witnesses for being here this morning.
I think we have a historic opportunity with tax reform to
reform our antiquated tax code and to address the concerns that
I continually hear from South Dakotans on jobs and our economy.
And last week, we had the opportunity to focus on
individual aspects of tax reform and the importance of making
sure it provides tax relief for middle-income taxpayers. And
today we have an opportunity to look at the business aspect of
tax reform, which is a critical component of this effort as
well.
There is significant overlap, I think, however, between the
two hearings. Because if we can streamline and modernize our
outdated tax code on the business side, it will enable
corporations and pass-through businesses, both small and large,
to reinvest, expand, create new jobs, and increase wages. And
that means real benefits for middle-income families in South
Dakota and across the country through the businesses that
employ them and for many through the small businesses, farms,
and ranches that they also own.
This is a strong panel. I want to get into the questions
here if I can.
I will begin with you, Mr. Hodge. In your testimony, you
make an important point when you note that corporate tax reform
may not put cash in people's pockets in the same way as cuts in
the individual rate, but that it can have a powerful effect on
lifting after-tax incomes and living standards. And I am just
wondering maybe if you could elaborate on that connection
between business tax reform and tax relief for middle-class
workers and families, especially if we assume that a reduction
in the corporate tax rate would be accompanied by reductions in
the individual tax rates that affect working individuals in
this country.
Mr. Hodge. When economists at the OECD studied which taxes
were most harmful for growth, they found that the corporate
income tax is the most harmful tax for economic growth, and in
large measure because capital is the most mobile factor in the
economy. So when we lower the tax on capital, we find that the
economy becomes much more productive, people have better tools
to work with, and their standards of living rise. And that
ought to be the primary goal of tax reform, to lift people's
real standard of living.
And you can try to do it through just cutting their income
taxes, but I think the right kind of business tax reform does
the most to lift people's after-tax incomes and ultimately
their standard of living.
Senator Thune. Yes, thank you.
Mr. DeBoer, in your testimony you make the case against the
immediate expensing of real estate, given the unique nature of
these assets. Your testimony also notes the recent MIT study
that suggests the recovery periods for commercial real estate
under the current tax code are out of sync with the economic
recovery period of such property.
Since we are trying to build a tax code that will promote
sustained economic growth, would shortening the recovery period
for commercial buildings from 39 years and rental housing from
27\1/2\ years be a reasonable alternative to immediate
expensing?
Mr. DeBoer. Yes. We strongly believe that. And I do not
disagree at all with what has been said about the power of
expensing. I am simply saying that sustainability in our
industry--it will incent our industry to build, but we see no
benefit to building buildings that are ahead of the demand in
the economy. It puts stress on local markets. It puts stress on
lenders' balance sheets. And ultimately, it is not good for the
long-term growth of the economy.
And so we are, from our industry, more interested in
economic lives of assets and real estate. As MIT has studied,
real estate's proper economic life is closer to 20 years than
39 or 27\1/2\ years.
And by the way, there is some misunderstanding about real
estate. Why would you depreciate a building that people see
standing for many, many years? And these buildings are very,
very capital-intensive. It is not just that they fall down.
People invest money into these buildings to keep them a
competitive part of our economy and allow these buildings to
adapt and be flexible to accommodate business as it changes
over time.
And I do not think anyone here would want to move into an
apartment or work in an office that has not been rehabbed and
updated for 30 or 40 years. So that is what this depreciation
is about. It is both physical wear and tear and economic
obsolescence. So yes, I agree with what you are saying.
Senator Thune. And you suggest, I think, a 20-year recovery
period. Would you apply that to both residential and
nonresidential property?
Mr. DeBoer. I would, but there might be an argument based
on what Senator Cantwell suggested earlier, that you may want
to have a different life for residential versus nonresidential,
which is in current law today. And that is there largely as an
incentive for housing.
Senator Thune. And lastly, should we consider expanding the
15-year recovery period that applies to improvements to certain
type of real property and/or shorten that period as well?
Mr. DeBoer. Well, if tax reform adopts an expensing policy
for all assets other than longer-lived--and that is how I would
define it, a longer-lived asset like a structure--then I would
say that lease-hold improvements to accommodate the business
needs should be expensed like any other business investment, if
that is the direction that Congress goes.
Senator Thune. Thank you.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Wyden?
Senator Wyden. Thank you very much, Mr. Chairman.
Let me start with you, Dr. Marron. As you know, there has
been a lot of discussion about the President's proposal to
create a special pass-through business income rate, which
strikes me as a giant tax giveaway for the top 1 percent,
masquerading under the guise of helping small businesses.
I was trying to look through your various charts. We have a
history in this committee of doing a lot of charts. In your
view, how much of the benefit goes to the top 1 percent in the
special pass-through?
Dr. Marron. I do not have the chart right in front of me,
but the result, as you say, was that if you do a maximum rate
like that, by definition all the benefit has to go to folks of
qualifying income who would be in a higher tax bracket. And so
the overwhelming majority of it goes to people in the top 20
percent and a very large portion goes to people in the top 1
percent.
Senator Wyden. Okay. Now, the administration has said--
although it has been months since they said they were going to
get this corrected. I asked Secretary Mnuchin, who sat where
you all are, about this. They have never done anything to
correct it. I just would be curious what you think of this
argument that there are ways to ensure unscrupulous individuals
are not going to turn this particular tax break into a massive
loophole.
Dr. Marron. So it is a race. If you create a very large tax
benefit to being able to declare your income in a certain
favored form, you are going to create a lot of people all along
the scrupulousness dimension--I am a scrupulous guy, but I
would LLC myself if it were legal and gave the right incentives
and did not remove my political viability--all the way to
people who will, you know, bend the rules and break the rules.
If you are talking about a tax gap that is 30-something for
ordinary income and 15 for pass-throughs, that is a giant
incentive for people to try to figure out how to get around it.
The IRS, legislators, will write some rules to try to limit
that. But my view of this is always that you should view it as
an ongoing iterative game, and the folks out there in the
business world who are looking for ways to get the lower rate
are going to keep working on that, keep working on that, and
over time you are going to have more of a problem.
Senator Wyden. Well, you are right. And of course, they
have vast arrays of talent to help them find those kinds of
holes. And I think your point is especially important.
Mr. Hodge, let us talk a little bit about some of the
history on retroactive and temporary tax cuts. You all have
done a lot of research on this. We have talked to you often on
our bills. In 2001 and 2003, there were the Bush tax cuts. The
advocates said, well, this is going to be a panacea of economic
growth, and what we saw was really a mountain of debt and a
windfall for the affluent.
Now, there are some in Congress who want to bring back
temporary debt-financed tax cuts, and they are making pretty
much the same kind of grandiose promises. And my sense is, and
you all have done a lot of work on this, that we have seen this
movie before. You all have done a lot on this topic lately,
demonstrating what I think really ought to be called the sugar-
high effect, where you get a small bump in the short term
followed by a longer period of lagging economic growth.
So if you would, tell me in your view, based on the work
that you all are doing there, what happens when you go after
another temporary tax cut? And I think your research shows most
of the temporary tax cut goes to the corporate shareholders,
people who are well-off. So why don't you give us your thoughts
on that.
Mr. Hodge. Sure; a temporary tax cut can be sort of the tax
equivalent of cash for clunkers, where it can draw activity
from the future to the present, and then ultimately future
activity declines below baseline.
We analyzed lowering the corporate tax rate for a short
period of time, say even a 10-year window, and we found that it
did have a boost in economic growth in the short term, but
since it pulled activity from the future, long-term economic
activity declined below baseline. So it ultimately slowed
growth at the expense of having growth in the near term.
Senator Wyden. And your colleagues do seem to suggest that
most of the benefit from these temporary cuts goes to the
corporate shareholders, a disproportionate number of whom are
wealthy.
Mr. Hodge. Yes, in part because, again, you are pulling
activity forward that can have a temporary boost in corporate
profits, and that, in the short term, will flow to shareholders
and owners of capital rather than workers.
Senator Wyden. I want to continue this discussion, because
it seems to me retroactive, debt-financed tax cuts,
particularly temporary ones, are a prescription for more
trouble in the American economy in the long term. And that is
why over the years what I have tried to do, most recently with
a member of the President's Cabinet, then-Senator Coats, who
sat over there, was to try to break that kind of cycle. So I
appreciate the scholarship and your answers.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Warner?
Senator Warner. Thank you, Mr. Chairman. And I appreciate
the panel.
I want to go back to the chairman's opening comments where
he, I think, acknowledged, and I will acknowledge as well, that
the United States corporate rates are some of the highest in
the world. Now, our effective rates are not as high.
But I guess I would like for the whole panel to comment, if
there is any disagreement in at least the factual basis that I
work on, that while America has statutorily the second-highest
rate, all of our competitive countries that we compete against,
all who have substantially lower corporate rates, all have a
different revenue source structure than we do.
When we look at, particularly, some of our European
competitors that have dramatically cut rates and continue to
cut rates, the way they make up for that is they have a VAT or
a GST. And when you actually compare, within that same kind of
corporate comparison, apples to apples and you look at where
America ranks in terms of its total tax burden--State, local,
and Federal, as a percent of our GDP--we actually rank 31st out
of 34.
So remarkably, the countries that have much lower corporate
rates have actually raised a much greater share of their GDP in
taxes, have a much higher tax burden.
Does anyone want to counter or contradict that? I mean, I
do not want to go down the whole list here, but I would think
it is important when we are thinking about how we lower
corporate rates, which I think makes sense, that you have to
pay for it.
And one of the things I am going to start with, Dr.
Marron--I mean, I see today, because we are not part of this
process yet, in The Wall Street Journal that the majority is
talking about a $1.5-trillion tax cut. The question I have when
you are talking about a $1.5-trillion tax cut in a country that
already has $20 trillion in debt, accumulated debt created by
both parties for a long time, when you also have, based upon
some of the growth assumptions--the administration has been
using a 3-percent growth rate while CBO has a 1.8-percent
growth rate--the delta on just the growth rate differential
creates an additional $3 trillion of potentially fictional
revenue.
If you have $3 trillion of fictional revenue there and you
have $1.5 trillion of unpaid tax cuts, adding that $4.5
trillion at a minimum of additional deficit-financed tax cuts,
Dr. Marron, what effect do you think that would have on the
economy?
Dr. Marron. Right. So as you know, if you look at CBO's
forecast, we are on track to add about $10 trillion to the debt
over the next 10 years. So, adding another trillion, trillion-
and-a-half would obviously make that even a more severe
challenge. Debt is rising faster than the economy at the
moment. Despite the fact that we are well into an economic
recovery, the unemployment rate is just below 5 percent. In
normal times, this would be a period in which you would think
about bringing deficits down, strengthening the fiscal balance
sheet so that we will be well-positioned for challenges that
come in the future.
If you expanded deficits now with an unfinanced tax cut or
only partly financed tax cut, you have the traditional problem
that the money has to come from somewhere. The resources--it is
really about the resources underlying that, right? The
resources would have to come from somewhere. It would either
crowd out private investment, or if it attracted a lot of
overseas investment, what it would mean is that more of the
economic output in the United States in the future would go to
foreigners rather than Americans.
And so either way you slice that, you end up in a situation
where there is a significant economic drag from substantial
increase in deficits.
Senator Warner. And I guess what I would point out again to
the majority is, back in 2013 when we thought about starting
this exercise again, my Republican colleagues started with a
unified letter saying that tax reform needs to be revenue-
neutral. And it is curious to me now, even before we get to
dynamic scoring, that we are talking about different growth
assumptions and somehow baking into a budget resolution the
allowance for $1.5 trillion of unpaid tax cuts, the growth
assumption numbers you add on some of the scoring issues.
And when you think about one of the concerns I have--and I
am not going to get to my other question--the challenge we
have, as well as the aggregate amount of debt that has been
created is, even if this was starting with a clean balance
sheet, it would be problematic. But it is exponentially more
problematic when you think about an era when I think most
economists assume we are going to see a rising level of
interest rates.
So debt service payments alone will squeeze out our
country's ability to make any other kind of significant
investments. We will have entitlement programs and an Army and
not much else.
Comments?
Dr. Marron. Yes, so we have been fortunate in that the
dramatic increase in debt we have seen in the last decade or so
has been accompanied by incredibly low interest rates. And so
the immediate interest burden is relatively small or normal by
historical standards.
But if, as CBO anticipates, interest rates go back up to
what we think of as a somewhat more normal level, right, you
would see a dramatic increase over time as our debt rolls over
and interest payments roll up.
Senator Warner. And one last comment, since my time is up.
But isn't it, I mean, roughly--and again, if anybody would
counter this, I would be happy. But for every hundred-basis-
point increase in interest rates, with the accumulated debt we
have now, and not even talking about some of these additionals,
are we not talking roughly $150 billion to $160 billion a year
of additional debt service per hundred-basis-point increase in
interest rates, roughly?
Dr. Marron. Yes, roughly, once it rolls over. Right. So we
have $15 trillion in outstanding publicly held debt, right?
Multiply that by 1 percent, and you get $150 billion a year,
yes.
The Chairman. Senator McCaskill?
Senator McCaskill. Thank you, Mr. Chairman.
Although pass-through businesses represent 95 percent of
the businesses, the income is not so evenly distributed among
the business owners. More than half of all pass-through income
in the United States goes to the top 1 percent of all
taxpayers. So the data would suggest that a simple rate cut for
pass-throughs is a huge tax cut to the 1 percent; there is no
question about that. It seems like this would just be an
opportunity for more loopholes.
You know, Dr. Marron, your testimony warned us that the
changes to the pass-through rates could create incentives for
gaming the tax system. Could you speak to that? And I
appreciated the fact that Senator Warner mentioned that we are
the only developed nation that has no kind of consumption tax.
We are it. We are the only one. So if we are going to follow
them down the path of a lower rate, not just for corporate, but
also for pass-through, we are asking for a real hit on
prosperity in this country in terms of debt. And I would like
you to speak to that, Dr. Marron.
And I particularly would like you to speak to--I remember
the days when Kansas was going to be a mecca for job creation.
They did this massive tax cut, and it was going to rain
prosperity and wage increases. Could you explain how things
went so awry in Kansas because of the pressures they felt in
terms of funding public education and all the other needs they
had in Kansas? And frankly, it has been an unmitigated disaster
in Kansas.
Dr. Marron. Right, so thank you. I guess I will do first
first. So as you describe, if we go down the path of creating a
new special pass-through business income tax rate that is lower
than ordinary rates, just by construction that is
systematically going to go to high-income folks, both because
the business income is concentrated at the high end and because
that maximum rate is, by definition, only going to help those
people who are in higher tax brackets.
And so mechanically, it is going to have exactly that
effect of focusing on the high end. And it creates this
loophole concern that people are going to restructure their
activities to qualify for that lower rate. What we saw in
Kansas----
Senator McCaskill. So when you say restructure their
activities to move to pass-through entities, that is why we
have seen explosive growth in pass-throughs in the last decade.
Dr. Marron. Absolutely. And there are a lot of good things
about pass-throughs; I have nothing against pass-throughs. The
challenge is, you do not want the tax code to over-reward them.
Senator McCaskill. Right.
Dr. Marron. The situation we saw in Kansas was so extreme
that a lot of otherwise ordinary, normal people, high-income
but otherwise normal people, would go out and restructure their
activity solely to qualify for that, not to create any new
economic activity. And so the net effect was, the State had
less revenue and there was no benefit from that.
And so what we have seen is, of course, the State is now
walking back from that, because that is just a nonsensical
approach to taxing and taxing pass-throughs at the State level.
The larger point that both you and Senator Warner raised is
about how our tax system compares to the rest of the world.
Now, we do have States that have retail sales taxes, so we do a
little layer of consumption tax spread across the States. But
we are, as you described, very different from the rest of the
world.
The rest of the developed world has significant consumption
taxes, value-added taxes. It is a tax rate you know how to
administer; it is a very efficient way to raise revenue.
People worry that those taxes are regressive. But the way
the rest of the world deals with that is, they have substantial
value-added taxes and then they spend some of the money in such
a way that it offsets the regressivity.
Senator McCaskill. Let us talk about complexity for a
minute. How much--and any of you can address this--but how much
more prosperity would we have, how much more economic activity
would we have, if we could just agree on how to define a child
and how to define a small business in the tax code?
You know, it is unbelievable how complicated it is for
small businesses, because there is not a consistency within the
code in terms of what a small business actually is. I cannot
imagine the productivity that is lost in terms of tax decisions
that are being made just because of that added layer of
complexity.
Mr. Lewis. So, Senator, that is a great question. As I
mentioned just a moment ago, the tax code will probably never
be simple. We live in a complicated world. But it surely should
be a lot less complex.
The message that you just sent about how we define a child
or how we do some of these other things, I think you have to
look back historically how we got there. We have a situation
where well-meaning legislators over time, for one reason or
another, put something in, and we simply never take anything
out. So the question is, how do we end up with so many
retirement plans? That is confusing to the average American
taxpayer.
So I think that is why this opportunity today for tax
reform is so wonderful. I mean, we are 31 years next month
since the last time we did this. This is a time to look at it
and clean it up, because American taxpayers need more time to
worry about running their businesses and less time about how to
comply with the code.
Senator McCaskill. Do you think that it is realistic that
Congress can do that part of it well in 60 days?
Mr. Lewis. Well----
Senator McCaskill. Come on, you know, let us tell the truth
here. Can we actually provide permanency, stability,
predictability, and less complexity out of this congressional
body in 60 days?
Mr. Lewis. I will say this. I will say that the effort for
tax reform has been happening for a long time. I hearken back
to Chairman Camp's H.R. 1 in 2014. There has been a lot of work
that has gone into that effort and has got us to this point.
Whether or not you are close enough to the finish line, I think
that is something that you will have to decide. But in terms of
effort, you know, 3 or 4 years of constant talking and going
back and forth, I know is welcome relief for taxpayers. And I
wish you well in that process.
Senator McCaskill. Thank you.
The Chairman. Thank you, Senator.
Senator Stabenow?
Senator Stabenow. Thank you very much, Mr. Chairman.
First, let me say that I support tax reform that puts money
in the pockets of hardworking people in Michigan and across the
country. And I want to make sure that the tax code incentivizes
American jobs.
And, when we look at what we need to be doing, it is also
important that we are critically analyzing subsidies that do
not make any sense anymore. And at the top of the list for me
are the subsidies provided to the top five big oil companies
through the tax code. Those may have made sense 100 years ago
when they were created; they make absolutely no sense now.
In many cases, these tax breaks are really ridiculous,
saying that oil companies are treated as manufacturers for
purposes of the domestic manufacturing deduction, for example.
Oil companies have enjoyed billions of dollars in special tax
breaks totaling $470 billion. And while receiving those tax
benefits, they have enormous profits. To keep the tax
incentives, they then turn around, the top five companies, and
spend a lot of money on lobbying to do that. And I am sure that
they are doing that right now.
So my question is, and, Dr. Marron, I would say to you,
does the evidence show that these oil company subsidies provide
benefits to consumers that would warrant keeping them in place
as we do tax reform?
Dr. Marron. I will say I have not seen any evidence that
would suggest that.
Senator Stabenow. Thank you. What should we be doing when
we are talking about effective ways to target tax dollars to
create American jobs and put more money back in the pockets of
the majority of Americans?
Dr. Marron. So on the business side, I think the key thing
is that you want to encourage investment in the United States
and you want to encourage the kind of investment that has the
most benefits. So things like research and development can have
spillover benefits to the rest of the economy, and you would
like to encourage that.
You know, basically, capital accumulation, equipment and
whatnot, in the United States makes workers more productive.
And over time--I know we have had issues with this in recent
years--but over time the evidence is still very strong that if
workers have more and better capital to work with, that
eventually shows up in their wages, salaries, and benefits.
Senator Stabenow. Well, my concern is, as we are debating
right now, various proposals we have seen would actually do
away with manufacturing incentives, cut interest deductibility,
maybe cut cost recovery and use the money simply to reduce
rates, and that is one of the big debates right now.
And my concern is, that means you are incentivizing a new
advanced manufacturing facility in Michigan the same way you
would be if it was in Mumbai, or incentivizing an American job
the same way that you would be incentivizing a job being
created in China.
And I think that is a big problem as we are having this
debate right now. And so how would reducing the tax incentives
that encourage companies to invest here impact their decision
as to whether they would invest and create jobs in the United
States?
Dr. Marron. This goes a little bit back to Senator
Roberts's discussion. I do not know if you all were here when
he talked about the red ant problem. So there are a lot of
moving parts that affect business decisions about where to
invest and how to invest. And the challenge for you--and this
is why I said in my opening remarks that I feel your pain,
because it is very hard to balance all of those. The rate
matters, the treatment of depreciation and expensing matters,
the treatment of interest deductibility matters, and the things
focused on particular industries like manufacturing all matter.
And the challenge is, how do you put together a package of
those that puts us on a trajectory of more growth? And I think
the answer is that there are good arguments for bringing the
top rate down, because it is so out of line with the rest of
the world. There are good arguments for making some amount of
depreciation even more favorable and treating investment in the
U.S. more favorably. But then you are left with a situation of,
how do you pay for that?
Limiting interest deductibility is the first thing that
comes to mind. And then we get into the discussion we were
having previously about other potential revenue sources.
Senator Stabenow. But when we are looking at things like
cutting interest deductibility, we are actually seeing the
possibility of raising taxes on small business and others that
are actually growing and creating jobs in our country.
Dr. Marron. Yes. And so one of the big challenges is that
there are some portions of our economy, particularly small
business, where we have already given them expensing. So they
already have full expensing for their investments, and so a tax
reform proposal that would move toward expensing but limit
interest deductibility will not help them. So we are kind of--
this is one of the corners you find yourself painted into, that
while a move towards expensing and limited interest
deductibility could be attractive for many larger businesses
and could encourage more investment in the United States, it
does not do anything for the small businesses that already get
to take advantage of expensing.
Senator Stabenow. Thank you.
Mr. Chairman, I hope we can come together and do something
that actually does more than a trickle-down tax cut for the top
1 percent and that would tackle the subsidies that do not make
sense in the tax code and reinvest those in the incentives that
are going to create jobs in America. Thank you.
The Chairman. Well, thank you, Senator.
This has been a particularly good panel. I have really
enjoyed each and every one of you and your comments.
And I have heard from my colleagues across the aisle the
parade of horribles that will ensue if Congress enacts a
proposal to provide a lower business income tax rate for pass-
through entities: that it will only benefit the rich and that
it will, according to Dr. Marron, quote, ``inspire tax
avoidance,'' which it may do.
And yet, two of you today have come to the table with what
I consider to be thoughtful approaches on how to address the
concerns that compensation or wage income that is taxed at
ordinary income tax rates will be inappropriately
recharacterized as business income subject to a preferential
business income tax rate.
I would like to have Mr. Lewis and then Mr. DeBoer comment
on their proposals, whether the concerns raised are legitimate,
but perhaps overblown, and provide us with their thoughts on
administrative issues associated with their proposals, if they
would.
Mr. Lewis. Okay. So thank you for the question, Senator.
First of all, our laws should encourage and not discourage the
formation of pass-through entities. The reality, and I think
the panel has indicated this today, is that so much of our
business is conducted through pass-through form in this
country. And we are competing globally with companies that are
structured in different ways.
One thing to keep in mind is that a pass-through entity has
the same kind of demands that a C corporation has. They have to
have the investment in tangible and intangible property, real
estate, technology, intellectual property, and, most
importantly, human capital. All businesses have uncertainty and
risk, and there should be a consistency and fair treatment of
all.
So now to your point about the gamesmanship and the
potential here. There are a lot of different issues that
entrepreneurs consider when they make the decision as to what
entity to form. Income tax is important, and I do not want to
diminish that, but the reality is, as I have worked with
individuals, that is only one of about a dozen. They also
consider implications of losing one's tax benefits, like fringe
benefits, losing unemployment coverage, covering one's own
health insurance now because they have gone out to form their
own business, and then also the costs of managing a business:
malpractice insurance, training, technology, software. This is
not just a flip-the-switch and walk-across-the-street-type
proposal.
So that is why we have proposed an anti-abuse-type regime,
because I think you are right. And the proposal we have come up
with is, for once, codifying the reasonable compensation
standard that is now just administered through the courts.
And then we should go further, as some of the proposals
do--H.R. 1 from Chairman Camp, for instance--and come up with
some sort of, I think some have called it a rough justice, but
a split between earnings as an employee versus earnings from
investment, and make that a safe harbor so that it is more
administrable.
So I think what you want to focus on is to create some sort
of a rule into the law to make sure that we try to get at the
gamesmanship, but then also provide an easily administered
provision for the IRS.
The Chairman. Well, thank you.
Mr. DeBoer. A couple of maybe bigger-picture points first,
if I may, Mr. Chairman. Senator Stabenow talked about how we
can help Americans and American businesses. I think the first
thing to keep in mind is not to do any harm to them. And some
of the proposals, particularly on the revenue offset side,
dramatically impact domestically based, capital-intensive
industries that are conducted in pass-through format. And that
is why we are so interested in this pass-through rate.
I understand Senator McCaskill's concern on the income to
the top 1 percent. I would like to look at that data. I think
that may include compensation for services to the entity, and
we are very, very interested, as Mr. Lewis is, in making sure
that that income does not come down and be taxed at a new lower
rate.
We have done a significant amount of work here to try to
look at the relationship between partners in a pass-through
entity and how much service is provided to the entity itself.
And our proposal at first blush is a little bit complicated. We
are starting to reach out to staff and flesh it out.
And I guess for purposes of this hearing, I simply want to
repeat what I said earlier in my opening statement. We are
pledged to work with the committee, Senator Wyden, Senator
McCaskill, and others, to make sure that with true compensation
to the entity, there is no gamesmanship.
But the fact of the matter is, these pass-through entities
do earn income, and that income, whether it is from rents in
the real estate business or development fees or what have you,
that income should be taxed lower if in fact corporate taxes
are going to come down.
And one other thing that I would say: these pass-through
entities are the vehicle of choice for startup businesses, they
are the vehicle of choice for minority-owned businesses, and
this is how most Americans who are interested in using their
business acumen to develop jobs and expand our economy, this is
the format that they do.
So encouraging activity in this area is very much
commendable, and thank you for looking at this. It is a
complicated issue, but one that I have no doubt you and your
staff can tackle.
The Chairman. Well, thanks to all four of you. I think this
has been a really interesting hearing. And I want to thank you
all for your attendance and for your contributions here today.
As I noted last week, this committee's approach to tax
reform will be methodical and inclusive. That is why hearings
like the one we have just had today will be critically
important as we continue to evaluate the tax code and continue
with marking up a bill that will enact meaningful, durable, and
efficient reforms.
My strong preference is that our evaluations and
determinations and the final language of any bill we come up
with will be bipartisan. And I intend to work towards that end.
That means we have a lot of work to do, but I am optimistic
that we can get it done.
For any of my colleagues who have written questions for the
record, I ask that you submit them by the close of business on
September 28th.
And with that, I again want to thank all four of you for
being here and for your excellent testimony.
And we will recess until further notice.
[Whereupon, at 12:25 p.m., the hearing was concluded.]
A P P E N D I X
Additional Material Submitted for the Record
----------
Prepared Statement of Jeffrey D. DeBoer, President and Chief Executive
Officer, The Real Estate Roundtable
Chairman Hatch, Ranking Member Wyden, and members of the committee,
my name is Jeffrey DeBoer, and I am president and chief executive
officer of The Real Estate Roundtable. Thank you for the opportunity to
testify this morning on business tax reform on behalf of Roundtable
members and the real estate industry.
The Real Estate Roundtable brings together leaders of the Nation's
top publicly held and privately owned real estate ownership,
development, lending, and management firms and leaders of major
national real estate trade associations. Collectively, Roundtable
members' portfolios contain over 12 billion square feet of office,
retail, and industrial properties valued at more than $1 trillion; over
1.5 million apartment units; and in excess of 2.5 million hotel rooms.
Participating trade associations represent more than 1.5 million people
involved in virtually every aspect of the real estate business.
We agree with the members of this committee, House leaders, and the
President that the time to reform the tax code is now. We share your
commitment to pro-growth tax reform that will move our economy forward
and help produce better jobs and bigger paychecks for all Americans.
Our industry has appreciated the open dialogue and opportunity to work
constructively with members and staff of this committee to ensure that
tax reform achieves its full potential.
My comments are offered in the spirit of support for the tax reform
effort, and they are aimed at ensuring the legislation successfully
spurs economic growth without unintentionally discouraging
entrepreneurship or creating unnecessary economic and market risks.
real estate and the economy
Real estate is deeply interwoven in the U.S. economy and the
American experience, touching every life, every day. Millions of
Americans share in the ownership of the Nation's real estate, and it is
a major contributor to U.S. economic growth and prosperity. Real estate
plays a central role in broad-based wealth creation and savings for
investors large and small, from homeowners to retirees invested in real
estate via their pension plans.
Commercial real estate provides the evolving physical spaces in
which Americans work, shop, learn, live, pray, play, and heal. From
retail centers to assisted living facilities, from multifamily housing
to industrial property, transformations are underway in the ``built
environment.'' Investment in upgrading and improving U.S. commercial
real estate is enhancing workplace productivity and improving the
quality of life in our communities.
Among its many and varied economic contributions, the real estate
industry is one of the leading job creators in the United States,
employing over 13 million Americans--more than 1 in every 10 full-time
U.S. workers--in a wide range of well-
paying jobs. Real estate companies are engaged in a broad array of
activities and services. This includes jobs in construction, planning,
architecture, building maintenance, management, environmental
consulting, leasing, brokerage, mortgage lending, accounting and legal
services, agriculture, investment advising, interior design, and more.
Commercial real estate encompasses many property types, from office
buildings, warehouses, retail centers, and regional shopping malls, to
industrial properties, hotels, convenience stores, multifamily
communities, medical centers, senior living facilities, gas stations,
land, and more. Conservatively estimated, the total value of U.S.
commercial real estate in 2016 was $13 to $15 trillion, a level that
roughly matches the market cap of domestic companies on the New York
Stock Exchange. Investor-owned commercial properties account for
roughly 90 percent of the total value, with the remainder being owner-
occupied. Based on the latest data available from the Federal Reserve,
U.S. commercial real estate is conservatively leveraged with about $3.8
trillion of commercial real estate debt.
Industry activity accounts for nearly one-quarter of taxes
collected at all levels of government (this includes income, property,
and sales taxes). Taxes derived from real estate ownership and its
sale/transfer represent the largest source--in some cases approximately
70 percent--of local tax revenues, helping to pay for schools, roads,
law enforcement, and other essential public services. Real estate
provides a safe and stable investment for individuals across the
country, and notably, retirees. Over $370 billion is invested in real
estate and real estate-backed investments by tax-exempt organizations
(pension funds, foundations, educational endowments and charities).
Commercial real estate is a capital-intensive asset, meaning that
income-
producing buildings require constant infusions of capital for
acquisition and construction needs, ongoing repairs, and maintenance,
and to address tenants' ever-changing technological requirements. Every
homeowner in America who has had to repair a roof or to replace a
furnace understands and appreciates that buildings are not a one-time,
fixed expense. Real estate development, and the real estate
improvements necessary for a building to avoid obsolescence, serves as
a constant and powerful economic multiplier. Real estate capital
expenditures ripple through the economy--creating jobs and generating
economic growth.
Real estate investment is a long-term commitment and involves time
horizons measured in 5 to 10 year increments, or longer--not the 3-
month quarters that other industries and asset classes use to measure
their performance. Consequently, from small towns to urban centers,
real estate ownership in the United States represents a positive,
bullish bet on America's economic future.
At the same time, the health and stability of U.S. real estate is
heavily dependent on broader trends in the economy. Debt and deficits
matter to real estate because of their impact on interest rates, the
cost of borrowing, and the availability of private capital for
investment and job creation. On one hand, some tax policies may cease
to be pro-growth if they are financed through an increase in the
Federal deficit. On the other hand, some revenue-raising options under
discussion would slow growth and put downward pressure on wages and
employment, so revenue neutrality for its own sake is not desirable.
Ultimately, the supply of real estate should be responsive to
demand in order to support sustainable economic growth, and demand for
real estate correlates with the overall level of economic activity.
Thus, where goes the economy, so goes real estate. And where goes real
estate, so goes the economy. The two are inextricably linked.
principles for sustainable, pro-growth business tax reform
The real estate industry agrees that tax simplification and reform
is needed and long overdue. We should restructure our Nation's tax laws
to unleash entrepreneurship, capital formation, and job creation. At
the same time, Congress should undertake comprehensive tax reform with
caution, given the potential for tremendous economic dislocation. Tax
policy changes that affect the owners, developers, investors and
financiers of commercial real estate will have a significant impact on
the U.S. economy, potentially in unforeseen ways.
A broad-based acceleration of economic growth through tax reform
would boost real estate construction and development and spur job
creation. However, Congress should be wary of changes that result in
short-term, artificial stimulus and a burst of real estate investment
that is ultimately unsustainable and counterproductive. Real estate
investment should be demand driven, not tax driven. In short, we should
avoid policies that create a ``sugar high'' that is fleeting and
potentially damaging to our future economic health.
Because of the long-term commitment required in real estate
investment, we are deeply concerned with how tax changes will affect
jobs, wages, and economic activity not just tomorrow, but well into the
future. In order to improve the economy's trajectory, growth should be
predicated on sound reforms that change underlying economic conditions.
Fortunately, today's commercial real estate markets are grounded in
strong fundamentals, as indicated by generally low vacancy rates,
positive growth of rents, and stable net operating income. By most
measures, commercial real estate conditions accurately reflect market
supply and demand.\1\ Sources of equity and debt capital are largely
available for economically viable real estate projects. In some parts
of the country and in certain markets, initial signs of oversupply are
starting to emerge. These signs are typical and expected in a healthy
real estate cycle.
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\1\ The Real Estate Roundtable, ``Sentiment Index: Second Quarter
2017'' (May 5, 2017), available at: http://www.rer.org/Q2-2017-RER-
Sentiment-Index.
We urge the Finance Committee to be mindful of how proposed changes
in commercial real estate taxation could dramatically affect not only
real estate investment activities but also job growth, retirement
savings, lending institutions, pension funds, and, of course, local
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communities.
Positive reforms will spur job-creating activity. For example, tax
reform that recognizes and rewards appropriate levels of risk-taking
will encourage productive construction and development activities,
ensuring that real estate remains an engine of economic activity. Tax
reform can also spur job creation, and assist the Nation in achieving
energy independence, by encouraging capital investments in innovative
and energy-efficient construction of buildings and tenant spaces.
Repealing the Foreign Investment in Real Property Tax Act (FIRPTA)
would open up new sources of private capital for U.S. real estate and
infrastructure projects. Authorizing States to impose sales tax
collection requirements on remote sellers would end harmful tax
discrimination against brick and mortar retailers and improve the
economic well-being of local communities.
Alternatively, some reforms might prove counter-productive to long-
term economic growth. Of major concern are proposals that could result
in substantial losses in real estate valuation. Lower values could
result from artificially stimulating excess supply, or adopting
policies that increase the cost of capital through higher borrowing
costs. Lower property values produce a cascade of negative economic
impacts, affecting property owners' ability to obtain credit, reducing
tax revenues collected by local governments and eroding the value of
retirees' pension fund portfolios.
Thus, as much as we welcome a simpler, more rational tax code--and
any associated improvements in U.S. competitiveness abroad--we continue
to urge that comprehensive tax restructuring be undertaken with
caution, given the potential for tremendous economic dislocation.
As history illustrates, the unintended consequences of tax reform
can be disastrous for individual business sectors and the economy as a
whole. A case in point is the Tax Reform Act of 1986, which ushered in
over-reaching and over-reactive policies--in some cases on a
retroactive basis. Significant, negative policy changes were applied to
pre-existing investments. Taken together, these changes had a
destabilizing effect on commercial real estate values, financial
institutions, the Federal Government and State and local tax bases. It
took years for the overall industry to regain its productive footing,
and certain aspects of the economy never recovered.
A nostalgia for the Tax Reform Act of 1986 has grown and spread in
Washington over the years. The 1986 Act is frequently cited as the
model that 21st-century tax reform should strive to mimic. The actual
economic evidence is much less favorable.\2\ If there is a major lesson
we can draw from the 1986 Act, perhaps it is this: revenue-raising
policy changes tend to be much more enduring than reductions in tax
rates, which are more easily undone to accommodate changing needs
related to fiscal policy.\3\
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\2\ Both economic growth and job creation slowed dramatically in
the United States for a number of reasons after the Tax Reform Act of
1986 took effect. In the 5 years before the legislation was adopted
(1982-1986), the United States' real rate of economic growth averaged
3.55 percent. In the 5 years after enactment of the 1986 Act (1987-
1991), the United States' economic growth rate averaged 2.64 percent.
World Bank National Accounts Database (accessed September 14, 2017).
Similarly, in the 5 years prior to its enactment (1982-1986), the
United States created an average of 160,000 jobs per month. In the 5
years after its passage (1987-1991), the United States created 130,000
jobs per month, or 30,000 fewer than before its enactment. U.S.
Department of Labor, Bureau of Labor Statistics, Current Employment
Statistics Survey (accessed September 14, 2017).
\3\ The 28 percent maximum individual income tax rate in the Tax
Reform Act of 1986 lasted 3 years before increasing to 31 percent in a
bipartisan budget agreement. Three years later, in 1993, the maximum
income tax rate increased again to 39.6 percent. In contrast, the base
broadeners, such as the lengthening of cost recovery schedules and
limitations on passive activity losses, became permanent fixtures of
the tax code.
We believe the four principles below should guide and inform your
efforts to achieve a significant, pro-growth overhaul of the Nation's
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tax code:
1. Tax reform should encourage capital formation (from domestic
and foreign sources) and appropriate risk-taking, while also providing
stable, predictable, and permanent rules conducive to long-term
investment;
2. Tax reform should ensure that tax rules closely reflect the
economics of the underlying transaction--avoiding either excessive
marketplace incentives or disincentives that distort the flow of
capital investment;
3. Tax reform should recognize that, in limited and narrow
situations (e.g., low-income housing and investment in economically
challenged areas), tax incentives are needed to address market failures
and encourage capital to flow toward socially desirable projects; and
4. Tax reform should provide a well-designed transition regime
that minimizes dislocation in real estate markets.
In short, rational taxation of real estate assets and entities will
support job creation and facilitate sound, environmentally responsible
real estate investment and development, while also contributing to
strong property values and well-served, livable communities.
potential elements of business tax reform and their impact on real
estate
In June of last year, House Ways and Means Committee Chairman Kevin
Brady (R-TX), House Speaker Paul Ryan (R-WI), and the House Republican
Conference put forward A Better Way, a bold tax reform proposal aimed
at creating a modern tax code. We support the blueprint's underlying
objectives, including the desire to reform the tax system to promote
economic growth, capital formation, and job creation. In addition, this
committee has explored several tax reform options, including corporate
tax integration. Senator Wyden has released a number of tax reform
discussion drafts related to various issue areas. In April, the
President's economic team released a one-page outline of the
administration's tax reform priorities. In July, congressional leaders,
the Treasury Secretary, and the Director of the National Economic
Council issued a joint statement identifying several areas of
agreement. While the details of tax reform remain uncertain, these
events have shed light on the potential contours of comprehensive tax
legislation. The remainder of my testimony will focus on specific
elements of business tax reform under consideration. Of course, our
views and input will continue to evolve as additional information and
details are made available.
The Business Interest Deduction--An Ordinary and Necessary Expense
Critical to Real Estate Ownership, Development, and Financing
The House Blueprint and other reform proposals have advocated
limiting or repealing the deductibility of net interest expense for
business-related debt. Restrictions on interest deductibility would
cause enormous damage to U.S. commercial real estate by dragging down
property values and discouraging new investment.
Access to financing and credit is critical to the health of U.S.
real estate and the overall economy. As a general matter, business
interest expense is appropriately deducted under the basic principle
that interest is an ordinary and necessary business expense. For real
estate in particular, because the vast majority of real estate is held
in pass-through form, the interest deduction does not result in a tax-
induced distortion in investment financing decisions.
The ability to finance productive investment and entrepreneurial
activity with borrowed capital has driven economic growth and job
creation in the United States for generations. America's capital
markets are the deepest in the world and provide our economy with a
valuable competitive advantage.
Borrowing is not limited to large companies--four out of five small
businesses rely on debt financing. Businesses rely on credit for
working capital and to weather shifts in demand. Limiting the
deductibility of interest would increase the cost of capital,
discouraging business formation and making it harder to grow into
larger businesses. Over time, rising interest rates will magnify the
harm, potentially leading to greater financial volatility and higher
default rates.
The notion that business interest should be deductible is deeply
ingrained in our economic system and precedes the modern income tax
itself. The corporate income tax of 1894 included a deduction for
business interest. In both an income tax system and a cash flow tax
system, business interest expense is appropriately deducted under the
basic principle that interest is an ordinary and necessary business
expense. Any economic bias in favor of debt-financed investment
principally relates to the tax penalty on the shareholders of C
corporations, who are double-taxed on their equity investments. Real
estate is held typically in pass-through form, and the interest
deduction does not result in a tax subsidy for debt-financed real
estate investment.
Repealing or imposing limits on the deductibility of business
interest would fundamentally change the underlying economics of
business activity, including commercial real estate transactions. This
could lead to fewer loans being refinanced, fewer new projects being
developed, and fewer jobs being created. Legislation altering the tax
treatment of existing debt could harm previously successful firms,
pushing some close to the brink of insolvency or even into bankruptcy.
By increasing the cost of capital, tax limitations on business debt
could dramatically reduce real estate investment, reducing property
values across the country, and discouraging entrepreneurship and
responsible risk-taking.
The burden of changing the deductibility of interest may fall
disproportionately on entrepreneurs and small developers--those most
likely to own properties in small and medium-sized markets--because
they use greater leverage to finance their activities and lack the deep
portfolio of assets to absorb the losses generated from expensing.
Restrictions may also impede efforts to attract private capital for
infrastructure investment.
Private-sector economists have modeled for the industry the impact
that elimination of the deductibility of business interest would have
on real estate investment and property values. They examined tax reform
based on the rates and structure of the House Blueprint, but without
the immediate expensing of structures. Their research suggests the
negative impact on property values and the after-tax returns on real
estate investment would be severe. For all of these reasons, Congress
should ensure that tax reform preserves the current tax treatment of
business interest.
Cost Recovery and the Expensing of Capital Investment--Tax Rules Should
Track the Actual Economics of Real Estate Ownership
Rather than taxing businesses on their net income, the House
Blueprint seeks to tax businesses on their net cash flow. For a
domestic business, the full cost of a new investment would be recovered
(deducted) immediately, rather than recovered (depreciated) over the
economic life of the investment. The underlying expectation is that the
shift to cash flow taxation will spur growth by reducing the tax burden
on new investment. While the joint statement in July appeared to move
away from a complete cash flow business tax system, it did promise
``unprecedented'' expensing of capital investment.
Economic studies suggest that expensing in the abstract is a
powerful, pro-growth tax policy. Personal property and certain real
estate assets already benefit from accelerated and bonus depreciation.
Today, 90 percent of the cost of an investment in 3-year property is
recovered for tax purposes within the first 18 months of its use. Five-
year property is 78 percent recovered in the first 18 months. Even 7-
year property is nearly 70 percent recovered in the first 18 months.\4\
Expensing these short-lived asset classes makes sense. Current tax
policy is already well on the way towards the expensing of equipment
and machinery, and full expensing of these assets may offer significant
tax simplification advantages. Alternatively, the committee could
consider proposals aimed at simplifying cost recovery for short-lived
assets, such as Senator Wyden's pooling proposal.
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\4\ David Mericle and Dan Stuyven, ``Corporate Tax Reform: Trading
Interest Deductibility for Full Capex Expensing'' (Goldman Sachs
Economics Research, November 30, 2016). See also Ryan Corcoran et al.,
``Understand Common Complexities When Applying Bonus Depreciation,''
RSM Insight Article (February 7, 2017).
However, real estate is different from these other capital assets.
Structures are long-lived, require constant infusions of capital, and
typically sell for a gain. Thus, real estate is subject to much longer
recovery periods and slower recovery methods. Expensing real estate
would constitute a much more dramatic shift from current law with
unknown consequences. The challenges associated with transitioning real
estate to an expensing regime are immense and, likely, prohibitively
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costly.
The Tax Foundation's own analysis of the economic impact of
immediate expensing reveals that nearly 73 percent of the boost to
economic growth generated from the full expensing of capital investment
would come directly from new real estate construction, development, and
investment.\5\ While real estate represents a large and important share
of the U.S. economy, it is not \3/4\ of the overall pie. The Tax
Foundation analysis suggests that the boost to GDP from immediate
expensing would not drive a broad-based, demand-driven increase in
economic activity. On the contrary, it suggests that any boost to
short-term growth would stem from an untested tax policy that is likely
to over-stimulate real estate markets.
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\5\ Stephen J. Entin, ``Tax Treatment of Structures Under
Expensing'' (May 24, 2017).
The industry concerns with expensing are based on historical
experience. Accelerated depreciation of real estate in the early 1980s
led to tax driven, uneconomic investment. Tax-motivated stimulation of
real estate construction that is ungrounded in sound economic
fundamentals, such as rental income and property appreciation
expectations, creates imbalances and instability in real estate
markets. No other major country in the world has immediate expensing of
real estate. The market implications of expensing real estate are
risky, untested, and unpredictable. The negative consequences could
harm State and local communities (through reductions in State and local
property tax revenue), the financial security of retirees (through
pension investments tied to real estate), and the banking system
(through the declining value of real estate on bank balance sheets and
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systemic risk to the financial system).
The House Blueprint proposes to deviate from cash flow taxation in
two key ways that would have critical implications for real estate.
First, land would not qualify for immediate expensing, only the value
of structures. Second, as discussed above, businesses could not deduct
currently their net interest expense. As a result, two major expenses
associated with investing in real estate--the cost of the underlying
land and the cost of borrowing capital to purchase the real estate--
would be excluded from the basic architecture of the cash flow tax
system.
Land represents a major share, on average roughly 30 percent, of
the value of real estate. The House Blueprint offers no express
rationale for the exclusion of land from immediate expensing. The two
suggestions offered informally to-date have been that land is a ``non-
wasting'' asset and ``we're not making any more of it.'' However, the
actual economic life of an asset and its status as a manufactured good
is irrelevant to a system that seeks to tax net cash flow. Under the
Blueprint's own terms, land should qualify for expensing. Denying
taxpayers' ability to expense land would create the very same economic
distortions that the Blueprint is seeking to remove from the tax code.
It would shift resources to other asset classes for reasons that are
purely tax-motivated. In addition, it would create new geographic
disparities and distortions based on the relative share of land in the
cost of real estate.
Current cost recovery rules do need reform. The real estate
industry favors tax rules that closely reflect the economics of
transactions. Existing depreciation schedules are too long. The
Massachusetts Institute of Technology (MIT) recently conducted a
comprehensive study on the rate of economic depreciation for commercial
real estate.\6\ MIT analyzed over 120,000 actual transactions and
13,000 land/development sites and developed a model of the entire life
cycle of commercial property. For the first time, ongoing capital
expenditures were added to the depreciation analysis. The research
makes great strides in separating the value of land from the value of
structures. The MIT study controlled for property and location
characteristics much more extensively than any prior published
research. The study is a tremendous improvement over prior government
studies, which rely on data from the 1960s and 1970s. The bottom line
is that the appropriate straight-line depreciations periods for real
estate should be closer to 20 years, not 27.5 or 39 years. Shortening
the straight-line depreciation of real estate to 20 years, rather than
expensing, would spur investment that is sustainable and economically
sound.
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\6\ Professor David Geltner and Sheharyar Bokhari, ``Commercial
Buildings Capital Consumption in the United States,'' (MIT Center for
Real Estate, November 2015); see also Andrew B. Lyon and William A.
McBride, ``Tax Policy Implications of New Measures of Building
Depreciation,'' Tax Notes (June 20, 2016).
With respect to depreciation ``recapture,'' the tax law should
continue to recognize that a portion of the income received on the sale
of real estate reflects the appreciation of the underlying land and is
appropriately taxed at the reduced capital gains rate.
Pass-Through Reform: Tax Changes Should Promote Growth and
Entrepreneurship for All Forms of Business Activity
Our pass-through regime is a competitive strength of the U.S. tax
system, not a burden. Entity choice is a differentiator that
contributes to our entrepreneurial culture. The expansion of the pass-
through sector has allowed American businesses to avoid the rigid
nature of the corporate form and its many demands on legal structure
and governance that are unrelated to tax considerations. Partnership
tax rules promote job creation by increasing business flexibility and
facilitating the pooling of expertise, capital, and know-how under one
roof. Partnerships can allocate the risks and rewards of the enterprise
as they choose, provided the distribution of profits and losses have
substantial economic effect. The result is a more dynamic business
environment that promotes innovation, productivity, and appropriate
levels of risk taking that are responsive to the needs of both limited
investors and general partners.
Real estate investment, new construction and development, and
rental income constitute a significant share of pass-through business
activity. Half of the country's nearly 4 million partnerships are real
estate partnerships. Pass-through entities (partnerships, LLCs, and S
corporations), as well as real estate investment trusts (REITs), are
ideal for real estate investment because they give investors
flexibility in how they structure the risks and rewards of the
business.
These partnerships include a wide variety of arrangements that
range from two friends who purchase, improve, and lease a modest rental
property to a large private real estate fund that raises capital from
sophisticated institutional investors. Similarly, listed REITs provide
the opportunity for small investors to invest in large scale,
diversified real estate operations using the same single tax system
available to partners in partnerships.
Recent tax reform proposals from congressional leaders and the
administration would establish a special tax rate applicable to the
business income of pass-through entities and sole proprietorships. Care
should be taken when creating a new rate structure for pass-throughs,
including REITs, to avoid an entity level tax or arbitrary rules that
penalize general partners or raise the tax burden on carried interest.
The pass-through rate should seek to spur economic growth and job
creation by reducing the tax burden on business formation and
entrepreneurship. With this in mind, a special tax regime for pass-
through entities should take into account the types of activity and
income that most commonly arise in noncorporate form. The pass-through
rate should avoid ``cliffs,'' phase-outs, and carve-outs that create
new economic distortions, discourage business growth, or aim to steer
investment to certain government-favored activities. Similarly, the
pass-through rate should avoid asset or revenue tests that ignore
differences in the capital intensity and financing structures of
certain industries.
Further, tax reform should maintain equivalence with respect to the
taxation of rent and interest, whether the rent or interest is
collected through a partnership, a limited liability company, an S
corporation, or a REIT. Under current law, a dollar of rental or
interest income, whether received through a REIT or a pass-through
entity such as a partnership, has the same rate, character and timing
for tax purposes. A shift away from equivalence would discriminate
against REIT-based rent or interest received by owners of the REITs,
even though REITs are not permitted to keep the rent or interest and
must pay it out annually to owners.
Lastly, the pass-through rate should avoid changes that
unintentionally reduce incentives for entrepreneurial risk-taking and
capital formation. For example, the pass-through rate should preserve a
partnership's ability to extend participation in the capital
appreciation of the business and its assets to a general partner who
bears risk and contributes sweat equity. The character of income should
continue to be determined at the partnership level.
The Real Estate Roundtable's Tax Policy Advisory Committee has
produced a white paper that suggests one possible approach for how to
design a reduced tax rate applicable to pass-through business income.
In short, rather than specifically seeking to measure reasonable
compensation or create an arbitrary rule that taxes a specific
percentage of pass-through income as ordinary and a percentage at the
business rate, the proposal looks at the relationships between the
partners. If a partner spends only a de minimis number of hours
providing services, then all of the partner's income is taxed at the
pass-through rate. If there are limited partners earning the same
return as the partner providing services (i.e., providing a
``benchmark''), then all the service partner's income is taxed at the
pass-through rate. Finally, if there is no benchmark provided by
outside investors, then the service partner would qualify for the pass-
through rate to the extent of a specified return on investment (perhaps
12 percent). Amounts above the specified percentage would be taxed as
ordinary income.
This approach would provide greater certainty to taxpayers at the
outset of a business venture. It would eliminate many of the
administrative challenges associated with measuring reasonable
compensation and create fewer opportunities for abuse. The white paper
acknowledges that there may be situations where an approach based on
reasonable compensation or other factors may be appropriate and more
equitable. The proposal only relates to the operating income of a pass-
through business.
Capital Gains and Entrepreneurial Risk-Taking--A Key Differentiator
That Encourages Vibrant and Dynamic Economic Growth
The tax code has historically encouraged and rewarded risk-taking
and entrepreneurship, and our tax rules have recognized that risk can
involve much more than the contribution of capital or cash. Low capital
gains tax rates help stimulate economic growth, increase investment,
and create jobs. In addition to encouraging risk-taking and
entrepreneurship--core strengths of the American economic model--low
capital gains rates reduce the tax-driven ``lock up'' of assets that
prevents properties from being put to their best and most efficient
use. Low capital gains taxes also minimize distortions that result from
taxing inflation-induced, uneconomic gains.
Because of the capital-intensive nature of long-lived real estate
assets, real estate partnerships often bring together (1) a general
partner who manages the business in exchange for an annual management
fee and a share of the profits and (2) investors who serve as limited
partners and contribute capital. Incorporating ``carried interest''
into the partnership structure allows entrepreneurs to match their
expertise and risk assumption with financial partners and aligns the
parties' economic interests so that entrepreneurial risk taking is
viable.
Tax reform should preserve the longstanding rule that determines
the character of partnership income at the partnership level. Changes
to carried interest taxation would instill substantial uncertainty in
the marketplace and have a chilling effect on capital investment.
Congress should reject legislation that specifically targets capital
gain on real estate sales (including carried interest), and any
comprehensive tax restructuring should continue to encourage capital
formation and appropriate entrepreneurial risk taking for the benefit
of the broader economy and job creation.
Like-Kind Exchanges: A Valuable Tool for Business Expansion, Growth,
and Job Creation
Under current law, section 1031 of the tax code ensures that
taxpayers may defer the immediate recognition of capital gains when
property is exchanged for property of a like kind. In order to qualify
for full tax deferral, a like-kind exchange transaction must involve
property used in a trade or business, or held as an investment, and all
proceeds (including equity and debt) from the relinquished property
must be reinvested in the replacement property. Section 1031 is used by
all sizes and types of real estate owners, including individuals,
partnerships, LLCs, and corporations. While the House Blueprint does
not expressly address like-kind exchanges, we understand some
policymakers view immediate expensing as a viable replacement for
section 1031 of the tax code. We disagree.
Real estate like-kind exchanges generate broad economic and
environmental benefits, and section 1031 should be preserved without
new limitations on the deferral of gains. Exchanges spur greater
capital investment in long-lived, productive real estate assets and
support job growth, while also contributing to critical land
conservation efforts and facilitating the smooth functioning of the
real estate market. Without section 1031, many of these properties
would languish underutilized and short of investment because of the tax
burden that would apply to an outright sale. Recent academic research
analyzing 18 years of like-kind exchange transactions involving real
estate found that they lead to greater capital expenditures,
investment, and tax revenue while reducing the use of leverage and
improving market liquidity.\7\ Another study by EY concluded that new
restrictions would increase the cost of capital, discourage
entrepreneurship and risk taking, and slow the velocity of
investment.\8\ As currently understood, the Blueprint would not fully
replicate the benefits of section 1031, particularly to the extent that
the land component of real estate remains ineligible for immediate
expensing.
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\7\ Professors David C. Ling (University of Florida) and Milena
Petrova (Syracuse University), ``The Economic Impact of Repealing or
Limiting Section 1031 Like-Kind Exchanges in Real Estate'' (June 2015),
available at: http://warrington.ufl.edu/departments/fire/docs/
paper_Ling-Petrova_EconomicImpactOfRepealingOrLimitingSection1031.pdf.
\8\ EY, ``Economic Impact of Repealing Like-Kind Exchange Rules''
(November 2015), available at: http://www.1031taxreform.com/
1031economics.
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State and Local Tax Deduction: Vital to Economic Health and Well-Being
of Local Communities
State and local taxes are the principal source of financing for
schools, roads, law enforcement and other infrastructure and public
services that help create strong, economically thriving communities.
Throughout the country, real estate is the largest contributor to the
local tax base. Most State and local taxes, including real estate
taxes, are deductible from Federal income. Eliminating the
deductibility of State and local taxes could disrupt demand for
commercial real estate in many parts of the country while raising taxes
on millions of Americans. It would shift power away from local
communities in favor of the Federal Government. The deductibility of
State and local taxes is grounded in the Constitution, federalism, and
States' rights. The State and local tax deduction prevents an erosion
of local governance and decision-making by prohibiting the Federal
Government from double-taxing amounts already taxed at the State and
local level. The burden of the change will fall disproportionately on
those regions that generate the most tax revenue for the Federal
Government--and the reduced demand for commercial real estate in
certain regions could lower property values and limit the ability of
the industry to continue creating jobs and driving economic growth.
Transition Rules/Technical Adjustments: Tax Reform Must Avoid Past
Mistakes, Provide Well-Designed Transition Regime
The $13-$15 trillion of existing commercial real estate stock and
$3.8 trillion of commercial real estate mortgage debt creates immense
transition challenges for tax reform. The stock of existing commercial
real estate is more than 12 times the size of total annual private
investment in equipment and machinery. Retroactive tax changes and
poorly designed transition rules in the Tax Reform Act of 1986
triggered a real estate depression and economic recession. Those
reforms (primarily, the passive activity loss rules) were minor
compared to the types of changes contemplated in the House Blueprint.
Grandfathering existing investment under the current rules, alone, is
not sufficient if new real estate investment is subject to a
dramatically different regime. Tax reform should provide a well-
designed transition regime that minimizes dislocation in real estate
markets.
Additionally, care should be taken to adjust the REIT rules
appropriately to ensure that the congressional intent to allow average
investors to access high quality commercial real estate is not
hampered.
Foreign Investment in Real Property Tax Act (FIRPTA): Reform Could
Boost
U.S. Real Estate and Infrastructure by Repealing Outdated
Barriers to Foreign Capital
The punitive Foreign Investment in Real Property Tax Act (FIRPTA)
regime subjects gains on foreign equity investment in U.S. real estate
or infrastructure to a much higher tax burden than applies to a foreign
investor purchasing a U.S. stock or bond, or an investment in any other
asset class. In addition to the tax burden, the withholding and
administrative filing requirements associated with FIRPTA are
frequently cited by foreign taxpayers as principal reasons for avoiding
the U.S. real estate market. FIRPTA is a major impediment to greater
private investment in both U.S. real estate and infrastructure.
In 2015, Congress passed the most significant reforms of FIRPTA
since its passage in 1980. Congress should build on the recent success
by repealing FIRPTA outright as part of tax reform. Unleashed by
FIRPTA's repeal, capital from abroad would create jobs by financing new
real estate developments, as well as the upgrading and rehabilitation
of existing buildings. Architects, engineers, construction firms,
subcontractors, and others would be put to work building and improving
commercial buildings and infrastructure.
* * *
Because commercial real estate is ubiquitous, it is easy to
overlook its positive connection to the fabric of our Nation.
Commercial real estate is where America lives, works, shops, plays, and
invests. The right tax policy can, for the benefit of all Americans,
help commercial real estate: create and maintain good jobs, lift
retirement savings, reduce energy consumption, and improve the quality
of life in local communities.
The Real Estate Roundtable is fully committed to working with the
Senate Committee on Finance to achieve a bold business tax reform
outcome that serves the overall economy. We appreciate your
consideration of these issues.
______
Questions Submitted for the Record to Jeffrey D. DeBoer
Questions Submitted by Hon. Orrin G. Hatch
Question. Mr. DeBoer, in your testimony you cite the Tax
Foundation's analysis of the economic impact of immediate expensing,
which found that 73 percent of the gains in economic growth from full
expensing would come from real estate construction, development, and
investment. You raised some serious concerns about full expensing,
indicating that it would ``over-stimulate'' real estate markets. Would
you tell us more about the impacts of full expensing on the real estate
industry?
Answer. Senator, today, economic fundamentals are driving real
estate investment decisions. Following a period of healthy markets with
low vacancies, rising rents, and stable operating income, some early
signs of oversupply are emerging in certain markets. While there are
important exceptions (e.g., foreign investors and FIRPTA), the tax code
is not inhibiting real estate activity.
In an income tax system, cost recovery rules should align with the
economic life of income-producing capital assets. Real estate is a
long-lived asset. Full and immediate expensing of commercial real
estate would distort the economics of real estate investment decisions.
Expensing would encourage developers to construct new buildings,
regardless of whether there is sufficient economic demand for the
space, and lead to unsustainable, tax-motivated investment. In
addition, full expensing would create large tax losses that create
incentives for transactions that have nothing to do with the underlying
commercial real estate needs of our property markets. Lastly, full
expensing would generate enormous transition challenges with respect to
the existing $13-15 trillion in commercial real estate in the United
States.
The Roundtable's concern with over-stimulative tax policy is well-
grounded and based on prior experience. The Economic Recovery Tax Act
of 1981 contained significant new tax incentives for commercial real
estate construction, including greatly accelerated cost recovery
schedules. Not surprisingly, the private sector responded to these
incentives. In just the 2 years between 1983 and 1985, the constant
dollar value of commercial construction increased 50 percent (Lynn
Browne and Karl Case, How the Commercial Real Estate Boom Undid the
Banks, Federal Reserve Bank of Boston Conference Proceedings, vol. 36,
57-113, 1992). The distribution of investment in the economy was
artificially skewed toward commercial real estate. About 14 percent of
total nonresidential investment was devoted to commercial construction
in the mid-1980s, compared to 8 percent in the second half of the
1970s. Id. While other factors also contributed to overbuilding, such
as bank lending practices and the availability of tax shelters,
accelerated cost recovery is widely regarded as a principal factor. See
D'Ann Petersen et al., ``The Role of Tax Policy in the Boom/Bust Cycle
of the Texas Construction Sector,'' Federal Reserve Bank of Dallas,
Working Paper 94-13 (1994); Raymond E. Owens, ``Commercial Real Estate
Overbuilding in the 1980s: Beyond the Hog Cycle,'' Federal Reserve Bank
of Richmond, Working Paper 94-06 (1994).
The surge in uneconomic, tax-driven investment was ultimately
unsustainable, and Congress reversed the tax policies that contributed
to the over-construction in the Tax Reform Act of 1986. The policies
enacted in 1986 were over-reactive, and in some cases, applied
retroactively. Policymakers should avoid making similar mistakes in
2017. Tax reform should shorten real estate cost recovery rules to
reflect the useful live of commercial real estate structures, which MIT
research suggests is closer to 20 years.
Question. I have heard from my colleagues across the aisle the
parade of horribles that will ensue if Congress enacts a proposal to
provide a lower business income tax rate for pass-through entities--
that it will only benefit the rich and that it will, according to Dr.
Marron, ``inspire tax avoidance.'' And yet two of the witnesses came to
the table with thoughtful approaches on how to address the concerns
that compensation, or wage income, that is taxed at ordinary income tax
rates will be inappropriately recharacterized as business income
subject to a preferential business income tax rate. I'd like to have
you comment on their proposals, whether the concerns raised are
legitimate but perhaps overblown, and provide your thoughts on
administrative issues associated with their proposals.
Answer. Properly structured, a reduced pass-through rate has
extraordinary potential to drive new investment and growth in
entrepreneurial businesses. These businesses--start-ups, entrepreneurs,
small and mid-sized firms and developers--represent the segment of the
economy where access to affordable financing, capital, and credit can
pose a real challenge. A reduced rate on pass-through income will not
only spur entrepreneurial activity and job creation, it will provide
small, mid-sized, and closely held businesses with a power tool to
attract the outside investment they need to fuel their growth.
Central to the committee's challenge is designing a reduced pass-
through rate that avoids tax abuses, such as disguising income as
business income when it is properly treated as wages. Here,
distinguishing an owner-operator's personal services income from his or
her income attributable to a capital investment in the business is a
very important issue. Fortunately, existing tax law provides rules that
can readily be applied to this problem.
First, for an owner who provides no services--or only de minimis
services like hiring a full-time CEO or developing or approving a basic
business plan to govern the entity--100% of that owner's income should
qualify for the reduced rate. This is similar to a rule currently
contained in longstanding proposed regulations applicable to defining
what properly constitutes self-employment income (i.e., personal
services income) as opposed to investment income for the owner-operator
of a limited partnership or limited liability company.
Second, for an owner who provides substantial services, such as a
full-time CEO, who also invests capital in the entity on the same terms
as limited investors, the return to capital that the owner-operator
receives on that investment should qualify for the reduced rate. There
cannot be ``disguised compensation'' if the owner-
operator is getting a return on his capital investment that is no
higher, dollar for dollar, than the return passive investors are
receiving. This is also similar to a well-accepted rule in the
longstanding proposed regulations governing self-employment income of
limited partners and limited liability company members. Those rules
recognize that one can be both a ``general partner'' and a ``limited
partner'' in the same entity, with different rules for those different
streams of income.
Third, where there is no third-party benchmark under the second
rule, there are several options. The IRS could apply a ``reasonable
compensation'' requirement. This is done currently for S corporations
to ensure that they pay their owner-operators a reasonable amount of
FICA wages. However, as many have suggested, this may prove cumbersome
and difficult to enforce. Instead, we think that Congress could simply
provide that a specified portion of the owner-operator's income--equal
to a statutory rate of return (such as 12 percent) applied to his or
her capital investment in the entity--would qualify for the reduced tax
rate, with the rest all treated as personal services income. In effect,
instead of measuring reasonable compensation, this approach looks to
the hard facts of how much capital the taxpayer has invested, and
applies a statutory rate of return to that amount.
We would be happy to provide the committee with more detailed
illustrations of how this approach might work with more complex
examples involving, for example, debt-financed contributions,
distributions of cash or property, temporary investments in reserves or
portfolio assets and so forth. We are confident that the technical
rules can be drafted so as to eliminate any realistic possibility of
abuse, but also to be transparent and easily administered by taxpayers
and the IRS.
Question. Mr. DeBoer, you noted in your testimony that ``tax reform
should provide a well-designed transition regime that minimizes
dislocation in real estate markets.'' I would go even further and note
that transition in this tax reform effort needs to consider all sectors
of the economy. You've noted that grandfathering provisions may not by
sufficient. Would you elaborate on the transition considerations that
you think Congress should take into account?
Answer. A well-designed transition regime is critically important
to the success of tax reform. A new tax system may appear promising in
concept, but fail to take into account the complexity of the U.S.
economy, including the market structures and forces that have developed
around existing tax rules. The Real Estate Roundtable estimates
existing U.S. commercial real estate is worth between $13-15 trillion.
Because commercial real estate has tax lives that are measured in
decades, rather than years, poorly designed transition rules pose a
greater risk to real estate owners and investors than other industries.
Failing to provide a smooth transition from one set of rules to the
next could cause significant financial loss and severe hardship for
taxpayers who invested capital and sweat equity based on longstanding
tax laws and principles. Moreover, because real estate is so interwoven
in the U.S. economy, harm to property values or real estate markets
could create a cascade of negative consequences for the broader
economy--from retirement benefits and local communities to the
financial system and job growth.
Different tax treatment between new and old investment risks
creates an un-level and unfair business environment. For example, if a
newly constructed building was 100-percent expensed and an existing
building remained subject to current depreciation schedules, the owner
of the new building would have a government-created competitive
advantage and could lease space at a lower cost while maintaining
profitability. The government should avoid distorting markets by
tipping the scale in favor of one taxpayer over another.
Grandfathering provisions can prevent unnecessary harm to existing
investments that were made based on a set of expectations regarding the
tax law. However, depending on their design, grandfathering provisions
can also have the unfortunate effect of locking in existing ownership
structures and creating new economic distortions. Real estate is
already an illiquid asset, relative to stocks and bonds. If tax reform
reduces market liquidity even more, it could reduce net investment and
put downward pressure on property values. The lock-up effect could
prevent properties from getting into the hands of new owners with the
time, resources, and desire to upgrade and improve the property.
Healthy liquidity in the real estate marketplace contributes positively
to capital expenditures as new owners look to increase the value of
their investment by upgrading and improving the building. The result is
job creation and economic growth.
Tax reform transition rules should seek to put taxpayers on a level
footing without penalizing business and investment decisions made prior
to enactment. To the extent that tax reform rewards capital formation,
the incentives should extend to both new and existing investment.
Lastly, the rules should be permanent--thereby providing industries
with long time horizons, such as real estate, with the policy certainty
they need when putting capital at risk.
Question. Mr. DeBoer, on page 7 of your written testimony, you say
that some
private-sector economists modeled for the real estate industry the
House Blueprint, ``but without the immediate expensing of structures.''
You go on to cite the study showing that there would be a negative
impact on property values. But if the economists' model did not allow
the immediate expensing of structures, isn't that quite different from
what the House proposed?
Answer. The economic modeling referenced in my testimony examined
the impact of reducing or eliminating the deductibility of business
interest while maintaining current depreciation rules. The House
Blueprint released in June 2016 would have provided for the full and
immediate expensing of structures. The unified framework released last
month excludes structures from immediate expensing. Extension of
expensing to structures likely would have an impact on property values,
particularly in the short term. Key considerations include: (1) whether
the owner has other income to absorb the losses generated by immediate
expensing, and (2) the parameters of the loss carryforward interest
rate adjustment (the House Blueprint provided an interest rate
adjustment to loss carryforwards to preserve their economic value going
forward, but lacked sufficient detail to accurately model the
provision).
Industry concerns with the immediate expensing of real estate
principally relate to the potential for over-stimulation of real estate
construction that is ungrounded in economic demand. These concerns are
not captured in the cash-flow model used to measure changes in internal
rates of return and property values, or for that matter, in the outside
macroeconomic models that estimate the impact of tax reform on overall
economic activity. Macroeconomic models generally do not account for
the negative consequences of excessive investment.
Question. Mr. DeBoer, you said a lot of things about the State and
local tax (SALT) deduction I would like to ask you about.
You said that ``Eliminating the deductibility of State and local
taxes could disrupt demand for commercial real estate.'' When I hear
proposals to eliminate the SALT deduction, I usually take this to mean
the itemized deduction for State/local taxes paid by residences. I have
assumed that such proposals, if enacted, would still allow the SALT
deduction as to SALT taxes paid in the business context or to the
extent paid in the production of income. Is my assumption correct? If
it is, it's not clear to me that eliminating the SALT itemized
deduction could disrupt demand for commercial real estate. Please
explain.
Answer. Senator, we agree that any elimination of the deductibility
of State and local taxes should not alter the deductibility of taxes
paid in the context of a trade or business, or to the extent they are
incurred in the production of income.
We are concerned that elimination of the deductibility of State and
local income and property taxes will lead to economic dislocation that
reduces demand for commercial real estate in affected regions. While
tenants and workers may be mobile and able to relocate, office
buildings and shopping centers are not. The dislocation that results
from repealing the State and local tax deduction will
disproportionately hurt immobile assets, including commercial real
estate and infrastructure. In these regions, economic development has
relied, at least partially, on longstanding tax rules that allow
taxpayers to offset a portion of the cost of State and local
institutions and governance on their Federal tax return. Changing the
rule now penalizes taxpayers, such as real estate owners, who deployed
capital with an expectation that Congress would not change the
fundamental precepts of Federal taxation.
Question. You also write that, ``The deductibility of State and
local taxes is grounded in the Constitution.'' Please explain that.
Answer. When Congress enacted the income tax, it built the
deductibility of State and local taxes into the tax system, from the
outset, in recognition of the principle of federalism underlying the
Constitution and the compact that formed the Nation. The original
framers of our income tax understood and acknowledged that Washington,
DC did not have a preemptive claim on the resources needed to sustain
government. By making State and local taxes deductible on the Federal
returns, Congress appropriately wanted to give State and local
governments priority over the pool of available tax revenues.
Question. You write that, ``The State and local tax deduction
prevents an erosion of local governance and decision-making by
prohibiting the Federal Government from double-taxing amounts already
taxed at the State and local level.'' When I hear about ``double
taxation,'' I often think of the foreign tax credit. The foreign tax
credit is often justified on the grounds of it preventing double
taxation. So, would you think there should be a SALT credit? Is a
credit necessary to alleviate double taxation? If not, then does this
suggest that the foreign tax credit is not necessary for alleviating
double taxation and that a foreign tax deduction would be sufficient?
Answer. In States with an individual income tax, income is double-
taxed. However, the State and local tax deduction allows most taxpayers
not subject to the AMT to reduce their Federal income by the amount of
State and local income taxes paid. The effect is to reduce (but not
eliminate) the amount of income that is subject to double taxation. A
credit could eliminate the double taxation for most taxpayers, but we
are not seeking a tax credit for State and local taxes paid (nor are we
advocating that the foreign tax credit be replaced with a foreign tax
deduction). Rather, in recognition of the importance of the existing
State and local tax deduction to local communities and economic
development in many regions of the country, we encourage Congress to
retain the deduction in its current form.
Question. Mr. DeBoer, I appreciated that in your testimony you
state that ``C corporations . . . are double-taxed on their equity
investments.'' I agree with you. That's why I have been working on a
corporate integration project for some time now. Has the Real Estate
Round Table taken a position on corporate integration?
Answer. Real estate is largely held in pass-through form, either
directly or through a partnership, LLC, or S corporation, or through a
REIT, which is taxed like a pass-through entity. The Roundtable does
not have a formal position on corporate integration, but generally
supports the simplification and streamlining of our business tax
system. Although REITs are organized as C corporations, they receive a
100 percent dividends-paid deduction provided various requirements are
met, and therefore represent a potential model for full corporation
integration. However, the dividends-paid deduction for REITs serves a
specific policy objective, providing smaller, retail investors an
opportunity to invest in professionally managed commercial real estate.
One potential concern with corporation integration is the policy
changes necessary to finance the transition to an integrated system. We
do not believe that Congress should raise taxes on real estate and
other industries that operate in pass-through form to help offset the
cost of integration. In addition, reducing the tax burden on equity
investment should not come at the expense of higher taxes on debt-
financed investment. Interest is a cost of doing business and should
continue to be fully deductible.
Question. Mr. DeBoer, you write that, ``Lower property values
produce a cascade of negative economic impacts.'' However, many policy-
makers, at all levels of government, pursue policies to allow for more
``affordable'' housing. I interpret affordable to mean lower-priced.
So, is the attempt to create affordable housing options a mistake? Does
that have negative economic impacts?
Answer. Adequate supply of affordable housing is critically
important and lacking in many parts of the country, as Senator Cantwell
noted during the hearing. While real estate generally should be taxed
on an economic basis, affordable housing is one area where tax
incentives fill an important void left unserved by market forces alone.
The costs of building and providing new housing--obtaining financing,
acquiring land, paying architects and engineers, constructing
buildings, maintaining them, and servicing the loans--exceed what many
low and even moderate-income renters can afford to pay. Provisions such
as the low-income housing tax credit represent an efficient, market-
driven mechanism to increase the supply of affordable housing with
minimal government interference. It should be preserved and potentially
expanded in tax reform.
The reference to the negative economic effects of lower property
values relates to the potential damage caused by government policies
that cause existing real estate values to decline. Affordable housing
that is the result of new supply coming to the market and meeting an
unmet economic need is desirable. In contrast, lower property values
that result from policy changes that increase the tax burden on current
property owners are counterproductive. Lower property values reduce the
tax base for local communities. Lower property values result in less
income for pension funds and education endowments that invest in real
estate. Lower property values threaten the balance sheets of banks and
financial institutions, increase the likelihood of defaults, and create
the potential for new systemic economic risks.
______
Questions Submitted by Hon. Ron Wyden
Question. Mr. DeBoer, real estate is a long-term investment, often
stretching decades. So it stands to reason that the long-term health of
the economy is critical for your industry to do well. Would you agree?
So if the House Republican tax plan were enacted and the analysis by
Dr. Marron's colleagues' analysis became reality--crippling Federal
debt and skyrocketing interest rates--how would that impact the real
estate industry?
Answer. Senator, fiscal discipline in Washington is important to
long-term economic growth and prosperity. Policies that temporarily
increase the Federal deficit can serve an important purpose during
periods of economic distress, but policies--tax or spending--that
contribute to structural budget imbalances are fraught with risk. At
the same time, revenue neutrality should not be an end in itself.
Rather, in the context of tax reform, policymakers should carefully
consider how proposed changes affect entrepreneurship, capital
formation, and job creation, among other important factors. Tax policy
should be stable, predictable, and permanent. In addition to the risks
you have identified, if tax reform dramatically increases the Federal
deficit, it is unlikely that the changes will be permanent, at least
not in their current form.
Question. Mr. DeBoer, the House Republican tax plan proposes to
eliminate the deduction for business interest expense. While large,
publicly traded corporations may be able to access additional equity
from the stock market in order to dodge this new tax, that's not a
choice for a lot of smaller businesses. Normally small businesses
depend solely on small business loans from local banks. In addition,
some businesses--particularly those that invest in real estate and
infrastructure--depend on bonds as a way to finance long-term projects.
I know your organization has been paying close attention to this issue.
What do you think would happen if Congress voted to deny companies the
ability to deduct interest?
Answer. Today, capital markets in the United States are the envy of
the world. Entrepreneurs are able to access debt amounts needed to
provide the flexibility to build, operate, and grow their business.
Responsible, appropriate leverage, as determined by lending regulators,
is very positive for economic growth and job creation. Eliminating, or
even limiting, the deduction for interest on business debt would cause
great dislocation, slow economic activity, and lessen the unique
importance of America's capital markets. The cost of debt is a
necessary expense that must be accounted for in order to accurately
measure the income from any business activity.
Question. Mr. DeBoer, you've spoken about the need for
infrastructure development. I've long said America needs an all-of-the-
above approach to infrastructure. The number one priority is more
funding, and I, and several of my Democratic colleagues, have put
forward a plan to do that. But this is a crisis that requires all hands
on deck. That's why I have a bipartisan proposal, with Senator Hoeven
of North Dakota, to give States more flexibility in how they finance
infrastructure, including allowing them to tap the private sector.
Private activity bonds are one key tool that local governments have to
develop infrastructure projects in partnership with the private sector.
Some Republicans want to eliminate these tools. Wouldn't it be better
if Congress were providing more pathways for infrastructure investment,
not eliminating an effective tool for financing infrastructure?
Answer. The Roundtable agrees that an all-of-the-above approach to
infrastructure finance is critical to meet our country's rapidly
expanding and evolving needs for safe and reliable infrastructure
across all types of asset classes--roads, bridges, transit, water,
sewer, energy, telecommunications, etc. Public investment in
infrastructure will always be critical, but receipts from the Federal
gas tax are insufficient. As cars become more fuel efficient, and as
the Nation is on the cusp of a ``transportation revolution'' trending
toward driverless vehicles and ride-sharing platforms, more financing
and funding sources are necessary beyond the Highway Trust Fund, which
is perpetually on the brink of insolvency.
We thus agree that Congress should enact policies that attract more
private-sector co-investment to partner with public funds to finance
infrastructure. Legislation like Senator Wyden's and Senator Hoeven's
Move America Act (S. 1229) which expands eligibility for tax-exempt
private activity bonds, should be part of the finance ``toolbox'' to
encourage private entities to invest in U.S. infrastructure. The
Roundtable also recommends that Federal policies should encourage
``best financing practices'' that layer and sequence successful Federal
programs with common State/local infrastructure finance platforms that
have a track record of success. For example, projects that use Federal
credit support and enhancement (like U.S.-DOT loans and guarantees
under the Transportation Infrastructure Finance Innovation Act (TIFIA),
and Railroad Rehabilitation and Improvement Financing (RRIF), should be
encouraged to complement and leverage State/local infrastructure
finance techniques (like tax increment finance (TIF) and special
assessment districts (SADs)). Projects drawing a TIF-TIFIA connection,
for example, can spread financing risks that will be attractive to draw
private debt and equity markets into infrastructure projects, so that
no single capital source bears undue risks. The Roundtable believes
that these types of policies--bringing Federal, State/local, and
private sector dollars to the table--are necessary to build the
infrastructure we need to get people to work, enhance worker
productivity, boost GDP, and enhance America's competitiveness
globally.
______
Question Submitted by Hon. Michael B. Enzi
Question. Mr. DeBoer, your testimony mentions the tax rules related
to foreign investment in U.S. real estate and how they can inhibit
domestic investment and job creation. In 2015, I was a cosponsor of a
bill that eliminated some of the burden associated with the Foreign
Investment in Real Property Tax Act (FIRPTA). Have you seen an impact
from the reforms we made in the PATH Act? What has it meant for real
estate and infrastructure investment and job growth? Should we be going
further, and if so, what do you recommend?
Answer. Senator Enzi, The PATH Act reforms, including the new
exemption from FIRPTA for foreign pension funds, have removed tax
barriers to investment in the United States and allowed new real estate
construction and development to attract foreign capital. Foreign
institutional investors, and in particular pension funds, are a large
and growing source of equity for capital-intensive real estate and
infrastructure projects. Many foreign economies have high savings
rates, and managers of those savings are looking to diversify their
investments. Some foreign economies lack mature financial markets and
offer few safe investment opportunities of their own. Pension funds are
attracted to U.S. commercial real estate and infrastructure, in part,
because it diversifies their investment portfolios, generates stable
returns, and provides a hedge against inflation. After passage of the
PATH Act, initial projections from Professor Ken Rosen of the
University of California-Berkeley suggested it would generate $20-30
billion in additional inbound investment. While it is still early and
quantitative data is just starting to come in, anecdotal reports
suggest foreign pension funds are responding to the FIRPTA relief,
qualifying for the provision, and actively investing in new U.S.
markets.
The United States is well-positioned to attract foreign investors,
assuming it provides a fair and nondiscriminatory set of tax rules.
Real estate brokerage firm Cushman and Wakefield estimates that $435
billion of total debt and equity funds were available globally for
direct real estate investment in 2017, an increase of $100 billion
since 2013. Unfortunately, for many non-pension investors, FIRPTA
continues to impose a discriminatory tax on passive investment in U.S.
real estate that does not apply to other asset classes. FIRPTA should
be repealed in its entirety. Professor Rosen estimates that repealing
FIRPTA will generate $65-125 billion in additional U.S. economic
activity, create 147,000-284,000 jobs, and lift income by $8-16
billion. Repeal would spur demand for real estate-related services,
property renovations and development, and lending activities. Perhaps
most importantly, it will create new economic demand that increases
income and wages.
______
Questions Submitted by Hon. Bill Nelson
Question. What metric or considerations should Congress use to
determine which tax breaks to eliminate in order to lower the rates?
Answer. Senator, we believe four principles should guide and inform
your efforts to achieve a significant, pro-growth overhaul of the
Nation's tax code. First, tax reform should encourage capital formation
(from domestic and foreign sources) and appropriate risk-taking, while
also providing stable, predictable, and permanent rules conducive to
long-term investment. Second, tax reform should ensure that tax rules
closely reflect the economics of the underlying transaction--avoiding
either excessive marketplace incentives or disincentives that can
distort the flow of capital investment. Third, tax reform should
recognize that, in limited and narrow situations (e.g., low-income
housing and investment in economically challenged areas), tax
incentives are needed to address market failures and encourage capital
to flow toward socially desirable projects. Finally, tax reform should
provide a well-designed transition regime that minimizes dislocation in
real estate markets. Tax reform that adheres to these principles will
spur economic growth and job creation.
Question. If you were king for a day, which tax breaks would you
eliminate first to pay for a lower rate?
Answer. A good place to start would be eliminating negative tax
expenditures from the tax code. Negative tax expenditures deviate from
an otherwise neutral income tax system and penalize specific types of
business activities or investments. The largest negative tax
expenditure in the tax code is the 39-year depreciation schedule for
nonresidential structures. According to the Treasury Department, this
tax penalty will cost taxpayers $105 billion over the next 10 years.
Cost recovery rules should align with the economic life of assets.
Leading, peer-reviewed research by MIT on the economic depreciation of
structures suggests the appropriate recovery period for both
nonresidential and residential rental property is closer to 20 years.
Shortening the depreciation period for real property to 20 years would
provide a sustainable boost to real estate investment and job creation.
Second, policymakers should repeal the Foreign Investment in Real
Property Tax Act (FIRPTA), which imposes a discriminatory tax penalty
on foreign investment in U.S. commercial real estate. Professor Ken
Rosen at the University of California-Berkeley estimates that repealing
FIRPTA would generate $65-125 billion in additional economic activity
and create 147,000-284,000 jobs.
Question. Could immediate expensing lead to any negative
consequences for the economy? If so, please provide some potential
scenarios. If not, please explain why.
Answer. Senator, expensing structures would encourage real estate
development and boost the Nation's GDP, but we are concerned that
underlying demand would not support much of the resulting development.
Such uneconomic development would be a false indicator of economic
strength and badly distort markets. As we witnessed in the 1980s,
encouraging uneconomic development is not sustainable policy over the
long term. That is not to say that the current cost recovery periods
for structures are correct. They are not, and they should be shortened.
MIT has reviewed a wealth of date regarding buildings, and their work
suggests the appropriate depreciation period is roughly 20 years.
Revising the tax rules to reflect this new and improved understanding
of the economic life of structures would provide meaningful and
sustainable lift to investment and job creation.
______
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 on
reforming the business tax code. The goal of the hearing is to examine
ways to create a healthier economic environment that will encourage job
creators to invest in the United States and increase their
competitiveness in the global market.
During this morning's hearing, we will discuss ways to improve the
business provisions of the U.S. tax code, with an eye toward creating
jobs and boosting wages for American workers and improving our
country's overall business climate.
This hearing is part of our ongoing effort--following years of tax
hearings and last week's hearing on individual reform--to draft and
report comprehensive tax reform legislation later this year.
Members of both parties recognize the need to reform the way we tax
businesses in the United States. As former President Obama noted when
discussing his own framework for business tax reform, the current
system ``does too little to encourage job creation and investment in
the United States while allowing firms to benefit from incentives to
locate production and shift profits overseas.''
As we all know, many elements of a particular business's tax burden
depend on the company's organizational form. For example, C
corporations are taxed at the corporate tax rate.
According to a recent report by the Congressional Budget Office,
the top Federal statutory corporate income tax rate has been 35 percent
since 1993 and, with State taxes added, the United States' average
corporate statutory rate is the highest in the industrialized world, at
more than 39.1 percent.
And, while some have noted that not all corporations pay the full
statutory rate, the average effective tax rate of U.S. corporations is
the fourth highest among G20 countries. According to a recent analysis
by Ernst and Young, when you integrate corporate-level taxes and
investor-level taxes such as those on dividends and capital gains, U.S.
tax rates are the second highest among developed countries. That last
one is important, given that the United States taxes most corporate
earnings that are distributed to shareholders twice--both at the
corporate and shareholder levels.
For the past few years, I have been working on a corporate
integration proposal that, among other things, would allow businesses
to deduct their dividends paid to help alleviate the double taxation
problem. I view this as a complement to a statutory corporate tax rate
reduction, not a substitute. We held a few hearings on this topic last
year, so I won't delve too deeply into the details at this time. For
now, I'll just say I continue to believe this idea--whether it applies
fully or in some other limited way--can help address a number of the
problems we're trying to solve with comprehensive tax reform. I look
forward to continuing this conversation as the process moves forward.
It is also important to note that, while the U.S. corporate tax
rate has remained unchanged for decades, the trend among our foreign
competitors has been to lower corporate rates, making American
businesses increasingly less competitive.
This is not just a Republican talking point. This problem is widely
acknowledged on both sides of the aisle. Even former President Bill
Clinton, who signed into law the rate increase to 35 percent, recently
argued the rate should now be lowered. I agree.
Our current business tax system--and the disparity between the U.S.
corporate rate and our foreign competitors' corporate rates--has
created a number of problems and distortions.
For example, the current system slows economic growth by impeding
capital formation, hindering wage growth and job creation, reducing
productive capacity, and lowering the standard of living in the United
States, all of which directly harm middle-class families and
individuals.
The current system lowers returns on investment, creating a bias
against savings and investment. This hinders the creation of wealth for
Americans across the economic spectrum, including the middle class.
The current system encourages corporations to finance operations
using debt rather than equity, which increases risks, particularly
during times of economic weakness.
The current system gives corporations incentives to shift income,
production, and intangible assets like intellectual property from the
United States to lower tax foreign jurisdictions, thereby eroding our
tax base.
In tax reform, we need to address all of these problems and
distortions, and many others as well. In particular, we need to lower
the corporate tax rate to relieve the burdens the tax imposes on
American workers, who, according to many economists, bear a significant
part of the corporate tax.
We also need to reduce the burden on pass-through businesses, whose
earnings are reported and taxed on individual tax returns. These types
of businesses include sole proprietorships, limited liability
companies, partnerships, and S corporations.
And, we need to fix our international tax system so that American
businesses can compete in the global marketplace without facing
significant disadvantages simply because they are headquartered in the
United States.
Each of these propositions is supported by people in both parties.
Of course, when politics enter the equation, the story sounds much
different.
According to some, all Republicans want to do in tax reform is give
tax breaks to the super-rich, cushy portfolios for Wall Street bankers,
and more handouts for greedy corporations, all at the expense of
middle-class workers and families.
Those types of claims may play well to political bases, but they
don't align with reality.
As I noted in our hearing last week, virtually all of our current
tax reform ideas are aimed squarely at helping the middle class as well
as low-income families. Our chief goals, particularly in business tax
reform, are to increase economic growth, create new jobs, grow wages
for the employees of both large and small businesses, expand
opportunities for all Americans, and improve standards of living for
everyone in the United States.
The proof, I suppose, will be in the pudding. As the committee
works through this process, with those goals in mind, I believe we will
be able to demonstrate why those in the middle class should feel as
though they have a stake in this discussion and how these ideas to
reform our current system will help.
Let's keep in mind that the status quo--sluggish economic growth,
stagnant wages, and decreased workforce participation--hasn't exactly
been doing the middle class any favors. The case for tax reform should
therefore be easy to make.
I want to reiterate what I said last week: namely, that this
committee will be the starting point for any tax reform legislation
that is considered in the Senate. While I expect we'll continue to hear
more arguments about secret tax plans written behind closed doors, this
committee is going to consider tax reform through regular order. That
applies to both the drafting and the reporting of any tax reform bills.
As I also said last week, I hope this process is bipartisan. As
with individual tax reform, there are many areas of business tax reform
where thoughts and interests of both Republicans and Democrats overlap.
There is fertile ground for bipartisan agreement on this and I hope we
can take advantage of this historic opportunity together.
I know that my friend, Ranking Member Wyden, shares these broad
objectives.
In fact, he has put forward his own tax reform proposals in the
past, likely with these same goals in mind.
And, at the end of the day, we should all, at the very least, agree
that the current tax system is broken and the current state of our
economy should not be accepted as the new normal.
I look forward to a robust discussion of these issues here today as
well as some acknowledgement of the bipartisan agreement that exists on
these matters.
______
Prepared Statement of Scott A. Hodge, President, Tax Foundation
Chairman Hatch, Ranking Member Wyden, members of the committee, I
commend you for taking on the challenge of reforming America's tax code
and especially the task of overhauling our outdated business tax
system.
The most important thing that Congress and the administration can
do to boost economic growth, lift workers' wages, create jobs, and make
the U.S. economy more competitive globally, is reform our business tax
system.
I'd like to focus my remarks on reforming the corporate tax system.
The tax issues facing pass-through businesses could fill an entire
hearing itself. The Tax Foundation generally supports the idea of
corporate integration, so perhaps we can address the pass-through
sector during questions.
My testimony will first outline the policies that our research
indicates will maximize economic growth and boost wages, what we call
``The Four Pillars of Corporate Tax Reform.'' I will then address the
challenges that you will face in crafting a successful tax reform
plan--balancing the math with the economics.
the four pillars of corporate tax reform
The Tax Foundation's extensive economic research and tax modeling
experience suggests that the committee should have four priorities in
mind when reforming the corporate tax system:
1. Providing full expensing for capital investments;
2. Cutting the corporate tax rate to a globally competitive level,
such as 20 percent;
3. Moving to a competitive territorial tax system; and
4. Making all three of these policies permanent.
While many of you, and certainly many in the business community,
may see some of these policies as competing for space in a tax plan, we
see those pieces as complementary and essential, not in conflict.
In our view, cutting the corporate tax rate and moving to a
territorial system are essential for restoring U.S. competitiveness and
reducing the incentive for profit-shifting and corporate inversions.
Expensing, we believe, is key to reducing the cost of capital in order
to revitalize U.S. capital investment which, in turn, will boost
productivity and wages.
Thus, a good tax plan should include all three of these policies
because they will not only boost economic growth, but do so in a way
that leads to higher wages and living standards for working Americans.
However, these gains are not possible if the policies are made
temporary, as some have suggested as a way of minimizing their revenue
loss or complying with the Byrd Rule. Temporary tax cuts deliver
temporary economic results; permanent tax reform delivers permanent
economic benefits.
the economic benefits of expensing and a corporate rate cut
Let's look at the economics of expensing and the corporate rate cut
in more detail. Both policies are very pro-growth and will ultimately
lift workers' wages. But, on a dollar-for-dollar basis, expensing
delivers twice the economic growth as a corporate rate cut.\1\
---------------------------------------------------------------------------
\1\ For an excellent discussion of this issue, see Kyle Pomerleau,
``Why Full Expensing Encourages More Investment Than a Corporate Rate
Cut,'' Tax Foundation Blog, May 3, 2017, https://taxfoundation.org/
full-expensing-corporate-rate-investment/.
The reason it does so is because expensing of new investment is
focused on cutting the cost of growing the capital stock, while the
rate reduction's benefits are spread over returns to existing capital
and to other activities such as research, management, advertising, and
---------------------------------------------------------------------------
other inputs that are already immediately deductible.
For example, if I own a factory that makes appliances, a lower
corporate rate will increase the amount of after-tax profit I earn on
each toaster, but it will not necessarily incentivize me to produce
more toasters. On the other hand, the only way that I can reap the
benefits of full expensing is by adding a new toaster assembly line or
building a factory. Thus, the corporate rate cut initially flows to my
bottom line, whereas the new capital investment immediately benefits my
workers and new employees.
the combined benefits of expensing and a corporate rate cut
The House GOP ``Better Way'' Tax Reform Blueprint combined
expensing with a 20 percent corporate rate. Our scoring of the plan
indicated that these policies created a powerful engine for economic
growth and lifting after-tax incomes.\2\ They should provide the core
of any pro-growth tax reform plan.
---------------------------------------------------------------------------
\2\ Kyle Pomerleau, ``Details and Analysis of the 2016 House
Republican Tax Reform Plan,'' Tax Foundation Fiscal Fact No. 516, July
5, 2016.
We used our Taxes and Growth (TAG) Macroeconomic Tax Model \3\ to
simulate the long-term economic effects of these policies separately
and combined to give you an idea of how they work together. The table
below summarizes the long-term results of this exercise.
---------------------------------------------------------------------------
\3\ For a full description of the TAG model, see https://
taxfoundation.org/federal-tax/taxes-and-growth-model-overview-
methodology/. We are also happy to give live demonstrations of the
model upon request.
Here we can see that cutting the corporate tax rate to 20 percent
and moving to full expensing for corporations each boost the long-term
level of GDP by 3 percent and increase the capital stock by more than 8
percent. This has the effect of lifting wages by more than 2.5 percent
and creating more than 575,000 full-time equivalent jobs. In this
example, long term is generally about 10 years, once the policies have
worked their way through the economy.\4\
---------------------------------------------------------------------------
\4\ Over the long term, a 20-percent corporate rate is a bigger tax
cut than expensing. That is why we are seeing comparable results from
the policies.
Combining the two policies does not double the results because of
their interactive effects. However, we can see that the two policies
together would increase the level of GDP by 4.5 percent and the capital
stock by nearly 13 percent. These economic forces act to lift wages by
---------------------------------------------------------------------------
an average of 3.8 percent and create 861,000 full-time equivalent jobs.
Long-Term Economic Effects of Expensing and a 20% Corporate Tax Rate
------------------------------------------------------------------------
20% Rate and
20% Corporate Full
Corporate Only Full Expensing
Tax Rate Expensing Combined
------------------------------------------------------------------------
GDP, long-run change in annual 3.1% 3.0% 4.5%
level (percent)..............
GDP, long-run change in annual $587 $571 $867
level (billions of 2016 $)...
Private business stocks 8.5% 8.3% 12.8%
(equipment, structures, etc.)
Wage rate..................... 2.6% 2.5% 3.8%
Full-time equivalent jobs (in 592 575 861
thousands)...................
------------------------------------------------------------------------
Tax Foundation, Taxes and Growth Model.
both policies boost after-tax incomes substantially
There is typically little public support for corporate tax reform
because most people don't see how it will benefit their lives.
Corporate tax reform may not ``put cash in people's pockets'' in the
same way as a cut in individual tax rates, but it can have a powerful
effect on lifting after-tax incomes and living standards.
As we saw in the modeling results above, both expensing and a
corporate rate cut can boost wages because of the increased
productivity generated by the growth in capital investment. Better
tools make workers more productive. Workers who are more productive
earn more over time. When these gains are combined with the overall
growth in the economy, after-tax incomes and living standards will
rise.
Tax Foundation's TAG model factors these macroeconomic effects into
our estimates of the change in after-tax incomes for taxpayers at
different income levels. The table below shows that a 20 percent
corporate tax rate would lift after-tax incomes by an average of 3.5
percent. Expensing lifts after-tax incomes by 3.4 percent. The TAG
model estimates that the combination of the 20 percent corporate tax
rate and full expensing would boost after-tax incomes by an average of
5.2 percent. Again, these gains represent the combination of wage
growth, economic growth, and the distributed dollar value of the tax
cuts.
Long-Term Policy Effects on After-Tax Incomes
------------------------------------------------------------------------
20% Rate and
20% Corporate Full
Income Group Corporate Only Full Expensing
Tax Rate Expensing Combined
------------------------------------------------------------------------
0% to 20%..................... 3.5% 3.4% 5.2%
20% to 40%.................... 3.3% 3.2% 4.8%
40% to 60%.................... 3.4% 3.3% 5.0%
60% to 80%.................... 3.4% 3.3% 5.0%
80% to 100%................... 3.6% 3.5% 5.3%
80% to 90%.................... 3.4% 3.3% 5.1%
90% to 95%.................... 3.5% 3.4% 5.2%
95% to 99%.................... 3.6% 3.5% 5.4%
99% to 100%................... 3.7% 3.6% 5.5%
Total..................... 3.5% 3.4% 5.2%
------------------------------------------------------------------------
Tax Foundation, Taxes and Growth Model.
cutting the corporate tax rate will immediately improve
u.s. competitiveness
It is well-known that the 35-percent U.S. Federal corporate tax
rate is the highest among the 35 member nations in the OECD. However,
U.S. firms also pay State income taxes. When the average State rate is
added to the Federal rate, American companies face an average U.S. rate
of 38.91 percent tax on corporate earnings.
In a recent study, Tax Foundation economists compared the corporate
tax rates levied by 202 jurisdictions across the globe and found that
the United States has the fourth highest statutory corporate income tax
rate in the world.\5\ The only jurisdictions with a higher statutory
rate are the U.S. territory Puerto Rico (with a population of 3.7
million), the United Arab Emirates (population 9.4 million), and the
tiny African island nation of Comoros (population 826,000).
---------------------------------------------------------------------------
\5\ Kyle Pomerleau and Keri Jahnsen, ``Corporate Income Tax Rate
Around the World,'' Tax Foundation Fiscal Fact 559, September 7, 2017,
https://taxfoundation.org/corporate-income-tax-rates-around-the-world-
2017/.
From a tax perspective, most other countries look much more
competitive than the United States. The worldwide average statutory
corporate income tax rate, measured across 202 tax jurisdictions, is
22.96 percent. When weighted by GDP, the average statutory rate is
---------------------------------------------------------------------------
29.41 percent--10 points lower than the U.S. statutory rate.
Our major trading partners in Europe have the lowest regional
average rate, at 18.35 percent (25.58 percent when weighted by GDP).
Conversely, among our major trading partners, Africa and South America
tie for the highest regional average statutory rate at 28.73 percent
(28.2 percent weighted by GDP for Africa, 32.98 percent weighted by GDP
for South America).
While we frequently hear the excuse that ``nobody really pays the
headline rate'' because of loopholes in the tax code, the fact is, the
tax codes in other countries also have loopholes. This means that the
effective corporate tax rate in those countries is typically well below
our effective rate.
Indeed, a recent Tax Foundation study compared the tax burden on
new investment, the marginal effective tax rate (METR), among 43
nations. After accounting for all the various deductions and credits in
each tax code, the study finds that the METR in the United States is
the fifth highest among the 43 nations at 34.8 percent.\6\ Were it not
for bonus depreciation, our ranking would be even higher.
---------------------------------------------------------------------------
\6\ Jack Mintz and Philip Bazel, ``Competitiveness Impact of Tax
Reform for the United States,'' Tax Foundation Fiscal Fact 546, April
20, 2017.
Lowering the corporate tax rate to at least 20 percent would
instantly make the U.S. more competitive while reducing the incentives
for profit-shifting and inversions.
moving to a territorial tax system is imperative
One of the most challenging issues facing lawmakers is over the
international aspects of tax reform: designing a territorial tax system
and crafting the rules that determine when the foreign income of U.S.
multinationals will be taxed and when it will be exempt from U.S. tax.
These rules are extremely complex, and the stakes are very high.
Tax writers must design rules that protect the U.S. tax base and
prevent tax avoidance, yet do so in a manner that is not burdensome and
does not stifle capital flows and legitimate business transactions. The
wrong choices could make U.S. firms even less competitive globally than
they are today.\7\
---------------------------------------------------------------------------
\7\ Kyle Pomerleau and Keri Jahnsen, ``Designing a Territorial Tax
System: A Review of OECD Systems,'' Tax Foundation Fiscal Fact No. 554,
August 1, 2017.
The interesting aspect of this issue is that the U.S. already has a
territorial tax system--but it only applies to foreign-owned companies.
Foreign-owned companies only pay U.S. income taxes on their U.S.
profits and, naturally, pay no U.S. tax on their foreign profits. This
situation automatically makes U.S. firms less competitive in foreign
markets. The only way to level the playing field is for lawmakers to
repeal our worldwide tax system and move to a territorial system for
all companies.
expensing saves more than $23 billion in compliance costs
One last thing to consider about expensing. A move to full
expensing accomplishes something that no rate cut can: it eliminates
pages from the tax code, thus saving taxpayers time and money. American
businesses today spend more than 448 million hours each year complying
with the Byzantine depreciation and amortization schedules, at an
estimated cost of over $23 billion annually. Moving to full expensing
eliminates the need for these complicated schedules, thus saving
businesses the $23 billion in compliances costs, which is an added
benefit to the impact the policy has on boosting wages and economic
growth.\8\
---------------------------------------------------------------------------
\8\ Scott A. Hodge, ``The Compliance Costs of IRS Regulations,''
Tax Foundation Fiscal Fact No. 512, June 15, 2016.
---------------------------------------------------------------------------
temporary tax cuts produce (no surprise) temporary economic benefits
Because of the procedural limitations associated with the Senate's
Byrd Rule, some lawmakers have talked about the merits of a temporary
tax cut plan, which would sunset after 10 years, much like the tax cuts
enacted by President George W. Bush in 2001 and 2003.
Tax Foundation economists used the TAG model to simulate the
effects of a temporary corporate rate cut to 15 percent compared to the
effects of a permanent rate cut, and the baseline estimates under
current law. The results are shown in the nearby chart.\9\
---------------------------------------------------------------------------
\9\ Alan Cole, ``Why Temporary Corporate Income Tax Cuts Won't
Generate Much Growth,'' Tax Foundation Fiscal Fact No. 549, June 2017.
A permanent corporate rate reduction reduces the cost of capital
and makes new investments worthwhile that otherwise would not have
been. Under the TAG model, a permanent cut to 15 percent boosts
investment substantially, which allows a sustained period of higher
growth. Such a policy adds about 0.39 percentage points to GDP growth
per year over a decade, eventually resulting in a GDP that is 3.9
percent larger than the baseline scenario after 10 years. This
additional 3.9 percent level adjustment to GDP remains for as long as
the policy stays in effect; more investments are profitable, and
---------------------------------------------------------------------------
therefore, the Nation is richer.
A temporary corporate rate reduction looks similar at first: it
initially produces more investment and growth. However, the effect is
never as strong as for the permanent cut. Worse, the improvements to
growth fade considerably. The increase in GDP peaks in the 6th year,
with a grand total of 1.37 percent added to GDP over all 6 years. Then,
growth from the 7th year on is actually slower than it would have been
with no tax cut at all. By the end of the 10th year and the sunset of
the policy, GDP is only 0.14 percent larger than it would have been
without the tax cut.
The lesson is very clear: the only way to boost the economy for the
long term is to make the business tax reforms permanent.
[GRAPHIC] [TIFF OMITTED] T1917.001
the challenges and trade-offs of business tax reform
The great economist Thomas Sowell once said that ``there are no
solutions, there are only trade-offs.'' As I'm sure you are already
discovering, you will face some big challenges in fixing the corporate
tax system. First, the math is hard. There are not as many
``loopholes'' in the corporate tax code as many people believe, so you
will likely have to think outside the box if you want corporate tax
reform to be revenue-neutral. Second, the economics of tax reform must
be at the forefront of your
decision-making. If you make the wrong choice in the base broadeners
you use to offset the tax cuts, you can neutralize all the benefits you
hope to achieve from the reforms. These challenges will require hard
decisions and considerable trade-offs.
the math is hard
Cutting the corporate tax rate to 20 percent and providing full
expensing could reduce Federal revenues by as much as $3 trillion over
10 years on a static basis. While our models show that the growth
effects of the policies could recover as much as 46 percent of this
revenue loss over a decade (and more beyond the budget window), finding
the revenue offsets to make these policies revenue neutral will be a
major challenge.
For example, if your goal is to eliminate corporate tax
expenditures to offset a rate cut, your options are limited. By our
estimates, there are only enough ``loopholes,'' or nonstructural items,
to eliminate in the corporate tax code to bring the rate down to about
28.5 percent.\10\ If the consensus is to lower the rate to 20 percent,
or even 15 percent as President Trump advocates, you will have to find
offsets outside the corporate tax base.
---------------------------------------------------------------------------
\10\ Scott Greenberg, ``To Lower the Corporate Tax Rate, Lawmakers
Will Have to Think Outside the Box,'' Tax Foundation Blog, June 8,
2017, https://taxfoundation.org/lower-corporate-tax-rate-think-outside-
box/.
One of the larger offsets included in the House GOP Blueprint was
the elimination of the net interest deduction for corporations. This
policy has the advantage of raising more than $1 trillion with minimal
impact on economic growth. Moreover, it also equalizes the treatment of
debt and equity financing, thus reducing the amount of leveraging in
---------------------------------------------------------------------------
the economy.
Aside from the elimination of net interest and the controversial
border adjustment proposal, there are very few politically palatable
revenue raisers or base broadeners available that can be used to help
reduce the corporate tax rate to 20 percent or below. A few of the
options that could raise more than $1 trillion over 10 years include a
$20 per-ton carbon tax, removing the Social Security Payroll tax cap,
and enacting a value-added tax (VAT).\11\
---------------------------------------------------------------------------
\11\ For a menu of options, see ``Options for Reforming America's
Tax Code,'' Tax Foundation, 2016, https://taxfoundation.org/options-
reforming-americas-tax-code/.
On the other hand, there are ways of reducing the cost of these
proposals by either phasing them in or modifying them. For example, the
cost of full expensing could be reduced substantially through the use
of neutral cost recovery. This option maintains current depreciation
schedules, but indexes them for inflation and a modest rate of return.
This modification gives taxpayers the net present value equivalent of
---------------------------------------------------------------------------
full expensing, but spreads the budgetary costs over time.
Congress could also follow the example of other countries, such as
Canada and the United Kingdom, who ratcheted down their corporate tax
rate over a number of years. This option would reduce the cost of the
policy within the 10-year budget window, but not during the second 10
years.
getting the economics right
In order to maximize the benefits of corporate tax reform, you must
be very careful in choosing the offsets you need to make the plan
revenue-neutral. You must avoid base broadeners that raise the cost of
capital because they will neutralize the benefits of the pro-growth tax
reforms.
A good example of how the wrong mix of policies can neutralize a
plan's economic growth potential is the draft tax reform plan proposed
by former Ways and Means Chairman Dave Camp. The so-called Camp Draft
cut the corporate tax rate to 25 percent, but largely offset the
revenue loss by lengthening depreciation lives--moving from the current
MACRS to ADS, the alternative depreciation system.
As the tax models used by the Joint Committee on Taxation and the
Tax Foundation showed, the longer depreciation lives raised the cost of
capital to such an extent that it largely negated the economic benefits
of the lower corporate tax rate.\12\ Revenue neutrality may be an
important goal, but it should not be achieved at the expense of
economic growth. That is self-defeating. To fully reach the goal of a
lower corporate tax rate, you may have to relax the standard for
revenue neutrality.
---------------------------------------------------------------------------
\12\ Stephen J. Entin, Michael Schuyler, and William McBride, ``An
Economic Analysis of the Camp Tax Reform Discussion Draft,'' Tax
Foundation Special Report No. 219, May 14, 2014.
One of the reasons that the House GOP ``Better Way'' Tax Reform
Blueprint contained the controversial border adjustment was the
recognition by its designers of the need to reach outside the
traditional corporate tax expenditure base to find the necessary
revenues to lower the corporate tax rate to 20 percent. The border
adjustment also had a minimal impact on economic growth. Thus it raised
more than $1 trillion over a decade in offsetting revenues while
maximizing the economic benefits of the lower corporate tax rate and
full expensing proposals.
conclusion
Mr. Chairman, corporate tax reform done right is key to growing the
economy, boosting real family incomes, and making the United States a
better place to do business in, and do business from. The Four Pillars
of Corporate Tax Reform--full expensing, a lower corporate tax rate, a
territorial system, and permanence--are the right policies to make this
tax reform effort a lasting success.
Thank you. I'm happy to answer any questions you may have.
______
Questions Submitted for the Record to Scott A. Hodge
Questions Submitted by Hon. Orrin G. Hatch
Question. Mr. Hodge, I appreciate that your testimony recognizes
the difficult exercise that Congress has in front of it to make the
tough choices and make the numbers work for comprehensive tax reform.
You suggest that Congress, as part of comprehensive tax reform, provide
for full expensing, and you identified in your testimony a potential
method for reducing the cost of moving the tax system to such a
proposal through indexing for inflation the current depreciation
schedules and providing an appropriate rate of return. Would you
elaborate more on your proposal and provide us a practical example of
how it might work?
Answer. As my colleague Kyle Pomerleau wrote in a recent Tax
Foundation study, ``How to Reduce the Up-Front Cost of Full
Expensing,'' https://taxfoundation.org/reduce-front-cost-full-
expensing/, ``One way to reduce the cost of full expensing during the
transition is to enact something called `neutral cost recovery' (NCR).
Under NCR, companies would get the benefit of full expensing:
deductions for capital investments would get the full present value
write-offs and bring the marginal tax rate on those assets down to
zero, but the government would not suffer large transitional costs.
This is how it would work: instead of providing a full write-off for
capital costs, the Federal Government would keep the current law's
depreciation schedule. However, depreciation allowances would be
adjusted to an interest rate to offset both the effect of inflation and
the time value of money.'' You can think of this as simply an enhanced
indexing of depreciation schedules, not all that different than the way
individual tax brackets are index to inflation.
Under NCR, a company still needs to depreciate assets over time
according to a schedule. However, annual deductions are adjusted by an
interest rate to offset the declining value of deductions over time. In
the first year, a $100 deduction is the same as it is under current
law. But as time goes on, the deductions grow in nominal terms. The
second year, the company deducts $104 and the next year $108. These
larger annual deductions end up offsetting the impact of the declining
value of money over time. Thus, the present value of the deduction
remains constant.
Question. Mr. Hodge, your written statement makes the case for
permanent tax reforms as opposed to temporary tax reforms. So permanent
is better than temporary. Is temporary better than nothing at all?
You've noted the fact that the math is hard in comprehensive tax reform
and complying with the Byrd rule in the Senate potentially provides
boundaries on what can be done. Is comprehensive tax reform an all or
nothing proposition, or would you recommend that Congress, if
necessary, carefully identify those items that might be permanent and
those that might be temporary in tax reform? What should Congress take
into consideration in such an analysis?
Answer. The decision to make a policy temporary or permanent should
depend on: (1) its impact on economic growth; (2) how much it effects
behavior and decision making; and (3) how much the temporary policy
would draw activity from the future to the present. If you are looking
to make any of the tax cuts temporary, I would restrict that to the
individual tax provisions. As we saw with the Bush tax cuts of 2003,
salaried workers can't generally shift income from the future to the
present, so little of the growth effect was lost on the temporary
nature of the policy.
Corporate changes are different. Because corporations plan for the
long-term, they need more stability in the tax code. They are also more
adept at shifting activity from the future to the present. That is why
temporary expensing may give you some economic growth today, but as the
expense of lower economic growth tomorrow. Thus, the corporate tax
provisions of any comprehensive package should be permanent.
Question. Mr. Hodge, the President and his administration have
indicated on many occasions that one of their primary goals in
comprehensive tax reform is to grow the economy. I think many, if not
all, of us in this room share that view. Would you provide us your
thoughts on why policies like full expensing and cutting corporate
income tax rates lead to higher economic growth? How would you rank the
tax policies that contribute most to economic growth, and why?
Answer. Dollar-for-dollar, tax changes that lower the cost of
capital will do more for economic growth than any other policies you
can enact. This is because capital is more mobile and, thus, more
sensitive to tax changes than labor, which is less mobile. Cutting the
cost of capital incentivizes new investment, which makes workers more
productive, thus increasing their wages and living standards over time.
Individual tax cuts may give people tax relief, but cutting the
corporate tax rate and full expensing do more in the long run to boost
wages and living standards. That should be the ultimate goal of any tax
reform plan.
Question. Mr. Hodge, you state that expensing delivers twice the
economic growth as a corporate rate cut. While you are certainly in
favor of a corporate rate cut, you note that a rate reduction's
benefits are spread over returns to existing capital. So, my question
is, would a delayed, or phased-in, rate cut significantly lessen this
windfall effect of giving benefits to existing capital?
Answer. Yes, every year following the first phase-in year would
benefit new capital more than existing capital, thus diminishing the
windfall for those old investments.
Question. Mr. Hodge, you state that permanent tax reform is much
better than a temporary tax cut. I agree with you. But my question is:
Would it be better to do nothing than to have a temporary tax cut?
Answer. Some temporary tax cuts can actually leave the economy
worse off in the long run than doing nothing. For example, when we
modeled the effects of a 5-year temporary expensing provision, we found
that after 10 years GDP was only 0.18 percent higher than it would have
been, but that the rate of growth was slower than trend. That is
because the temporary policy pulled so much activity from the future to
the present that it left the future with fewer resources.
Question. Mr. Hodge, in your written testimony, you cite favorably
the House GOP Blueprint's proposal to eliminate the deduction for net
interest expense for corporations. But can you help me understand, why
is that elimination focused on net interest expense? Why net? If we
think interest in some circumstances shouldn't be deductible, why
wouldn't that be across the board, whether or not one had interest
income?
Answer. Restricting the elimination of the interest deduction to
net interest protects banks and lending institutions from the
restriction. For them, borrowed money is their cost of goods sold and
should be deductible. The idea is to restrict the deduction only to
those who borrow as an end user.
Question. Mr. Hodge, you cite, in your written testimony, as an
option for raising over a trillion dollars annually, the possibility of
removing the Social Security Payroll tax cap. I didn't see your
testimony as endorsing that idea, but I did want to ask you about it.
Under current law, the benefits one receives from the Social Security
program are tied, somewhat, to the payments one makes into the Social
Security trust fund, via one's FICA or Social Security taxes. But if
the Social Security Payroll tax cap were eliminated, wouldn't this make
the connection between payments in and benefits out even more tenuous
than is currently the case? I'd be concerned about the healthiness of
the Social Security system, and for its broad support, if that were
done.
Answer. Yes, if Congress were to lift the payroll tax cap while
keeping the defined benefit, it would essentially have the same effect
of funding Social Security out of general revenues, thus undermining
the self-financing nature of the program. Social Security would then
become no different than any other transfer program in government.
Question. Mr. Hodge, you noted that the OECD has said that the
corporate tax is the least efficient tax. You noted that this is mostly
because of the high mobility of the corporate tax base. What did the
OECD say was the most efficient tax? Is the tax base of the most
efficient tax highly mobile?
Answer. In their study, ``Tax and Economic Growth'' (https://
www.oecd.org/tax/tax-policy/41000592.pdf), OECD economists set out to
determine which taxes were most conducive to economic growth. Or,
conversely, they wanted to create a hierarchy or rule of thumb for
thinking of which taxes were most harmful to growth, so that government
would shift the composition of their tax systems to one that did the
least harm to their economies.
Here is that hierarchy:
Corporate income taxes are most harmful for economic growth
because capital is the most mobile factor in the economy.
Personal income taxes are second-most harmful for growth. People
are not as mobile as capital, but marginal tax rates influence their
decisions to work, save, and invest.
Consumption taxes are next-most harmful for growth. Taxes can
influence decisions to consume, but the impact is less than taxes on
income.
Property taxes are least harmful for growth because property is
the least mobile factor.
Question. Mr. Hodge, both you and Dr. Marron favor expensing, and
both of you believe it should be a higher priority for Congress than a
reduction of the corporate tax rate. I understand one of the main
arguments for such prioritization is that a corporate tax rate cut,
while incentivizing new investment is, in large part, a windfall to old
capital. That is, a corporate rate cut gives a benefit to income that
would have been generated anyway. Expensing, on the other hand, only
gives a tax benefit to new investments, so wouldn't be granting
windfall benefits. Am I stating that argument correctly?
Answer. Yes, that is a correct way of understanding the issue.
Question. But I also want to ask, couldn't expensing also result in
a windfall benefit? That is, if a business was going to invest $100
million, say, in capital equipment under the Alternative Depreciation
System (ADS), then to allow the $100 million to all be deducted in the
first year of such investment, to allow it to be expensed, wouldn't
that be giving a tax benefit for activity that would have happened
anyway? Shouldn't that be considered a windfall benefit?
Answer. It is not a windfall, because allowing a business to
immediately deduct their expenses--capital or otherwise--is the proper
way to measure net business profits. When you force a business to write
that capital expense over a long period of time, you are actually
taxing them closer to gross revenues, not net profits. Thus, they are
being over-taxed.
Question. Finally, would one way to address this problem be to
allow full expensing for capital expensing that exceeds some base
account, similar to how is done with the R&D credit. (With the R&D
credit the point of that is that the R&D credit is targeted on research
that would not have happened anyway, that would not have happened but
for the credit.) Perhaps this could be a way to get most of the same
growth effect from expensing, but while limiting the revenue costs.
Answer. No. Remember, the R&D credit is in addition to whatever
deductions that companies get for their R&D expenses. Thus it is giving
them an extra deduction for whatever activity they are engaged in. As I
mention above, companies should be able to immediately expense their
expenses of any kind because that is the correct way of calculating net
profits.
Question. Some believe if tax reform loses revenue, the resulting
deficits may crowd out private investment. Could you please explain
that more?
Answer. We are very skeptical of this argument. In our review of
recent economic history, there is little or no relationship between
deficits and interest rates. If anything, the relationship has been
negative--interest rates have fallen as the deficit increased. Our
reading of recent empirical studies confirms this lack of relationship.
Congress is now considering a tax cut package in the range of $1.5
trillion over 10 years. The global credit market is simply too big for
a tax cut that would add about $150 billion to the deficit annually to
move global interest rates. Besides, our model suggests that the
economic benefits of such a tax cut would more than outweigh any
downsides if interest rates were to tick up a few basis points.
Question. You seem to think that a move towards expensing would be
more helpful to the economy than would a corporate rate cut. But, I
will tell you that from many corporations I hear from, they seem to
prefer the corporate rate cut. Why do you think that is? How much of
that has to do with financial accounting--and if so, how much should
policymakers take that into account?
Answer. Accountants and economists see the world differently, and
good tax policy should be driven by economics not by accounting.
Corporate CFOs tend to care more about their financial statements than
cash-flow or economic incentives. Expensing does not benefit their P&L
in the same way as a corporate rate cut. Thus, they don't see the
benefit of expensing. Besides, many of these companies are contracting
out the manufacturing of their products to foreign firms, thus
expensing does not improve the return from that relationship as does a
rate cut. But one reason that so much U.S. manufacturing has moved
offshore is because of how poorly we treat capital investment. Moving
to full expensing would reverse that trend.''
Question. If investment in capital assets were allowed to be
expensed, should there be exceptions to this for LIFO? For land? For
real estate improvements?
Answer. I tend to think that if we were to allow full expensing as
a policy LIFO would be unnecessary because inventories would be
expensed immediately. Same with real estate improvements, since they
are a cost of doing business. Land generally does not depreciate
(separate from the issue of minerals), thus it should not be expensed.
______
Question Submitted by Hon. Mike Crapo
Question. Mr. Hodge, when talking about comprehensive tax reform,
I've often said that if one tried to create a tax code that was more
unfair, more complex, more costly to comply with and more anti-
competitive for American business, you couldn't do worse than the tax
code we have now. One of the challenges is, then, if we are going to
enact comprehensive tax reform that addresses each and every one of
those problems with the current code, how can we actually measure our
success in achieving all of those goals?
I know you all have done a lot of work there at the Tax Foundation.
So I was interested in your views. At our hearing last week, one of the
witnesses suggested that the Joint Tax Committee's conventional
analysis on the changes in after-tax income would be the most
appropriate way to measure the effects of reform. If we were talking
about just a traditional run of the mill tax cut bill, then maybe you
can argue that traditional JCT analysis would be sufficient.
But if we're going to completely reform the code in a way where we
will be able to tell the typical American taxpayer that they no longer
spend the hours every year saving their receipts and documenting their
expenses and either doing their own taxes or spending hundreds of
dollars to buy some software or pay someone else to do their taxes,
that will be a real and meaningful benefit for them, but isn't
necessarily going to be reflected in a typical JCT analysis.
The same thing goes for when we reform the business and
international tax codes, which won't just help the bottom line of those
American businesses, but will also create more job opportunities and
higher wages for American workers.
Can you discuss any work you and the Tax Foundation have done, or
any thoughts you have, about how we can best account for and then
explain to the American taxpayer all of the benefits they will see from
comprehensive tax reform, including those that are not reflected in a
conventional JCT analysis, and those that are not necessarily so easily
quantifiable?
Answer. The success or failure of tax cuts are typically marked by
how they impact the last line on a taxpayer's 1040. But whether or not
people save on their tax bills is only part of the story. It is almost
more important to know how a tax plan will effect the economy, capital
investment, wages, and after-tax incomes. After all, wouldn't it be
terrible to enact a tax reform plan that gave people a tax cut today,
only to so depress investment and economic growth that wages fell and
jobs were lost?
Our Taxes and Growth (TAG) macroeconomic tax model takes all of
those economic factors into account. Sure, the model can estimate how
taxpayers' 1040s will be effected. But, the model also measures how a
tax plan will impact their after-tax incomes once the economy finally
adjusts to the tax changes. If their after-tax incomes go up, you know
the plan was pro-growth. If their incomes go down, you know that some
part of the tax plan undermined growth. That is the true value of
dynamic scoring.
______
Questions Submitted by Hon. Bill Nelson
Question. In your opinion, did the 1986 Tax Reform Act solve the
problems it was intended to fix? If so, please provide some examples of
how. If not, why?
Answer. To the extent that the goal of the 1986 Act was to simplify
the tax system, I suppose it could be considered a success. But if the
goal was to promote economic growth, our modeling of the 1986 Act
suggests that it was a failure.
My colleagues went back and modeled all the major tax bills over
the past 50 years and found that the 1986 was actually bad for economic
growth because it raised the cost of capital on businesses in order to
provide tax cuts for individuals. Thus, we found that the albeit
simpler post-1986 tax code slowed the economy.
Question. Do you believe Congress should consider cutting
entitlement and safety net programs--like Social Security, Medicare,
TANF, and food stamps--to pay for tax reform? If so, why? If not, why
not?
Answer. I think that tax reform and entitlement reform are each
hard enough on their own that they should not be tried at the same
time.
Question. President Trump has said he wants to lower the top
business tax to 15 percent. Do you believe this can be done without
significantly adding to the deficit? If so, please explain how through
a detailed example (with budget estimates).
Answer. I guess it depends upon what you mean by significantly add
to the deficit. When we model a cut in the corporate rate to 15
percent, we estimate that it would reduce Federal revenues by about
$2.1 trillion over a decade on a static basis. After accounting for the
growth effects from that lower rate, our model suggests that the cost
of the rate cut would fall to about $1 trillion.
As for offsets, eliminating numerous deductions in the corporate
code and eliminating interest deductibility would get you about half-
way to revenue neutral. In order to get to full revenue neutrality,
you'd have to look outside of the corporate code for offsets.
Question. What metric or considerations should Congress use to
determine which tax breaks to eliminate in order to lower the rates?
Answer. Let economics be your guide. Start with the tax breaks that
do most to distort the economy and those that inappropriately benefit
certain industries at the expense of others. Then, you should ask, will
repealing this provision do more economic harm than the benefits we
expect to achieve from the tax provision it will offset? If so, then it
is not a good tradeoff. If yes, then the tradeoff is worth it.
Question. If you were king for a day, which tax breaks would you
eliminate first?
Answer. I'd start with the State and local tax deduction, followed
by the exemption for credit unions, energy production credits, bio-
diesel credits, tax credits for clean-fuel burning vehicles, section
199 manufacturing deduction, exclusion of interest for State and local
bonds. Those are all good starts.
Question. Do your economic and revenue scoring models account for
things like ``Passive Loss'' and ``At-Risk'' rules, which would prevent
many real estate investors, including many small businesses, from being
able to use immediate expensing?
Answer. No, our model doesn't account for that unless it is written
into the policy that we are scoring. That is why lawmakers will have to
take that into account by scaling up loss carryforwards. The House GOP
Blueprint essentially indexed carryforwards to inflation plus a small
rate of return in order to preserve the real value of the deduction.
Question. Do your economic and revenue scoring models factor in how
an elimination or decrease in interest deductibility would impact small
businesses, banks, and access to affordable capital?
Answer. Yes, our model takes into account the entire macroeconomic
effect of the policy. When we scored the House GOP Blueprint, our model
found that eliminating interest deductibility would only reduce the
level of GDP by 0.4 percent over 10 years. That is a pretty small
effect.
______
Prepared Statement of Troy K. Lewis, CPA, CGMA, Immediate Past Chair,
Tax Executive Committee, American Institute of Certified Public
Accountants
introduction
Chairman Hatch, Ranking Member Wyden, and members of the Senate
Committee on Finance, thank you for the opportunity to testify today on
business tax reform. My name is Troy Lewis. I am an Associate Teaching
Professor at Brigham Young University. I am also a sole tax
practitioner and the Immediate Past Chair of the Tax Executive
Committee of the American Institute of Certified Public Accountants
(AICPA). I am pleased to testify today on behalf of the AICPA.
The AICPA is the world's largest member association representing
the accounting profession with more than 418,000 members in 143
countries and a history of serving the public interest since 1887. Our
members advise clients on Federal, State, local and international tax
matters and prepare income and other tax returns for millions of
Americans. Our members provide services to individuals, not-for-profit
organizations, small and medium-sized businesses, as well as America's
largest businesses.
As the committee tackles this rare opportunity to enact bold, pro-
growth business reform, we urge Congress to take a holistic approach to
provide tax reform to all of America's businesses. Fair and equitable
tax reform will drive economic growth and job creation, enhancing the
competitiveness of all types of American businesses not only in the
United States but also abroad.
The AICPA is a long-time advocate for an efficient and pro-growth
tax system based on principles of good tax policy.\1\ We need a tax
system that is fair, stimulates economic growth, has minimal compliance
costs, and allows taxpayers to understand their tax obligations. These
features of a tax system are achievable if principles of good tax
policy are considered in the design of the system.
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\1\ AICPA, ``Guiding Principles for Good Tax Policy: A Framework
for Evaluating Tax Proposals,'' January 2017, https://www.aicpa.org/
ADVOCACY/TAX/downloadabledocuments/tax-policy-concept-statement-no-1-
global.pdf.
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aicpa proposals
In the interest of good tax policy and equitable and effective tax
administration, we appreciate the opportunity to address the following
issues:
1. Cash method of accounting.
2. Tax rates for pass-through entities.
3. Distinguishing compensation income.
4. Interest expense deduction.
5. Cost recovery.
6. Definition of compensation.
7. Alternative Minimum Tax repeal.
8. Mobile workforce.
1. Cash Method of Accounting
The AICPA supports the expansion of the number of taxpayers who may
use the cash method of accounting.\2\ The cash method of accounting is
simpler in application than the accrual method, has fewer compliance
costs, and does not require taxpayers to pay tax before receiving the
related income. Therefore, entrepreneurs often choose this method for
small businesses.
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\2\ AICPA letter, ``Investment in New Ventures and Economic Success
Today Act of 2017 (S. 1144),'' June 22, 2017, https://www.aicpa.org/
Advocacy/Tax/DownloadableDocuments/AICPA-Letter-to-Senator-Thune-in-
Support-of-the-INVEST-Act-S1144.pdf.
We are concerned with, and oppose, any new limitations on the use
of the cash method for any business, including those businesses whose
income is taxed directly on their owners' individual returns (such as
partnerships and S corporations). Requiring businesses to switch to the
accrual method upon reaching a gross receipts threshold unnecessarily
creates a barrier to growth.\3\
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\3\ A required switch to the accrual method affects many small
businesses in certain industries, including accounting firms, law
firms, medical and dental offices, engineering firms, and farming and
ranching businesses.
The AICPA believes that further restricting the use of the cash
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method of accounting for businesses would:
a. Discourage natural small business growth;
b. Impose an undue financial burden on their individual owners;
c. Increase the likelihood of borrowing;
d. Impose complexities and increase their compliance burden; and
e. Treat similarly situated taxpayers differently (merely because
income is taxed directly on their owners' individual returns).
Congress should not further restrict the use of the long-standing
cash method of accounting for the millions of U.S. businesses (e.g.,
sole proprietors, personal service corporations, and pass-through
entities) currently utilizing this method.
2. Tax Rates for Pass-Through Entities
If Congress, through tax reform, lowers the income tax rates for C
corporations, all types of business entities should receive a rate
reduction. Our laws should continue to encourage, or more accurately--
not discourage--the formation of pass-through entities as these
business structures provide the flexibility and control desired by many
owners that is not available within the more formal corporate
structure. The vast majority of America's businesses are structured as
pass-through entities (partnerships, S corporations, limited liability
companies, or sole proprietorships).\4\ Tax reform should not
disadvantage these entities or require businesses to engage in complex
entity changes to obtain favored tax status.
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\4\ See Census Bureau, ``County Business Patterns,'' https://
www.census.gov/programs-surveys/cbp.html; Census Bureau, ``Nonemployer
Statistics,'' https://www.census.gov/programs-surveys/nonemployer-
statistics.html.
Tax reform should recognize the importance of consistent tax rates
on business income generated from all of America's pass-through
entities, including professional service firms. Inequities would arise
from having significantly different income tax rates based on an overly
simplistic approach such as one based solely on the structure, sector,
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or the general nature of a business' activities.
Professional service firms are an important sector in our economy
and heavily contribute to the Nation's goals of creating jobs and
better wages.\5\ For example, according to the current employment
statistics from the U.S. Bureau of Labor, the Accountants and Auditors
service industry has a job growth outlook of 11% (as opposed to the
average growth rate of 7% for all occupations) for the years 2014-
2024.\6\ Furthermore, the jobs created by professional service firms
are driving a more educated workforce for delivery of advanced services
and products. These jobs are often coveted due to higher wages as well
as health care, retirement, and other benefits.
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\5\ In 2014 (the latest data available), the U.S. professional
services industry comprised about 883,000 firms and employed 8.6
million Americans. The industry achieved combined annual revenues of
$1.6 trillion in 2015. Selectusa.gov; Professional Services Spotlight,
https://www.selectusa.gov/professional-services-industry-united-states.
\6\ Bureau of Labor Statistics website, Publications, Business and
Financial, ``Accountants and Auditors,'' https://www.bls.gov/ooh/
business-and-financial/accountants-and-auditors.htm.
Excluding professional services reflects a view of the industry
that may have applied in the 1950s, but certainly does not represent
the current integrated global environment. In today's economy,
professional service pass-throughs are increasingly competing on an
international level with businesses organized as corporations, require
a significant investment in tangible and intangible assets, and rely on
the contribution of salaried, nonequity professionals to generate a
significant portion of the revenue.\7\ Artificially limiting the use of
a lower business rate, regardless of industry, would penalize a
business for operating as a pass-through entity.
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\7\ The United States is the world's most desired location for
professional services firms. In today's integrated global environment,
businesses find it critical to access the talent, institutions,
business processes, and client base offered in the United States;
Selectusa.gov; Professional Services Spotlight, https://
www.selectusa.gov/professional-services-industry-united-states.
All business owners have: uncertainty and risk to manage; increased
administrative and reporting responsibilities at the State, local and/
or Federal level; a potentially significant investment in assets; \8\
and ultimately an obligation to their customers and employees. Without
the benefit of a fair and consistent rate reduction for all pass-
through entities, the incentive to start or grow a business is
diminished, with a corresponding loss of jobs and reduction in wages.
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\8\ Although professional service firms are not as heavily invested
in tangible assets as manufacturing firms, they generally have a
substantial investment in intangible assets. For example, accounting,
legal, engineering, computer consulting, and other professional service
practices require continuing and substantial investment in software,
hardware, assembling, and training a workforce, marketing,
cybersecurity, office facilities, and malpractice insurance.
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3. Distinguishing Compensation Income
If Congress provides a reduced rate for active business income of
sole proprietorships and pass-through entities, we recognize that it
will place additional pressure on the distinction between the profits
of the business and the compensation of owner-operators. We recommend
determining compensation income by codifying traditional definitions of
``reasonable compensation'' supplemented, if necessary, by additional
guidance from the U.S. Department of the Treasury and the Internal
Revenue Service.
The definition of reasonable compensation should reflect the type
of business, the time spent by owners in operating the business, owner
expertise and experience, and the existence of income-generating assets
in the business (such as other employees and owners, capital and
intangibles). Other relevant factors include available guidance (if
any) used to help determine reasonable compensation for the geographic
area and years of experience (such as, wage data guides provided by the
U.S. Bureau of Labor Statistics), and the book value and estimated fair
market value of tangible and intangible assets that generate income for
the business.
Former Ways and Means Committee Chairman Dave Camp's 2014
discussion draft \9\ included a proposal to treat 70% of pass-through
income of an owner-operator as employment income. While this proposal
presented a simple method, it would result in an inequitable outcome in
many situations. If Congress moves forward with a 70/30 rule, or other
percentage split, we recommend limiting it to active owners and making
the proposal a safe harbor option. For example, the proposal must make
clear that the existence and the amount of the safe harbor is not the
required amount permitted but that the reasonable compensation standard
utilized for corporations will remain available to taxpayers. These
rules will provide a uniform treatment among closely held business
entity types.
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\9\ H.R. 1 (113th Congress), The Tax Reform Act of 2014, https://
www.congress.gov/bill/113th-congress/house-bill/1, section 1502; also
see Section-by-Section Summary, pages 32-33, https://
waysandmeans.house.gov/UploadedFiles/
Ways_and_Means_Section_by_Section_Summary_FI
NAL_022614.pdf.
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4. Interest Expense Deduction
Another important issue for small businesses, as well as for
professional service firms, is the ability to deduct interest expense.
New business owners incur interest on small business loans to fund
operations prior to revenue generation, working capital needs,
equipment acquisition and expansion, and to build credit for future
loans. These businesses rely on financing to survive. Equity financing
for many start-up businesses is simply not available. A limitation in
the deduction for interest expense (such as to the extent of interest
income) would effectively eliminate the benefit of a valid business
expense deduction for many small businesses, as well as for many
professional service firms. If a limit on the interest expense
deduction is connected with a proposal to allow for an immediate write-
off of acquired depreciable property, it is important to recognize that
this combination adversely affects service providers and small
businesses while offering larger manufacturers and retailers a greater
tax benefit. As a result, business formations by small start-ups are
hindered.
Currently, small businesses can expense up to $510,000 of
depreciable acquisitions per year under section 179 and deduct all
associated interest expense. One tax reform proposal \10\ under
consideration would eliminate the benefit of interest expense while
allowing immediate expensing of the full cost of new equipment, and
depreciable real estate, in the first year. However, since small
businesses do not usually purchase large amounts of new assets, this
proposal would generally not provide any new benefit for smaller
businesses (relative to what is currently available via the section 179
expensing rule). Instead, it only eliminates an important deduction for
many businesses, which are forced to rely on debt financing to cover
their operating and expansion costs.
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\10\ House Republican's Tax Reform Task Force Blueprint, ``A Better
Way: Our Vision for a Confident America,'' June 24, 2016, https://
abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf.
At a minimum, we suggest allowing small (and perhaps ``mid-size'')
businesses to continue to deduct net interest expense.
5. Cost Recovery
In general, the AICPA supports cost recovery legislation, such as
Senator Thune's Investment in New Ventures and Economic Success Today
Act of 2017, S. 1144, which would simplify, for businesses and their
owners, certain accounting rules and key parts of the IRC.\11\
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\11\ AICPA letter, ``Investment in New Ventures and Economic
Success Today Act of 2017 (S. 1144),'' June 22, 2017, https://
www.aicpa.org/Advocacy/Tax/DownloadableDocuments/AICPA-Letter-to-
Senator-Thune-in-Support-of-the-INVEST-Act-S1144.pdf.
Many of the cost recovery provisions (such as, the expansion of the
deduction for start-up and organizational expenses, the expensing of
inventory by small and mid-sized businesses, and the exception for
small and mid-sized businesses from capitalization of certain costs to
inventory) would contribute to simplifying the tax rules and encourage
economic growth and efficiency. We also appreciate that S. 144 updates
the schedule of cost recovery periods for depreciable property under
Revenue Procedure 87-56 to include a range of technology and other
types of property that did not exist in 1987 would provide clarity,
eliminate controversy, and provide a more accurate reflection of
depreciation.
6. Definition of Compensation
Tax reform discussions have considered whether the tax system
should use the same definition for taxable compensation of employees as
it does for the compensation that employers may deduct.
We are concerned, particularly from a small business perspective,
about any decrease of an employer's ability to deduct compensation paid
to employees, whether in the form of wages or fringe benefits (health
and life insurance, disability benefits, deferred compensation, etc.).
We are similarly concerned about expansion of the definition of taxable
income for the employees, or removal of the exclusion for fringe
benefits. Such changes in the tax code would substantially impact the
small and labor-intensive businesses' ability to build and retain a
competitive workforce.
7. Alternative Minimum Tax Repeal
The AICPA supports the repeal of the alternative minimum tax
(AMT).\12\ The current system's requirement for taxpayers to compute
their income for purposes of both the regular income tax and the AMT is
a significant area of complexity of the tax code requiring extra
calculations and recordkeeping. The AMT also violates the transparency
principle because it masks the amount a taxpayer can deduct or exclude,
as well as the taxpayer's marginal tax rate. Small businesses,
including those operating through pass-through entities and certain C
corporations, are increasingly at risk of being subject to the AMT.
---------------------------------------------------------------------------
\12\ AICPA written testimony before the House Committee on Ways And
Means, Subcommittee on Select Revenue Measures, March 3, 2011,
``Hearing on Small Businesses and Tax Reform,'' https://www.aicpa.org/
Advocacy/Tax/DownloadableDocuments/FINALTESTIMONYFOR
THOMPSONMarch32011.pdf, and AICPA comments to the House Committee on
Ways and Means on the Tax Reform Act of 2014, January 12, 2015, https:/
/www.aicpa.org/Advocacy/Tax/DownloadableDocuments/AICPA-Comments-on-
2014-Camp-Draft-General-Comments-Final
.pdf.
The AMT was created to ensure that all taxpayers pay at least a
minimum amount of tax on their economic income. However, businesses
suffer a heavy burden because they often do not know whether they are
affected by the AMT until they file their Federal income tax returns.
Therefore, they must constantly maintain a reserve for possible AMT,
which takes away from resources they could allocate to business needs
---------------------------------------------------------------------------
such as hiring, expanding, and giving raises to workers.
The AMT is a separate and distinct tax regime from the ``regular''
income tax. IRC sections 56 and 57 create AMT adjustments and
preferences that require taxpayers to make a second, separate
computation of their income, expenses, allowable deductions, and
credits under the AMT system. This separate calculation is required for
all components of income including business income for sole
proprietors, partners in partnerships and shareholders in S
corporations. Businesses must maintain annual supplementary schedules,
used to compute these necessary adjustments and preferences, for many
years in order to calculate the treatment of future AMT items and,
occasionally, receive a credit for them in future years. Calculations
governing AMT credit carryovers are complex and contain traps for
unwary taxpayers.
Sole proprietors who are also owners in pass-through entities must
combine the AMT information from all their activities in order to
calculate AMT. The computations are extremely difficult for business
taxpayers preparing their own returns and the complexity affects the
IRS's ability to meaningfully track compliance.
8. Mobile Workforce
The AICPA supports the Mobile Workforce State Income Tax
Simplification Act of 2017, S. 540, which provides a uniform national
standard for non-resident State income tax withholding and a de minimis
exemption from the multi-state assessment of State non-resident income
tax.\13\
---------------------------------------------------------------------------
\13\ For additional details, see AICPA written statement, ``AICPA
Statement for the Record of the April 13, 2016 Hearing on `Keep it
Simple: Small Business Tax Simplification and Reform, Main Street
Speaks,' '' April 7, 2016, https://www.aicpa.org/Advocacy/Tax/
Downloadable
Documents/aicpa-comments-mobile-workforce-subcom-small-bus-hearing.pdf.
The current situation of having to withhold and file many State
nonresident tax returns for just a few days of work in various States
is too complicated for both small businesses and their employees.
Businesses, including small and family businesses that operate
interstate, are subject to a multitude of burdensome, unnecessary and
often bewildering non-resident State income tax withholding rules.
These businesses struggle to understand and keep up with the variations
from State to State. The issue of employer tracking and complying with
all the different State and local tax laws is complicated and costly.
The documentation takes extra time, adding to the loss in economic
---------------------------------------------------------------------------
productivity for small businesses.
S. 540 would provide long-overdue relief to all businesses from the
current web of inconsistent State income tax and withholding rules on
nonresident employees. Therefore, we urge Congress to pass S. 540 that
provides national uniform rules and a reasonable 30 day de minimis
threshold before income tax withholding is required.
concluding remarks
The AICPA has consistently supported business tax reform efforts
that are based on the principles of good tax policy, as we are
convinced it will promote simplification, reduce business compliance
costs and stimulate economic growth. As Congress drafts tax reform
legislation, we encourage you to provide equality, certainty and
clarity for all business owners. Businesses, regardless of entity
structure, sector or the general nature of its activities, should
similarly thrive under comprehensive tax reform.
The AICPA appreciates the opportunity to submit this testimony and
we look forward to working with the committee as you continue to
address business tax reform.
______
Questions Submitted for the Record to Troy K. Lewis
Questions Submitted by Hon. Orrin G. Hatch
Question. I have heard from my colleagues across the aisle the
parade of horribles that will ensue if Congress enacts a proposal to
provide a lower business income tax rate for pass-through entities--
that it will only benefit the rich and that it will, according to Dr.
Marron, ``inspire tax avoidance.'' And yet two of the witnesses came to
the table with thoughtful approaches on how to address the concerns
that compensation, or wage income, that is taxed at ordinary income tax
rates will be inappropriately recharacterized as business income
subject to a preferential business income tax rate. I'd like to have
Mr. Lewis and Mr. DeBoer comment on their proposals, whether the
concerns raised are legitimate but perhaps overblown, and provide their
thoughts on administrative issues associated with their proposals.
Answer. Professional service providers face the same economic and
legal challenges as other businesses. Any perceived tax savings of
restructuring as an independent contractor, are unlikely to cover the
incremental business cost of obtaining one's own employment benefits,
losing unemployment coverage, providing for self-funded health care and
incurring business-related costs (investment in technology, malpractice
insurance, annual continuing education, office rental expense, etc.).
Furthermore, employers are bound by case law in determining
employment status, which would prevent them from contracting with
former employees who impulsively changed their status to independent
contractor. If an employer claims independent contractor status for a
worker without a reasonable basis, both the worker and employer are
subject to penalties and taxes.
Question. Recently, Treasury Secretary Mnuchin commented on tax
reform generally, and in particular on the potential for a lower rate
for pass-through business income. He made a distinction between income
that was generated from services businesses, which would be subject to
ordinary income tax rates, and other income. Mr. Lewis, am I correct
that your testimony suggests that not all returns in services
businesses are returns on labor, so that some portion of the return
should be subject to the pass-through business rate? Would you
elaborate more on that point?
Answer. Yes, you are correct. A portion of pass-through income is
business income (or a ``return on capital'') and a portion is
compensation-related (or a ``return on labor''). There is existing case
law on the issue, and we recommend codifying the traditional
definitions of ``reasonable compensation'' supplemented, if necessary,
by additional guidance from the U.S. Department of the Treasury and the
Internal Revenue Service.
The definition of reasonable compensation should reflect the type
of business, the time spent by owners in operating the business, owner
expertise and experience, and the existence of income-generating assets
in the business (such as non-owner employees and capital invested).
Other relevant factors include available guidance (if any) used to help
determine reasonable compensation for the geographic area and years of
experience (such as, wage data guides provided by the U.S. Bureau of
Labor Statistics), and the book value and estimated fair market value
of tangible and intangible assets that generate income for the
business.
Former Ways and Means Committee Chairman Dave Camp's 2014
discussion draft included a proposal to treat 70% of pass-through
income of an owner-operator as employment income. While this proposal
presented a simple method, it would result in an inequitable outcome in
many situations. If Congress moves forward with a 70/30 rule, or other
percentage split, we recommend limiting it to active owners and making
the proposal a safe harbor option. The reduced rate should apply to
owners who do not work in the business (i.e., none of their income
should qualify as employment income). Congress should also avail the
reasonable compensation standard (currently utilized for corporations)
to all taxpayers. These rules would provide uniform treatment among
closely-held business entity types.
Question. Mr. Lewis, I understand some of your testimony to say
that interest expense should remain deductible, but that some
accelerated depreciation /expensing is a good thing. However, the House
Blueprint saw those issues as tied together. That is, it connected the
call for expensing with its elimination of net interest expense
deductibility. Do you think those issues should not be seen as related
to each other? Do you have a comment on the House Blueprint's
elimination of net interest expense?
Answer. Interest expense and accelerated expensing are both
important issues. I am not suggesting that you tie the issues together.
However, if they are tied together, it is important to note that small
businesses can currently expense up to $510,000 of depreciable
acquisitions per year under section 179 and deduct all associated
interest expense. Also, since small businesses do not usually purchase
large amounts of new assets, the Blueprint's proposal would generally
not provide any new benefit for smaller businesses (relative to what is
currently available via the section 179 expensing rule). Instead, it
only eliminates an important deduction for many businesses, which are
forced to rely on debt financing to cover their operating and expansion
costs.
______
Questions Submitted by Hon. Bill Nelson
Question. I have a bipartisan bill with Senator Collins to make
sure small business don't have to pay a higher tax on their business
income than the largest corporations. The bill is called the Main
Street Fairness Act (S. 707). Do you think a bill like ours would be a
good place to start for tax reform?
Answer. The AICPA does not currently have a position on your and
Senator Collins' Main Street Fairness Act.
Question. In your opinion, did the 1986 Tax Reform Act solve the
problems it was intended to fix? If so, please provide some examples of
how. If not, why?
Answer. It would take an extensive analysis, which I have not
performed, to determine if the 1986 Tax Reform Act solved the problems
it was intended to fix. My personal thought is that it likely solved
some problems but not all of them. For example, the 1986 Tax Reform Act
resolved the prevalence of abuse of tax shelters by creating a new
section 469 of the Internal Revenue Code which prevented taxpayers from
offsetting income with passive deductions and credits.
Question. Please provide suggestions on how Congress should
determine which tax breaks to eliminate in order to pay for lower
rates.
Answer. The AICPA does not have a position on which tax breaks to
eliminate in order to pay for lower rates; however, we encourage a
holistic approach, based on the principles of good tax policy, that is
both equitable and meaningful to drive economic opportunities for
individuals and families while leveling the playing field for American
businesses not only in the United States but also abroad.
Question. If you were king for a day, which tax breaks would you
eliminate first?
Answer. The AICPA does not have a position on which tax breaks to
eliminate first; however, the AICPA is a long-time advocate for an
efficient and pro-growth tax system based on the principles of good tax
policy. We need a tax system that is fair, stimulates economic growth,
has minimal compliance costs, and allows taxpayers to understand their
tax obligations. These features of a tax system are achievable if
principles of good tax policy are considered in the design of the
system.
______
Prepared Statement of Donald B. Marron, Ph.D., Institute Fellow,
Urban Institute and Urban-Brookings Tax Policy Center
Chairman Hatch, Ranking Member Wyden, and members of the committee,
thank you for inviting me to appear today to discuss the opportunities
and challenges in business tax reform. The views I express are my own
and should not be attributed to the Tax Policy Center, the Urban
Institute, the Brookings Institution, their boards, or their funders.
America's business tax system is needlessly complex and
economically harmful. Thoughtful tax reform can make our tax code
simpler, boost American competitiveness, create better jobs, and
promote shared prosperity.
Business tax reform will boost long-run economic growth if it
inspires more investment in the United States and if firms make
investments with higher social returns. With high statutory rates,
numerous tax breaks, and deferral of overseas profits, our current
system creates many perverse incentives. Corporations sometimes see a
more favorable investment climate abroad, multinationals hoard money in
overseas affiliates, different types of investment face widely varying
tax rates, debt financing is favored over equity, new and small
businesses struggle under disproportionate compliance costs, and
businesses big and small invest too much in tax planning. Thoughtful
tax reform can reduce these distortions, encourage businesses to invest
more domestically, and reorient investment to opportunities that yield
higher returns for society.
But as you know, tax reform is hard. Meaningful reforms create
winners and losers--and you may hear more complaints from the latter
than praise from the former. In hopes of making your job a little
easier, my testimony addresses seven main points about business tax
reform:
1. Policymakers should be realistic about near-term growth from
business tax reform. The growth effects of more and better investment
accrue gradually, with their largest effects beyond the 10-year budget
window. If reform is revenue neutral, revenue raisers may temper future
growth. If reform loses revenue--tax cuts mixed with reform--deficits
may crowd out private investment. Either way, the boost to near-term
growth may be modest, at least in the budget window. Dynamic scoring by
the Joint Committee on Taxation, which reflects the mainstream economic
view, will thus play only a small role in paying for tax reform.
2. The corporate income tax makes our tax system more progressive;
corporate tax cuts would thus particularly help people with high
incomes. Much of the burden from corporate income taxes falls on
corporate shareholders and investors more broadly, people who tend to
have high incomes. The rest of the burden falls on workers including
executives, professionals, and managers as well as rank-and-file
employees. Economists debate how much of the burden falls on workers,
but overall it is clear that corporate tax reductions would
particularly benefit those with high incomes. Workers will benefit most
from reforms that encourage more and better investment in the United
States.
3. Taxing pass-through business income at a preferential rate
would create new opportunities for tax avoidance. When taxpayers see an
opportunity to switch from a high tax rate to a lower one, they often
take it. This is especially true when they can make the shift with a
mere paper transaction, not a real change in economic behavior.
Prominent examples include Kansas's experiment with eliminating taxes
on pass-through income, S corporations' profits exemption from Medicare
payroll taxes, and preferential rates for long-term capital gains.
Taxpayers will react the same way if pass-through business income gets
preferential treatment. Legislative and regulatory measures to limit
tax avoidance will introduce new complexities, create arbitrary
distinctions, and impose new administrative burdens.
4. Limiting the top tax rate on pass-through business income would
benefit only people with high incomes. In the Better Way plan, House
Republicans propose that pass-through business income be taxed at no
more than 25 percent, well below the 33-percent rate they propose for
wages, salaries, and other ordinary income. The only taxpayers who
would benefit are those who have qualifying business income and have
enough income to otherwise be in a higher tax bracket. Almost all tax
savings would go to people in the top of the income distribution.
Creating a complete schedule of pass-through rates could reduce this
inequity, but it would also expand the pool of taxpayers tempted by tax
avoidance.
5. Taxing pass-through business income at the corporate rate would
not achieve tax parity. Owners of pass-through businesses face one
layer of tax: individual income taxes on their share of business
profits. Corporate shareholders face two layers. The company pays
corporate income taxes on its profits, and taxable shareholders pay
individual income taxes on their dividends and capital gains. Taxing
pass-through business income at the corporate rate would thus favor
pass-throughs over corporations. Tax parity requires either a higher
tax rate on pass-through business income, a new tax on pass-through
distributions, or elimination of shareholder taxes.
6. It is extremely difficult to pay for large cuts in business tax
rates by limiting existing business tax breaks and deductions. A new
Tax Policy Center analysis finds that eliminating all corporate tax
expenditures except for deferral could pay for lowering the corporate
tax rate to 26 percent. To go any lower would require cutting other
business deductions, such as for interest payments. But deductions lose
value as tax rates fall. The more you cut rates, the harder it becomes
to raise offsetting revenue by limiting tax breaks and other
deductions. To pay for large rate reductions, lawmakers will therefore
need to raise other taxes or introduce new ones. Options include
raising taxes on shareholders, a value-added tax, and a carbon tax.
7. Making business tax cuts retroactive to the start of 2017 would
not promote growth and would benefit only shareholders. Retroactive tax
cuts would give a windfall to profitable businesses. That does little
or nothing to encourage productive investment. Indeed, it could weaken
growth by leaving less budget room for more pro-growth reforms.
Retroactive tax cuts do not help workers; the benefits would go solely
to shareholders.
I elaborate these points in the remainder of my testimony.
1. policymakers should be realistic about near-term growth
from business tax reform
Thoughtful business tax reform will encourage more and better
investment in the United States. But the benefits of that investment
will not show up immediately. They build gradually over time as
businesses accumulate their stock of productive capital. The largest
benefits may occur beyond the usual 10-year budget window.
Moreover, the potential growth from business tax reform will be
offset, at least in part, by other aspects of reform. If reform is
revenue neutral, revenue raisers may temper future growth. If reform
reduces the corporate tax rate while slowing investment write-offs, for
example, the net effects on investment and growth will reflect the
growth penalty from slower write-offs along with any growth benefits
from lower rates. Depending on the changes, the net effect could even
slow growth. If reform loses revenue--tax cuts mixed with reform--
deficits may crowd out private investment. Either way, the net boost to
economic growth will be less than might be suggested by a narrow focus
on the growth-increasing aspects of reform.
Policymakers should therefore be realistic about how much
additional growth they can expect from business tax reform and how much
dynamic scoring can help pay for its costs. Former Ways and Means
Chairman Dave Camp's tax reform in 2014 provides a good example. His
proposal reduced the corporate tax rate to 25 percent, but among the
offsetting revenue raisers were limits on interest deductibility and
slower depreciation. As a result, the Joint Committee on Taxation
(2014) concluded that the plan would likely reduce future investment.
The plan boosted economic activity modestly, because JCT believed other
features would encourage people to work more. On net JCT expected
Camp's plan to lift gross domestic product by a total of 0.1 to 1.6
percent over 10 years, yielding additional Federal revenues of $50 to
$700 billion. Welcome amounts, to be sure, but modest relative to the
revenue changes of large-scale business tax reform.
2. the corporate income tax makes our tax system more progressive
The burden of the corporate income tax falls on three types of
people. Corporate shareholders bear some of the tax because it reduces
the dividends and capital gains they receive. Owners of capital bear
some of the tax because it reduces the return to capital in the economy
more broadly. And workers bear some of the tax because it reduces the
size and quality of the U.S. capital stock, which in turn reduces their
wages, salaries, and benefits.
Debate continues about how much each group bears. Some individual
studies suggest workers may bear as much as 60 to 70 percent of the
corporate income tax. But many other studies find lower shares. Federal
agencies estimate that workers bear 19 to 25 percent of the corporate
income tax (Huang and Debot 2017).
My colleagues at the Tax Policy Center estimate that in the long
run, 20 percent of changes in the corporate tax rate are ultimately
borne by workers (Nunns 2012). The remainder is borne by corporate
shareholders (60 percent) and capital owners generally (20 percent).
Changes in investment write-off rules, however, can have a bigger
effect on workers. Depreciation and expensing rules have a more direct
effect on investment--and thus the productivity that drives wages,
salaries, and benefits--than do changes in the corporate tax rate. TPC
estimates that, in the long run, 50 percent of changes in depreciation
rules and expensing are borne by workers and 50 percent by all capital.
In these discussions, terms like ``workers'' and ``labor'' refer to
all types of workers, including highly paid executives, professionals,
and managers. Economists expect increased investment to boost
productivity and incomes across all types of jobs and decreased
investment to do the reverse.
[GRAPHIC] [TIFF OMITTED] T1917.002
The benefits of cutting corporate income taxes thus go
predominantly to people with high incomes. Under TPC's estimates, about
70 percent of the benefit from cutting corporate tax rates would go to
people in the top fifth of the income distribution, with 34 percent
going to people in the top 1 percent (figure 1). The benefits of
accelerating investment write-offs would be somewhat less concentrated
at the top, with 62 percent going to the top fifth by income and 24
percent to the top 1 percent.
3. taxing pass-through businesses at preferential rates
will inspire tax avoidance
American businesses take many forms, from sole proprietors working
from home to publicly traded multinationals that span the globe. The
largest businesses are usually organized as C corporations, which pay
the corporate income tax. Millions of sole proprietorships,
partnerships, limited liability corporations, and S corporations,
however, do not pay the corporate income tax. Instead, their owners pay
ordinary income taxes on their share of profits. These entities are
often called pass-throughs because for tax purposes their income passes
through to their individual or owners.
Pass-throughs are an important economic force. They account for
about 95 percent of all businesses and more than half of all business
revenue (Looney and Krupkin 2017, Prisinzano et al. 2016).
Both President Trump and the Better Way plan have proposed that
business income from pass-throughs be taxed at a lower maximum rate
than wages, salaries, and other types of ordinary income. The Trump
administration proposed that all business income be taxed at 15
percent, with a top individual tax rate of 35 percent. In their Better
Way proposal, House Republicans proposed a 25 percent tax rate on pass-
through business income, below their top 33 percent rate on ordinary
income.
These rate differentials--20 percentage points under President
Trump's proposal and 8 percentage points under the Better Way's--would
create new avenues for tax avoidance. Taxpayers facing higher tax rates
on their nonbusiness income would now get a big tax saving if they can
recharacterize some of that income as business income. Highly paid
professionals, for example, might provide services through LLCs and
claim some portion of their compensation as business income.
Taxpayers clearly respond to such rate differentials. When Kansas
exempted all pass-through income from its State income tax, with rates
up to about 5 percent, Kansans responded by creating new LLCs,
partnerships, and so on. State revenue plummeted without any apparent
economic boost (DeBacker et al. 2016). At the Federal level, profits
from S corporations are not subject to Medicare payroll taxes. The
resulting rate differentials--2.9 percentage points through 2012, up to
3.8 percentage points since 2013--have inspired some professionals to
route income through S corporations and treat it as profit rather than
compensation (Burman and Rosenberg 2017). Preferential tax rates
similarly encourage people to convert ordinary income into capital
gains and dividends.
President Trump and the Better Way architects have both indicated
they will introduce measures to curb avoidance. Legislative and
regulatory measures can limit avoidance but will introduce new
problems. Eligibility rules will create new complexity, create
arbitrary distinctions (e.g., between qualifying and nonqualifying
businesses), and increase administrative costs. Enforcement will
require Internal Revenue Service resources and impose new taxpayer
burdens. And despite such efforts, some avoidance will still occur.
Payroll tax avoidance through S corporations, for example, continues to
be an issue today (Burman and Rosenberg 2017).
4. limiting the top tax rate on pass-through business income would
benefit only people with high incomes
Proposals for a maximum tax rate on pass-through business income
would overwhelmingly benefit people with high incomes for two reasons.
First, people with high incomes are much more likely to have business
income. The Tax Policy Center estimates, for example, that the top 1
percent receive more than half of pass-through business income. Second,
maximum rates would help only taxpayers whose income is high enough
that they would otherwise be in a higher tax bracket.
The benefits from a maximum tax rate on pass-through business
income thus skew enormously to people with high incomes. Rohaly,
Rosenberg, and Toder (2017) recently considered several scenarios in
which business income from pass-throughs faces a maximum tax rate of 15
or 25 percent and with narrow and broad definitions of qualifying
income. They estimated the effects of the maximum against a baseline of
a 33-percent top individual tax rate and no alternative minimum tax,
similar to leading Republican proposals. In all four cases, the
benefits of a maximum tax tilt heavily to the high end. In the case
with a 25-percent maximum rate and a broad definition of qualifying
income, for example, they find that 88 percent of the tax savings go to
people in the top 1 percent by income (figure 2).
One way to reduce this inequity would be to introduce a complete
schedule of preferential rates for taxpayers at all income levels. If a
reformed code has individual rates of 35 percent, 25 percent, and 10
percent, for example, the preferential rate schedule for pass-through
business income might be 30 percent, 20 percent, and 5 percent.
Benefits would still skew to people with the highest incomes because
they receive the most business income. But this rate structure would
eliminate the extra skew that comes from a maximum rate. On the other
hand, this approach would greatly amplify concerns about tax avoidance.
A maximum rate invites avoidance by the relatively few taxpayers with
income high enough to benefit. A schedule of preferred rates invites
avoidance by taxpayers at all income levels.
[GRAPHIC] [TIFF OMITTED] T1917.003
5. taxing pass-through business income at the corporate rate
would not achieve tax parity
In a perfect world, businesses would organize as corporations or
pass-throughs based on business and personal considerations. In
practice, taxes often drive those decisions.
Some observers have suggested that taxing pass-through and
corporate income at the same rate would create a level playing field.
The Main Street Tax Fairness Act (H.R. 5076 and S. 707), for example,
would tax pass-through business income at the corporate tax rate. If
the corporate rate fell, the pass-through rate would fall as well.
However, making these rates equal would not achieve parity.
Business income from pass-throughs faces a single layer of tax: each
owner pays individual income taxes on his or her share of business
profits. Corporate income, however, faces two layers of tax: one when
the company pays its taxes and the other when shareholders receive
dividends or realize capital gains. Several factors limit the size of
this second layer of tax. Most dividends and capital gains are taxed at
preferential rates. Capital gains are not taxed until they are
realized. And most corporate stock is held by tax-exempt and tax-
deferred investors (Burman, Clausing, and Austin 2017). But accounting
for all those factors, corporate income still faces higher taxes, on
average, than does pass-through income.
Taxing pass-through business income at the corporate tax rate would
thus not achieve parity. True parity requires that pass-through income
face a higher tax rate than corporate income, that pass-through income
face a second layer of tax, or that shareholder taxes be eliminated.
6. it is extremely difficult to pay for large cuts in business tax
rates by limiting existing business tax breaks and deductions
Tax policy experts have spent much of this decade trying to find
enough payfors to lower the corporate tax rate to 25 or 28 percent, the
rates targeted by Governor Romney and President Obama in the 2012
presidential campaign. In his 2014 proposal, Dave Camp demonstrated
that a 25 percent rate might be technically possible but would require
substantial cuts in existing tax breaks and limits on interest
deductibility. The Tax Policy Center (2017) recently estimated that the
corporate rate could be reduced to 26 percent without losing revenue in
the long run if all corporate tax expenditures were eliminated except
deferral. This would require eliminating such tax benefits as
accelerated depreciation for machinery and equipment, expensing of
investments for small businesses under section 179 of the code,
expensing of research costs, the research credit, and the low-income
housing credit, among others.
Today, some Republican proposals go much further, lowering the
corporate rate to 15 to 20 percent. It is extremely difficult to pay
for such large cuts by limiting business tax breaks and deductions
alone. As TPC and JCT analyses indicate, getting the corporate rate
into the mid-20s may use up all business tax breaks. And there's a
second challenge: deductions lose value as tax rates fall. A deduction
that costs $100 at today's 35 percent rate is worth only $80 at a 28
percent rate and only $43 at a 15 percent rate. The more you cut rates,
the less budget savings you get by rolling back each deduction.
The only way to pay for large rate reductions is to increase other
taxes or introduce new ones. One option is to raise taxes on
shareholders, who get significant benefits from corporate tax
reductions. Eric Toder and Alan Viard (2016) offer one approach, which
would tax shareholder gains at ordinary income tax rates as they accrue
rather than at realization. Another option is to introduce a value-
added tax or a close relative like the destination-based cash flow tax.
A third option is to introduce a carbon tax, which would discourage
emissions of greenhouse gases and accelerate our move to cleaner energy
sources.
7. retroactive tax cuts would not boost growth,
would benefit only shareholders
Some tax policy optimists once hoped reform would happen quickly,
with many changes taking effect on January 1, 2017. With three-quarters
of the year now behind us, some voices still argue for that start date,
especially for any business tax cuts.
Making tax cuts retroactive would do little or nothing to promote
economic growth. Indeed, it could weaken growth since it would leave
less budgetary room to enact other pro-growth reforms. The purpose of
business tax reform is not to put additional cash into the coffers of
profitable businesses. Some slack may remain in our economy, but giving
windfalls to businesses would provide little or no stimulus. Instead,
the goal of business tax reform should instead be to change the
financial incentives businesses face so they invest more and invest
better here at home. Retroactive tax cuts fail to do that.
The benefits of retroactive tax cuts would go solely to
shareholders, not to workers. A retroactive tax cut would thus be more
regressive than forward-looking cuts in corporate tax rates or more
favorable investment write-offs. The Tax Policy Center estimates that
76 percent of the benefits of a retroactive cut in corporate taxes
would go to people in the top fifth of the income distribution
(compared with 70 percent for forward-looking rate reductions and 62
percent for faster write-offs) and 40 percent to the top 1 percent
(compared with 34 percent and 24 percent, respectively).
As 2017 draws to a close, lawmakers should focus on business tax
reforms in 2018 and beyond.\1\
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\1\ One possible exception are the temporary tax provisions that
expired at the end of last year but are widely expected to be extended.
For my general views on these ``tax extenders,'' see Marron (2012).
Thank you again for inviting me to appear today. I look forward to
---------------------------------------------------------------------------
your questions.
References
Burman, Leonard E., Kimberly A. Clausing, and Lydia Austin, 2017. ``Is
U.S. Corporate Income Double-Taxed?'' National Tax Journal 70 (3):
675-706.
Burman, Len, and Joe Rosenberg, 2017. ``Preferential Pass-Through
Business Tax Rates and Tax Avoidance.'' Washington, DC: Urban-
Brookings Tax Policy Center.
DeBacker, Jason Matthew, Bradley Heim, Shanthi Ramnath, and Justin M.
Ross, 2016. ``The Impact of State Taxes on Pass-Through Businesses:
Evidence From the 2012 Kansas Income Tax Reform.'' Available
through SSRN.
Huang, Chye-Ching, and Brandon Debot, 2017. ``Corporate Tax Cuts Skew
to Shareholders and CEOs, not Workers as Administration Claims.''
Washington, DC: Center on Budget and Policy Priorities.
Joint Committee on Taxation, 2014. ``Macroeconomic Analysis of the Tax
Reform Act of 2014.'' Washington, DC: Joint Committee on Taxation.
Looney, Adam, and Aaron Krupkin, 2017. ``Nine Facts About Pass-Through
Businesses.'' Washington, DC: Urban-Brookings Tax Policy Center.
Marron, Donald, 2012. ``The `Tax Expirers.' '' Testimony before the
Subcommittee on Select Revenue Measures of the Committee on Ways
and Means, U.S. House of Representatives, June 8th.
Nunns, Jim, 2012. ``How TPC Distributes the Corporate Income Tax.''
Washington, DC: Urban-Brookings Tax Policy Center.
Prisinzano, Richard, Jason DeBacker, John Kitchen, Matthew Knittel,
Susan Nelson, and James Pearce, 2016. ``Methodology to Identify
Small Business.'' Washington, DC: U.S. Department of the Treasury.
Rohaly, Jeffrey, Joseph Rosenberg, and Eric Toder, 2017. ``Options to
Reduce the Taxation of Pass-through Income.'' Washington, DC:
Urban-Brookings Tax Policy Center.
Tax Policy Center Staff, 2017. ``The Tax Reform Tradeoff: Eliminating
Tax Expenditures, Reducing Rates.'' Washington, DC: Urban-Brookings
Tax Policy Center.
Toder, Eric, and Alan Viard, 2016. ``Replacing Corporate Revenues with
a Mark-to-Market Tax on Shareholder Income.'' Washington, DC:
Urban-Brookings Tax Policy Center.
______
Questions Submitted for the Record to Donald B. Marron
Questions Submitted by Hon. Orrin G. Hatch
Question. Dr. Marron, I was particularly interested in your
testimony regarding the incidence of the corporate income tax and your
comment that ``the benefits of cutting corporate income taxes thus go
predominantly to people with high incomes.'' What I didn't find in your
testimony is whether you believe it is nevertheless appropriate to
reduce the statutory corporate income tax rate in tax reform,
especially given that the U.S. corporate rate is regarded by almost
everyone as globally uncompetitive. Would you please provide us your
thoughts on that? I'm very curious to hear if your views are in line
with the views of both former President Obama and President Trump on
this issue.
Answer. Yes, I believe we should cut the statutory corporate tax
rate. Our current system features an especially high statutory rate and
numerous tax breaks. Tax considerations thus loom large--too large in
my view--in corporate decision-making. Lowering the corporate rate and
repealing many tax breaks would create a simpler, fairer, more
competitive tax system.
Question. Dr. Marron, you identify in your testimony that growth
effects in the near-term from tax reform may be modest, at least in the
typical 10-year budget window used by congressional scorers. Growth had
been stuck at a sluggish 2 percent or so, on average, during the
previous administration, and some view continued sluggishness as some
sort of destiny because of demographics and the like. However, even a
quarter or half a percent sustained increase in economic growth would
yield tremendous dividends, including dividends to middle-class
Americans. Dr. Marron, I wonder if you agree that even a quarter or
half a percent sustained increase in growth would be meaningful to
Americans over the next 10 years, and whether the benefits would
continue after that.
Answer. The impacts of faster economic growth depend on how much
growth accelerates, why it accelerates, and how the gains from growth
are shared in society. If tax reform somehow lifts productivity growth
by a quarter of a percent annually over the next decade and if those
gains are broadly shared, then many Americans would see significant
benefits. (If the growth came from increased labor supply, the benefits
of increased economic activity would have to be weighed against the
opportunity cost of shifting people's time from other activities.)
For example, consider a family with $50,000 of income in 2017.
Today their income might be expected to grow about 2 percent annually,
reaching $61,000 in 2027. If it grew at 2.25 percent instead, their
income would be $62,500 in 2027. That $1,500 gain is a real benefit.
Note, however, that their gain would be only $125 in the first year
of higher growth and only $500 in 2021. The benefits of faster growth
take time to accumulate.
This example considers a scenario in which tax reform would lift
productivity growth by 0.25 percentage points in each of the next 10
years, raising the level of economic activity by about 2.5 percent in
2027. That would be a tremendous accomplishment, far beyond what I
would expect from the Framework or related proposals.
Question. Dr. Marron, you seem to put forward a Gordian knot in
your testimony regarding pass-through businesses. On the one hand,
lowering rates for pass-throughs would, as you suggest, create new
opportunities for tax avoidance. On the other hand, you seem to
indicate that attending to the issue by attempting to put up guardrails
to deal with those opportunities for avoidance could impose new
complexities, create arbitrary distinctions, and impose new
administrative burdens. Dr. Marron, does that mean that nothing can be
done to lower taxes on pass-throughs?
Answer. It is a mistake to think of recent proposals as trying to
lower taxes on pass-through businesses. Instead, they are proposals to
lower taxes on a select group of pass-through businesses.
The Framework proposal, for example, would create a 25-percent
maximum tax rate on pass-through income. This would do nothing to
reduce taxes for the vast majority of pass-through entities whose
income is already taxed at 25 percent or less.
Lawmakers understandably want to limit the benefits of the special
rate even further. To do so requires some way of distinguishing pass-
through income that ``deserves'' a lower rate from pass-through income
that doesn't. As I said in my testimony, any effort to do will impose
new complexities, create arbitrary distinctions, impose new
administrative burdens, and invite gaming by high-income taxpayers.
Congress can try to limit those problems with simple, broad-brush rules
such as allowing the lower rate for only 30 percent of pass-through
income. By itself, however, that does nothing to focus the benefit on
``deserving'' businesses or to discourage game playing.
Question. Dr. Marron, in testimony before a House Committee in
2014, you identified IRS research that estimated that corporations and
partnerships spent more than $100 billion complying with the Federal
income tax code for tax year 2009. Furthermore, you identified that
small businesses bear the majority of those costs, with, at the time,
$66 billion borne by businesses with less than $1 million in revenue
and $91 billion for businesses with less than $10 million in revenue.
Given such high costs of compliance, which largely fall on smaller
businesses, do you believe that tax reform that simplifies the tax
system for businesses could meaningfully reduce those compliance costs,
especially for smaller businesses?
Answer. Reducing compliance burdens on responsible small businesses
should be a priority for reform. Increasing section 179 expensing and
expanding eligibility for cash accounting are two ways to do so.
Question. Dr. Marron, you favor expensing and believe it should be
a higher priority for Congress than a reduction of the corporate tax
rate. I understand one of the main arguments for such prioritization is
that a corporate tax rate cut, while incentivizing new investment is,
in large part, a windfall to old capital. That is, a corporate rate cut
gives a benefit to income that would have been generated anyway.
Expensing, on the other hand, only gives a tax benefit to new
investments, so wouldn't be granting windfall benefits. Am I stating
that argument correctly?
Answer. As you say, one concern about cutting the corporate tax
rate is that companies would pay lower taxes on profits that result
from decisions and investments they have already made. That's a pure
windfall to the companies. Another concern is that companies would pay
lower taxes in the future on what economists call their super-normal
returns, i.e., the profits they make in excess of their cost of
capital. Expensing avoids both of these problems. It applies only to
new investments, not past ones. And it applies only to the normal
profits from investing, not the super-normal profits.
Question. But I also want to ask, couldn't expensing also result in
a windfall benefit? That is, if a business was going to invest $100
million, say, in capital equipment under the Alternative Depreciation
System (ADS), then to allow the $100 million to all be deducted in the
first year of such investment, to allow it to be expensed, wouldn't
that be giving a tax benefit for activity that would have happened
anyway? Shouldn't that be considered a windfall benefit?
Answer. I would draw a distinction here between a windfall benefit
and what economists call an inframarginal benefit. Cutting the
corporate tax rate creates a windfall for companies that have made
profitable investments in the past. Expensing doesn't have that
problem. But both expensing and lowering the corporate rate raise the
issue you mention--some of the benefit would accrue on investments that
businesses would have made in the United States anyway. Lowering taxes
on these inframarginal investments does nothing to incentivize new
investment.
Question. Finally, would one way to address this problem be to
allow full expensing for capital expensing that exceeds some base
account, similar to how is done with the R&D credit? (With the R&D
credit the point of that is that the R&D credit is targeted on research
that would not have happened anyway, that would not have happened but
for the credit.) Perhaps this could be a way to get most of the same
growth effect from expensing, but while limiting the revenue costs.
Answer. This approach makes some sense conceptually, but would be
difficult to implement in practice. The dividing line between marginal
and inframarginal investments changes constantly as economic conditions
evolve and as individual businesses gain and lose market share.
Question. Mr. Marron, you write that if tax reform loses revenue,
the resulting deficits may crowd out private investment. Could you
please explain that more?
Answer. If tax reform loses revenue, the Federal Government has
five options for making up the difference. It could raise future taxes,
reduce future spending, sell public assets, print more money, or
borrow. In my testimony, I focused on the scenario with more borrowing.
In that case, the borrowed resources must come from some combination of
increased private saving, reduced private investment, and capital
inflows from abroad. Based on research by the Congressional Budget
Office and others, I expect that a material amount of the resources
will come from reduced private investment. That ``crowding out'' will
reduce the future capital stock and reduce the economic gains from tax
reform.
Question. Dr. Marron, you seem to think that a move towards
expensing would be more helpful to the economy than would a corporate
rate cut. But I will tell you that many corporations I hear from seem
to prefer the corporate rate cut. Why do you think that is? How much of
that has to do with financial accounting--and if so, how much should
policymakers take that into account?
Answer. Several factors are at play here. First, the magnitude of
the potential tax cuts differs. Corporations would get a bigger benefit
from a large cut in the corporate rate than from a move to full
expensing. Second, as you note, some corporations may prefer the
financial accounting implications of a corporate tax cut (although
companies with unused net operating losses may dislike it). I do not
think policymakers should give these concerns much weight. Responsible
management should focus on the economic value they create, not how it
may appear in financial statements. That said, there is some evidence
that financial accounting for taxes does influence corporate decisions
and, in particular, that a focus on financial accounting can weaken the
investment incentives from full expensing.
Question. Dr. Marron, if investment in capital assets were allowed
to be expensed, should there be exceptions to this for LIFO? For land?
For real estate improvements?
Answer. In principle, a consumption-based tax system would allow
expensing for all assets, whether equipment, structures, inventory, or
land. Such a system would also forbid tax deductions for interest
payments from any debt financing these investments.
In practice, lawmakers may want to focus consumption tax treatment
on assets that are most sensitive to taxes, while maintaining income
tax treatment for assets that are less sensitive. Land is an obvious
candidate, since taxes have little effect on the amount of land
available for productive use.
______
Questions Submitted by Hon. Ron Wyden
Question. Dr. Marron, there is no question that tax reform needs to
make American businesses more competitive. But one of the central
questions of this hearing is who primarily benefits from corporate rate
cuts.
Treasury, CBO, JCT, and the Tax Policy Center all find that roughly
three-
quarters of the benefit from a corporate rate cut would benefit
shareholders and owners of capital--most of whom are wealthy. I know
the Tax Policy Center has gone even further and looked at the benefits
by income category.
Can you tell the committee how much of a windfall the wealthiest 1
percent would receive from a corporate rate cut?
Rather than looking at the economic consensus by CBO, JCT,
Treasury, and TPC, some on this committee choose to cherry-pick one-off
studies from economists outside the mainstream who agree with their
political views.
I assume the Tax Policy Center didn't just pull their figures out
of thin air. Could you explain how TPC arrived at its estimates, and
how they differ from those studies that are outside of the mainstream?
Answer. The Tax Policy Center estimates that 34 percent of the
benefit from cutting the corporate tax rate would go to households in
the top 1 percent of the income distribution.
The Tax Policy Center estimates that, in the long run, 20 percent
of the corporate income tax burden falls on workers, 60 percent on
corporate shareholders, and 20 percent on all capital investors
overall. Senior fellow Jim Nunns explains the evidence underlying those
estimates in ``How TPC Distributes the Corporate Income Tax.'' He
reviewed the extensive theoretical and empirical literature on the
incidence of corporate income taxes.
Studies that find that most of the corporate burden falls on
workers differ from the mainstream in three main ways. First, those
studies often assume that the United States is a small, open economy.
Under that assumption, capital moves quickly and easily in response to
tax changes, shifting most or all the burden to domestic workers. In
reality, the United States is a very large economy, so some of the
burden will be borne by domestic capital. Second, those studies often
focus on the normal returns to investment, but ignore super-normal
returns, i.e., profits in excess of a normal rate of return. Taxes on
normal returns are much more likely to fall on workers than are taxes
on super-normal returns. Third, some of those studies try to estimate
the incidence of the corporate income tax by comparing wages and taxes
in different countries over time. Unfortunately, it is difficult to
control for all relevant factors in doing those comparisons, resulting
in some studies with implausible estimates of the burden on workers.
Question. Dr. Marron, earlier this year the Tax Policy Center
estimated the economic impact of the House Republican tax plan. It
found that the plan would cost more than $3.5 trillion over the first
10 years and as much as $9 trillion by the end of the second decade.
The study also found that this massive debt-finance tax cut would
begin dragging down the economy within the first 10 years and would
shrink the economy by more than 2.5 percent by the end of the second
decade.
Please explain to the committee the risks debt-financed tax cuts
pose to the economy.
Answer. Tax reforms that encourage new, productive private
investment and expand the labor supply can boost our economy.
Additional deficits, however, can offset those gains. With our economy
near full employment, deficits will either crowd out some private
investment, attract investment from abroad (thus directing some
economic gains to overseas investors), or a combination of both. Debt-
financed tax cuts thus create a race between the potential economic
gains from tax reductions and the economic losses from higher deficits.
In practice, the conventional economic models used by CBO, JCT, and TPC
find that the deficit effects eventually win. Debt-financed tax cuts
thus undermine long-run economic growth.
______
Questions Submitted by Hon. Bill Nelson
Question. If you can, please provide some suggestions on how the
President could achieve some of his stated objectives for business tax
reform--including (1) reducing complexity in the tax code and hours
spent on tax-related paperwork and (2) sustaining 3-percent economic
growth or higher.
Answer. Small businesses bear a disproportionate share of the
compliance burden from our tax system. Expanding section 179 expensing
and cash accounting could ease the burden somewhat for these
businesses. Lawmakers should also ensure that changes to the code, such
as special treatment for pass-throughs, not create new complexities and
compliance burdens.
We've enjoyed two consecutive quarters of 3 percent economic
growth. But achieving persistent 3-percent growth over the next decade
is unlikely, even with pro-growth reforms. Pro-growth reforms include
reducing the corporate tax rate, allowing full expensing of new
investments (especially for smaller businesses), reducing the mortgage
interest deduction (which directs too much domestic capital into
single-family homes), expanding the Earned Income Tax Credit (which
brings more people into the workforce), and limiting the extent to
which tax changes increase long-term deficits.
Question. Do you believe Congress should consider cutting
entitlement and safety net programs--like Social Security, Medicare,
TANF, and food stamps--to pay for tax reform? If so, why? If not, why
not?
Answer. No, I do not. There is no need for a major tax cut. The
economy has largely recovered from the financial crisis, and revenues
are near historical averages relative to the size of the economy.
Looking ahead, the fiscal pressures of our aging population and rising
health-care costs will likely require significant fiscal adjustments,
reducing the growth of spending and raising the trajectory of revenues.
Given that context, there is no sense is cutting entitlement programs
to pay for tax cuts today.
Question. President Trump has said he wants to lower the top
business tax to 15 percent. Do you believe this can be done without
significantly adding to the deficit? If so, please provide a potential
scenario for deficit-neutral tax reform in detail (with budget
estimates).
Answer. I do not see any politically acceptable way to reduce the
top business tax rate to 15 percent. Making up the lost revenue will
simply be too challenging. That said, my colleagues at the Tax Policy
Center have explored several ways to make a 15-percent rate work. These
include:
Jim Nunns, ``Neutral Tax Reform with 15-Percent Business Income
Tax Rate,'' which applies a 15-percent tax rate to corporations and
pass-throughs.
Eric Toder and Alan Viard, ``Replacing Corporate Revenues with a
Mark-to-
Market Tax on Shareholder Income,'' which lowers the corporate rate to
15 percent and makes up revenue by taxing shareholders.
Donald Marron and Eric Toder, ``Carbon Taxes and Corporate Tax
Reform,'' which explores how revenue from a carbon tax could help pay
for lowering the corporate tax rate (this analysis considers corporate
tax rates in the 20s, but a larger carbon tax could help get the rate
to 15 percent).
Question. Please provide any suggestions you have for how to reform
the tax code for businesses without increasing income inequality.
Answer. One way to limit the degree to which business tax reform
increases income inequality is to focus on revenue neutral policy
changes. For example, policymakers could allow full expensing of new
business investment and pay for it by rolling back other tax breaks or
by limiting interest deductibility. Designed well, such revenue neutral
reforms can encourage new investment--helping workers throughout the
income distribution--without providing a net tax cut to business
owners, who tend to have higher incomes.
Another approach is to pair business tax reductions with expanded
credits in the individual income tax. For example, reductions in the
corporate income tax rate could be combined with an expanded Child Tax
Credit, an expanded Earned Income Tax Credit, or a new family credit to
ensure that benefits flow to people throughout the income distribution.
The overall distributional effect will depend, however, on how those
tax reductions are ultimately paid for.
______
Prepared Statement of Hon. Ron Wyden,
a U.S. Senator From Oregon
Before I get to the substance of today's hearing, I need to address
what's coming down the pike in this committee and on the Senate floor.
And nothing I'm about to say should take away from our friendship, Mr.
Chairman, or the fact that we've been able to get some important work
done over the last several weeks, particularly with respect to CHIP.
Last night the majority announced, without consulting the minority,
that on Monday the Finance Committee will hold a hearing on the Graham-
Cassidy-Heller health-care proposal. I want to make clear that this is
an abomination. It's an abomination of the process, it's an abomination
of the substance, and it's an abomination of the history of this
storied committee. First of all, this bill is a prescription for
suffering and disastrous consequences for millions of Americans.
Second, the CBO has informed the Congress that it'll be several weeks
at the very least before it can provide full estimates for the bill. So
this means the majority will be charging ahead with a radical,
destructive transformation of our health-care system with the American
people still in the dark. This bill's going to be a few roll call votes
away from the President's desk and Republicans will not have answers to
the basic threshold questions: What will happen to premiums? What will
happen to coverage?
The idea that a bill this destructive and far-reaching can swing
through the Finance Committee for a single hearing on a Monday morning
and hit the Senate floor a day or two later makes a mockery of the
legislative process Senator McCain urged us to return to.
Furthermore, this abomination of a process stands in stark contrast
to what this committee has been able to achieve with respect to the
Children's Health Insurance Program. But unfortunately, just when this
committee ought to be celebrating a big victory for the millions of
kids who count on CHIP, the Graham-Cassidy-Heller proposal threatens
the health care of millions of children and families.
Second point: the reconciliation process relies on secrecy, speed,
and brute force to ram partisan bills through the Senate, and it's been
an absolute trainwreck on health care. But Leader McConnell is
committed to Reconciliation Round Two on tax reform. And that means
another secretive, partisan bill coming together behind closed doors--
which leads me to a few points on the substance of today's hearing.
The details leaking out of the ``Big Six'' meetings paint a clear
picture of an unprecedented tax giveaway for the most fortunate and
biggest corporations. The centerpiece could very well be a $2-trillion
loophole having to do with what's called pass-through status.
Pass-through status is supposed to be about helping small
businesses, and there's no question that small businesses--who fuel
local economies and hire the most workers--need a boost in tax reform.
But any tax change that allows tax cheats to abuse pass-through status
by ``self-declaring'' to avoid paying their fair share and dodge Social
Security taxes would be worse than what's on the books today. The day
the pass-through loophole becomes law would be Christmas morning for
tax cheats. It would make a mockery of the Trump pledge that, quote,
``the rich will not be gaining at all with this plan.'' And that's just
one element of what's on offer.
Bottom line, it's time for the Congress to take the lies out of the
corporate tax rate in America. Many of the biggest corporations in the
country employ armies of lawyers and accountants who know all the tax
tricks. They winnow their tax rates down to the low teens, single
digits, even zero. So the Congress cannot pair a big corporate rate cut
with a plan to enshrine a vast array of loopholes that let corporations
off the hook for paying their fair share. That's a surefire way of
heaping a heavier burden onto the middle class.
I hope the committee is able to take a close look at those issues
today. As I mentioned, I'll be in and out this morning as I have an
engagement with the Commerce Committee, but I look forward to returning
for questions as soon as I'm able.
Thank you, Chairman Hatch.
______
Communications
----------
A Call To Invest in Our Neighborhoods (ACTION) Campaign
10 G Street, NE, Suite 580
Washington, DC 20002
202-842-9190
www.EnterpriseCommunity.com
The A Call To Invest in Our Neighborhoods (ACTION) Campaign is a
national coalition representing over 2,000 national, state, and local
organizations and businesses advocating to preserve, strengthen, and
expand the Low-Income Housing Tax Credit (Housing Credit). We thank
Chairman Orrin Hatch and the Committee for holding this critically
important hearing, and we appreciate the opportunity to provide
feedback on business tax reform.
We are especially grateful for Finance Committee Chairman Hatch's and
Committee member Senator Maria Cantwell's leadership in championing
legislation to expand and strengthen the Housing Credit, our nation's
primary tool for encouraging private investment in affordable rental
housing. We strongly urge the Committee to advance this critical bill,
the Affordable Housing Credit Improvement Act of 2017 (S. 548) this
year, and protect both the Credit and multifamily Housing Bonds--a
central component of the Housing Credit program--as part of any tax
reform effort considered by Congress.
The Housing Credit is a Critical Part of Our Corporate Tax System
The use of the tax code to provide affordable rental housing through
the Housing Credit and multifamily Housing Bonds has been one of the
most important successes of the current business tax system. President
Reagan and the Congress showed remarkable foresight when they created
the Housing Credit as part of the Tax Reform Act of 1986. The Housing
Credit is now our nation's most successful tool for encouraging private
investment in the production and preservation of affordable rental
housing, with a proven track record of creating jobs and stimulating
local economies. For over 30 years, the Housing Credit has been a model
public-
private partnership program, bringing to bear private sector resources,
market forces, and state-level administration to finance more than 3
million affordable apartments--nearly one-third of the entire U.S.
inventory--giving more than 7 million households, including low-income
families, seniors, veterans, and people with disabilities, access to
homes they can afford. Roughly 40 percent of these homes were financed
in conjunction with multifamily Housing Bonds, which are an essential
component of the program's success.
The Housing Credit differs from many other corporate tax expenditures,
which subsidize activity that still may occur without a tax benefit. In
contrast, virtually no affordable rental housing development would
occur without the Housing Credit. It simply costs too much to build
rental housing to rent it at a level that low-income households can
afford. In order to develop new apartments that are affordable to
renters earning the full-time minimum wage, construction costs would
have to be 72 percent lower than the current average.
Jeffrey D. DeBoer, President and CEO at the Real Estate Roundtable, who
testified before the Committee as part of this hearing, recognized the
Housing Credit's special standing within the corporate tax system.
DeBoer's written testimony notes that the Housing Credit is an example
of a tax incentive that is ``needed to address market failures and
encourage capital to flow to socially desirable projects.''
Also, unlike most other corporate tax expenditures, substantially all
of the net benefits of the Housing Credit go to low-income families,
not corporations. This is because the Housing Credit is a purchased tax
benefit, and corporations must pay in advance for the credit they
receive. While corporations are the intermediaries who claim the
credits in order to deliver private resources to affordable rental
housing to low-income populations, it is the low-income families who
live in these homes that the credit ultimately serves.
The Housing Credit is a Proven Solution to Meet a Vast and Growing Need
Despite the Housing Credit's tremendous impact, there are still 11.1
million renter households--roughly one out of every four--who spend
more than half of their income on rent, leaving too little for other
necessary expenses like transportation, food, and medical bills. This
crisis is continuing to grow. HUD reports that as of 2015, the number
of households with ``worst case housing needs'' had increased by 38.7
percent over 2007 levels, when the recession began, and by 63.4 percent
since 2001. A study by Harvard University's Joint Center for Housing
Studies and Enterprise Community Partners estimates that the number of
renter households who pay more than half of their income towards rent
could grow to nearly 15 million by 2025.
The Housing Credit transforms lives by providing quality, affordable
homes to people in need. It plays a critical role in financing housing
for families, seniors, persons with disabilities, veterans, and more.
The Housing Credit is also central to the revitalization of Public
Housing through HUD's Rental Assistance Demonstration (RAD). Since RAD
was established in 2012, the Housing Credit has leveraged nearly $1.7
billion to help recapitalize almost 28,000 homes.
The Housing Credit Creates Jobs
Housing Credit development supports jobs--roughly 1,130 for every 1,000
Housing Credit apartments developed, according to the National
Association of Home Builders (NAHB). This amounts to roughly 96,000
jobs per year, and more than 3.4 million since the program was created
in 1986. NAHB estimates that about half of the jobs created from new
housing development are in construction. Additional job creation occurs
across a diverse range of industries, including the manufacturing of
lighting and heating equipment, lumber, concrete, and other products,
as well as jobs in transportation, engineering, law, and real estate.
The Housing Credit Stimulates Local Economies and Improves Communities
The Housing Credit has a profound and positive impact on local
economies. NAHB estimates that the Housing Credit adds $9.1 billion in
income to the economy and generates approximately $3.5 billion in
federal, state, and local taxes each year.
Conversely, a lack of affordable housing negatively impacts economies.
Research shows that high rent burdens have priced out many workers from
the most productive cities, resulting in 13.5 percent foregone GDP
growth, a loss of roughly $1.95 trillion, between 1964 and 2009.
Housing Credit development also positively impacts neighborhoods in
need of renewal. About one-third of Housing Credit properties help
revitalize distressed communities. Stanford University research shows
Housing Credit investments improve property values and reduce poverty,
crime, and racial and economic isolation, generating a variety of
socio-economic opportunities for Housing Credit tenants and
neighborhood residents.
Affordable Housing Improves Low-Income Households' Financial Stability
Affordable housing promotes financial stability and economic mobility.
It leads to better health outcomes, improves children's school
performance, and helps low-
income individuals gain employment and keep their jobs. Affordable
housing located near transportation and areas with employment
opportunities provides low-income households with better access to
work, which increases their financial stability and provides employers
in those areas with needed labor.
Families living in affordable homes have more discretionary income than
low-income families who are unable to access affordable housing. This
allows them to allocate more money to other needs, such as health care
and food, and gives them the ability to pay down debt, access
childcare, and save for education, a home down payment, retirement, or
unexpected needs.
The Housing Credit is a Model Public-Private Partnership
The Housing Credit is structured so that private sector investors
provide upfront equity capital in exchange for a credit against their
tax liability over 10 years, which only vests once the property is
constructed and occupied by eligible households paying restricted
rents. This unique, market-based design transfers the risk from the
taxpayer to the private sector investor. In the rare event that a
property falls out of compliance during the first 15 years after it is
placed in service, the Internal Revenue Service can recapture tax
credits from the investor. Therefore, it is in the interest of the
private sector investors to ensure that properties adhere to all
program rules, including affordability restrictions and high-quality
standards--adding a unique accountability structure to the program.
The Housing Credit is State Administered With Limited Federal
Bureaucracy
The Housing Credit requires only limited federal bureaucracy because
Congress wisely delegated its administration and decision-making
authority to state government as part of its design. State Housing
Finance Agencies, which administer the Housing Credit in nearly every
state, have statewide perspective; a deep understanding of the needs of
their local markets; and sophisticated finance, underwriting, and
compliance capacity. States develop a system of incentives as part of
their Qualified Allocation Plans (QAP), which drives housing
development decisions, including property siting, the populations
served, and the services offered to residents. States are also deeply
involved in monitoring Housing Credit properties, including compliance
audits and reviews of financial records, rent rolls, and physical
conditions.
The Demand for Housing Credits Exceeds the Supply
Viable and sorely needed Housing Credit developments are turned down
each year because the cap on Housing Credit authority is far too low to
support the demand. In 2014--the most recent year for which data is
available--state Housing Credit allocating agencies received
applications requesting more than twice their available Housing Credit
authority. Many more potential applications for worthy developments are
not submitted in light of the intense competition, constrained only by
the lack of resources.
The scarcity of Housing Credit resources forces state allocating
agencies to make difficult trade-offs between directing their extremely
limited Housing Credit resources to preservation or new construction,
to rural or urban areas, to neighborhood revitalization or developments
in high opportunity areas, or to housing for the homeless, the elderly,
or veterans. There simply is not enough Housing Credit authority to
fund all of the properties needed, but with a substantial increase in
resources, many more of these priorities would be addressed--and the
benefits for communities would be even greater.
Though the need for Housing Credit-financed housing has long vastly
exceeded its supply, Congress has not increased Housing Credit
authority permanently in 16 years.
We Urge Congress to Expand and Strengthen the Housing Credit
To meaningfully grow our economy and address our nation's growing
affordable housing needs through tax reform, we urge Congress to
increase the cap on Housing Credit authority by 50 percent. Such an
expansion would support the preservation and construction of up to
400,000 additional affordable apartments over a 10-year period. We also
call on Congress to retain the tax exemption on multifamily Housing
Bonds, which are essential to Housing Credit production.
S. 548, which would authorize such an expansion, has earned strong
bipartisan support in the Senate and among Senate Finance Committee
members.
This legislation would increase Housing Credit allocation authority by
50 percent phased in over 5 years, and enact roughly two dozen changes
to strengthen the program by streamlining program rules, improving
flexibility, and enabling the program to serve a wider array of local
needs. For example, S. 548 would encourage Housing Credit development
in rural and Native communities, where it is currently more difficult
to make affordable housing developments financially feasible; Housing
Credit developments that serve the lowest-income tenants, including
veterans and the chronically homeless; the development of mixed-income
properties; the preservation of existing affordable housing; and
development in high-opportunity areas. The legislation would also
generate a host of benefits for local communities, including raising
local tax revenue and creating jobs.
We also encourage Congress to make adjustments to the Housing Credit
necessary to offset the impact that a lower corporate tax rate would
have on Housing Credit investment. Senator Cantwell raised this
important point during the hearing, when she noted that just the
prospect of a lower corporate tax rate over the last year has resulted
in lower pricing of Housing Credits by investors. This has impacted
production at a time when our nation's shortage of affordable housing
is vast and growing. However, Congress could negate the negative impact
on the Housing Credit created by a lower corporate tax rate by making
adjustments to the Housing Credit program's discount rate. Members of
ACTION stand ready to help the Committee make these modifications to
the program, which are outside the scope of S. 548, and ensure that
affordable housing production continues at a robust level regardless of
other changes made in tax reform.
An investment in the Housing Credit is an investment in individuals,
local communities, and the economy. It transforms the lives of millions
of Americans, many of whom are able to afford their homes for the first
time--and it transforms their communities and local economies. The
ACTION Campaign applauds the leadership the Senate Finance Committee
has shown in support of the Housing Credit to date and urges the
Committee to expand and strengthen the Housing Credit and multifamily
Housing Bonds.
ACTION Campaign Co-Chairs
National Council of State Housing Agencies
Enterprise Community Partners
ACTION Campaign Steering Committee Members
Affordable Housing Tax Credit Coalition
Council for Affordable and Rural Housing
Council of Large Public Housing Authorities
CSH
Housing Advisory Group
Housing Partnership Network
LeadingAge
Local Initiatives Support Corporation/National Equity Fund
Make Room
National Association of Affordable Housing Lenders
National Association of Home Builders
National Association of Housing and Redevelopment Officials
National Association of Realtors
National Association of State and Local Equity Funds
National Housing and Rehabilitation Association
National Housing Conference
National Housing Trust
National Low Income Housing Coalition
National Multifamily Housing Council
Stewards of Affordable Housing for the Future
Volunteers of America
For a full list of ACTION Campaign members, visit
www.rentalhousingaction.org.
______
American Farm Bureau Federation
600 Maryland Avenue, SW, Suite 1000W
Washington, DC 20024
p. 202-406-3600
t. 202-406-3606
www.fb.org
The American Farm Bureau Federation is the country's largest general
farm organization, with nearly 6 million member families and
representing nearly every type of crop and livestock production across
all 50 states and Puerto Rico. Our members grow and produce the food,
fiber, and fuel that propel our nation's economy as well as putting
food on our tables. According to USDA, 11 percent of U.S. employment
comes from the agriculture and food industry, accounting for 21 million
jobs of which about 18 million are off-the-farm positions.
Federal tax policy affects the economic behavior and well-being of farm
households as well as the management and profitability of farm and
ranch businesses. Farm Bureau supports replacing the current federal
income tax with a fair and equitable tax system that encourages
success, savings, investment, and entrepreneurship.
Farms and ranches operate 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
that impact agricultural producers. They want a tax code that doesn't
make the challenging task of running a farm or ranch business more
difficult than it already is.
Farm Bureau supports tax laws that help the family farms and ranches
that grow America's food and fiber, often for rates of return that are
modest compared to other business. What is needed is tax reform that
supports high-risk, high-input, capital-intensive businesses like farms
and ranches that predominantly operate as sole proprietors and pass-
through entities. We believe that tax reform should be equitable and
designed to encourage private initiative and domestic economic growth.
Farm Bureau commends the Committee on Finance for holding a hearing on
business tax reform. The statement that follows focuses on and provides
additional commentary on the tax reform issues most important to
farmers and ranchers.
COMPREHENSIVE TAX REFORM WILL BOOST FARM
AND RANCH BUSINESSES
Any tax reform proposal considered by Congress must be comprehensive
and include individual as well as corporate reform and rate reduction.
By far, the most common form of farm ownership is as a sole-proprietor.
In total, farms and ranches operated as individuals, partners and S
corporation shareholders constitute about 94 percent of our nation's 2
million farms and ranches and about 85 percent of total agricultural
production. Because many business deductions and credits are used by
both corporate and pass-through businesses, their elimination without
substantial rate reduction for all business entities could result in a
tax increase for the vast majority of farmers and ranchers.
LOWER EFFECTIVE TAX RATES WILL BENEFIT FARM
AND RANCH BUSINESSES
Farm Bureau supports reducing effective tax rates and views this as the
most important goal of tax reform. Tax reform that lowers rates by
expanding the base should not increase the overall tax burden (combined
income and self-employment taxes) 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 business entities and for all rate brackets could result in a tax
increase for agriculture.
Farming and ranching is a cyclical business. A period of prosperity can
be followed by one or more years of low prices, poor yields or even a
weather disaster. Without the opportunity to even out income over time,
farmers and ranchers will pay more than comparable non-cyclical
businesses. Tax code provisions like income averaging allow farmers and
ranchers to pay taxes at an effective rate equivalent to a business
with the same aggregate, but steady revenue stream. Farm savings
accounts would accomplish the same objective plus allow a farmer or
rancher to reserve income in a dedicated savings account for withdrawal
during a poor financial year. Installment sales of land benefit both
buyers and sellers by providing sellers with an even income flow and
buyers with the ability to make payments over time.
ACCELERATED COST RECOVERY HELPS FARMERS REMAIN EFFICIENT
Farmers and ranchers need to be able to match income with expenses in
order to manage their businesses through challenging financial times.
Expensing allows farm and ranch businesses to recover the cost of
business investments in the year a purchase is made. In addition to
Section 179 small business expensing, the tax code also provides
immediate cost recovery through bonus depreciation and through long-
standing provisions that allow for the expensing of soil and water
conservation expenditures, expensing of the costs of raising dairy and
breeding cattle and for the cost of fertilizer and soil conditioners
such as lime. Farm Bureau supports the expansion of immediate
expensing.
Because production agriculture has high input costs, Farm Bureau places
a high value on the immediate write-off of all equipment, production
supplies and pre-
productive costs. While Section 179 does provide full expensing for
most small and mid-size farms, USDA reports that almost a quarter of
the large farms that account for nearly half of all agricultural
production made investments exceeding the expensing limit in 2015.
Thus, an expansion of immediate expensing has the potential to change
the investment behavior of farms responsible for a significant amount
of agriculture production.
When farmers are not allowed immediate expensing they must capitalize
purchases and deduct the expense over the life of the property.
Accelerated deductions reduce taxes in the purchase year, providing
readily available funds for upgrading equipment, to replace livestock,
to buy production supplies for the next season and for farmers to
expand their businesses. This is not only a benefit to production
agriculture; a study in the journal Agricultural Finance Review found
that for every $1,000 increase to the Section 179 expensing amount,
farms that had been previously limited by the expensing amount made an
incremental capital investment of between $320 and $1,110.
CASH ACCOUNTING HELPS FARM AND RANCH BUSINESSES
TO CASH FLOW
Cash accounting is the preferred method of accounting for farmers and
ranchers because it allows them to match income with expenses and aids
in tax planning. Farm Bureau supports the continuation of cash
accounting.
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 provides the flexibility farmers need to plan for major
business investments and in many cases provides guaranteed availability
of some agricultural inputs.
Under a progressive tax rate system, farmers and ranchers, whose
incomes can fluctuate widely from year to year, will pay more total
taxes than taxpayers with more stable incomes. The flexibility of cash
accounting also allows farmers to manage their tax burden on an annual
basis by controlling the timing of revenue to balance against expenses
and target an optimum level of income for tax purposes.
Loss of cash accounting would create a situation where a farmer or
rancher might have to pay taxes on income before receiving payment for
sold commodities. Not only would this create cash flow problems, but it
also could necessitate a loan to cover ongoing expenses until payment
is received. The use of cash accounting helps to mitigate this
challenge by allowing farm business owners to make tax payments after
they receive payment for their commodities.
DEDUCTING INTEREST EXPENSE IS IMPORTANT FOR FINANCING
Debt service is an ongoing and significant cost of doing business for
farmers and ranchers who typically rely on borrowed money to buy
production inputs, vehicles and equipment, and land and buildings.
Interest paid on these loans should be deductible because interest is a
legitimate business expense. According to the USDA Economic Research
Service, interest expense accounts for 17.9 percent of fixed expenses
for farms and ranches. Immediate expensing will not offset the loss of
this deduction, especially for the bulk of farmers and ranchers
currently covered under Section 179 small business expensing.
Farm and ranch businesses are almost completely debt financed with
little to no access to investment capital to finance the purchase of
land and production supplies. In 2015, all but 5 percent of farm sector
debt was held by banks, life insurance companies and government
agencies. Without a deduction for interest, it would be harder to
borrow money to purchase land and production inputs and the agriculture
sector could stagnate.
Land has always been farmers' greatest asset, with real estate
accounting for 79 percent of total farm assets in 2015. Since almost
all land purchases require debt financing, the loss of the deduction
for mortgage interest would make it more difficult to cash flow loan
payments and could even make it impossible for some to secure financing
at all. The need for debt financing is especially critical for new and
beginning farmers who need to borrow funds to start their businesses.
REPEALING ESTATE TAXES WILL AID IN FARM TRANSITIONS
Estate taxes disrupt the transition of farm and ranch businesses from
one generation to the next. Farm Bureau supports estate tax repeal,
opposes the collection of capital gains taxes at death, and supports
the continuation of unlimited stepped-up basis.
Farming and ranching is both a way of life and a way of making a living
for the millions of individuals, family partnerships, and family
corporations that own more than 97 percent of our nation's more than
2.1 million farms and ranches. Many farms and ranches are multi-
generation businesses, with some having been in the family since the
founding of our nation.
Many farmers and ranchers have benefited greatly from congressional
action that increased the estate tax exemption to $5 million indexed
for inflation, provided portability between spouses, and continued the
stepped-up basis. Instead of spending money on life insurance and
estate planning, most farmers are able to upgrade buildings and
purchase equipment and livestock. And more importantly, they have been
able to continue farming when a family member dies without having to
sell land, livestock or equipment to pay the tax.
In spite of this much-appreciated relief, estate taxes are still a
pressing problem for some agricultural producers. One reason is that
the indexed estate tax exemption, now $5.49 million, is still catching
up with recent increases in farmland values. While increases in
cropland values have moderated over the last 3 years, cropland values
remain high. On average cropland values are 62 percent higher than they
were a decade ago. As a result, more farms and ranches now top the
estate tax exemption. With 91 percent of farm and ranch assets
illiquid, producers have few options when it comes to generating cash
to pay the estate tax.
REDUCED TAXATION OF CAPITAL GAINS ENCOURAGES INVESTMENT
The impact of capital gains taxes on farming and ranching is
significant. Production agriculture requires large investments in land
and buildings that are held for long periods of time during which land
values can more than triple. USDA survey data suggests about 40 percent
of all family farms and ranches report some gain or loss, more than
three times the average individual taxpayer. Farm Bureau supports
reducing capital gains tax rates and wants an exclusion for farm land
that remains in production.
Capital gains taxes are owed when farm or ranch land, buildings,
breeding livestock and some timber are sold. While long-term capital
gains are taxed at a lower rate than ordinary income to encourage
investment and in recognition that long-term investments involve risk,
the tax can still discourage property transfers or alternatively lead
to a higher asking price.
Land and buildings typically account for 79 percent of farm or ranch
assets. The current top capital gains tax is 20 percent. Because the
capital gains tax applies to transfers, it provides an incentive to
hold rather than sell land. This makes it harder for new farmers and
producers who want to expand their business, say to include a child, to
acquire property. It also reduces the flexibility farms and ranches
need to adjust their business structures to maximize use of their
capital.
STEPPED-UP BASIS REDUCES TAXES FOR THE
NEXT GENERATION OF PRODUCERS
There is also interplay between estate taxes and capital gains taxes:
stepped-up basis. Step-up sets the starting basis (value) of land and
buildings at what the property is worth when it is inherited. Farm
Bureau supports continuation of stepped-up basis.
Capital gains taxes on inherited assets are owed only when sold and
only on gains over the stepped-up value. If capital gains taxes were
imposed at death or if stepped-up basis were repealed, a new capital
gains tax would be created and the implications of capital gains taxes
as described above would be magnified. This is especially true for the
vast majority of farmers and ranchers who are both under the estate tax
exemption and have the benefit of stepped-up basis.
Stepped-up basis is also important to the financial management of farms
and ranches that continue after the death of a family member. Not only
are land and buildings eligible for stepped-up basis at death but so is
equipment, livestock, stored grains, and stored feed. The new basis
assigned to these assets resets depreciation schedules, providing
farmers and ranchers with an expanded depreciation deduction.
LIKE-KIND EXCHANGES HELP AG PRODUCERS STAY COMPETITIVE
Like-kind exchanges help farmers and ranchers operate more efficient
businesses by allowing them to defer taxes when they sell assets and
purchase replacement property of a like-kind. Farm Bureau supports the
continuation of Section 1031 like-kind exchanges.
Like-kind exchanges have existed since 1921 and are used by farmers and
ranchers to exchange land and buildings, equipment, and breeding and
production livestock. Without like-kind exchanges some farmers and
ranchers would need to incur debt in order to continue their farm or
ranch businesses or, worse yet, delay mandatory improvements to
maintain the financial viability of their farm or ranch.
FARMERS AND RANCHERS PAY SIGNIFICANT STATE AND LOCAL TAXES
Farm Bureau supports continuation of the deduction for state and local
taxes. Loss of the deduction for state and local taxes paid would have
a significant impact on farm and ranch businesses. According to the
USDA Economic Research Service, state and local property taxes account
for 16 percent of fixed expenses for all farms. An additional,
important contributing factor is that taxes are often built into the
price of rent and lease payments, which are substantial for farms.
Therefore, losing the state and local tax deduction likely would cause
higher rent and lease payments. It should be noted that the figures for
taxes mentioned above are only for real estate and property taxes and
do not include any state income taxes if those exist. Therefore, the
overall local and state tax burden is likely higher than stated above.
SUMMARY
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 revenue-neutral and fair to farmers and ranchers. Tax reform should
embrace the following overarching principles:
- Comprehensive: Tax reform should help all farm and ranch
businesses, including sole proprietors, partnerships and sub-S
corporations.
- Effective Tax Rate: Tax reform should reduce combined income and
self-
employment tax rates low enough to account for any deductions/credits
lost due to base broadening.
- Cost Recovery: Tax reform should allow businesses to deduct
expenses when incurred, including business interest expense. Cash
accounting should continue. Section 1031 like kind exchanges should
continue. There should be a deduction for state and local taxes.
- 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.
______
American Forest and Paper Association (AF&PA)
1101 K Street, NW, Suite 700
Washington, DC 20005
(202) 463-2700
http://www.afandpa.org/
The American Forest and Paper Association (AF&PA) serves to advance a
sustainable U.S. pulp, paper, packaging, tissue, and wood products
manufacturing industry through fact-based public policy and marketplace
advocacy. AF&PA member companies make products essential for everyday
life from renewable and recyclable resources and are committed to
continuous improvement through the industry's sustainability
initiative--Better Practices, Better Planet 2020.
U.S. manufacturers of paper and wood products appreciate the
opportunity to provide input to the Senate Finance Committee as it
considers how tax reform will grow our economy and create jobs across
America. AF&PA supports comprehensive tax reform that encourages
economic growth, job creation, and the competitiveness of all U.S.
businesses. Central to this is a low corporate tax rate, support for
investment in U.S. manufacturing and its global supply chain and a
competitive territorial-based international tax system.
The U.S. forest products industry--made up of both C-corporations and
pass-through entities--is a significant contributor to the U.S.
economy, employing nearly 900,000 men and women in above-average wage
jobs, investing heavily in equipment and improvements, and exporting
products throughout the world. The U.S. forest products industry also
supports jobs in other sectors of the U.S. economy. A recent study
conducted by the Economic Policy Institute found that each paper
industry job supports 3.25 jobs in supplier industries and in local
communities as the result of respending and tax receipts.
The U.S. forest products industry provides excellent employee payroll,
retirement, and health benefits to its workers. Meeting a payroll of
approximately $50 billion, the forest products industry employs about
the same number of people as the automotive industry and more people
than the chemical and plastics industries. The industry has a generous
compensation and benefits structure--earnings of pulp and paper mill
workers exceed the average for all U.S. private sector workers by about
23 percent.
The industry produces more than $200 billion in paper and wood products
annually, accounting for approximately 4.0 percent of the total U.S.
manufacturing GDP, and ranks among the top 10 manufacturing sector
employers in 45 states. In a typical year, the forest products industry
transforms approximately 13 billion cubic feet of wood--the majority of
which is purchased from privately-owned forest land--into value-added
paper, packaging, lumber, and other wood products.
Our key goals include lowering the corporate tax rate and a reformed
competitive international tax system to help attract and retain
business operations and good paying jobs in the United States. To
ensure capital-intensive manufacturers invest and expand with new and
more efficient equipment, we support appropriate depreciation, interest
expense, and research and experimentation tax policies. Further,
capital gains and dividends rates for individuals should be tailored to
ensure U.S. equity markets remain a reliable source of capital. AF&PA
believes that a reformed tax code should be long-term, prospective,
provide for a smooth transition, and not result in negative market
bias.
We are highly capital-intensive, in some cases more so than the average
manufacturing industry. Data from the U.S. Census Bureau's fourth
quarter 2016 Quarterly Financial Report indicate that depreciation,
depletion, and amortization amounted to 5.0 percent of paper industry
sales, versus 3.2 percent for all manufacturing. The industry has made
significant investments and facility upgrades in recent years.
According to the Annual Survey of Manufacturers, in 2015, the paper and
wood products industry invested $12 billion in plant and equipment.
Items such as recovery boilers, turbine generators, paper machines, and
environmental controls are critical to maintaining technologically
advanced manufacturing facilities that compete in an extremely
competitive global marketplace.
In addition to capital cost recovery issues, the tax provisions on net
interest expense, employee benefits, and the deduction for pension,
profit sharing, stock bonus, and annuity plans are important to our
industry. Thus, we will be keenly monitoring developments and sharply
focused on transition rules in these areas. In evaluating any tax
reform proposals, we note that the lower the corporate rate, the less
significant many of the tax attributes utilized by the industry become.
The industry's supply chain and customer base is globally integrated
and includes many cross-border transactions. Exports of U.S. paper and
wood products account for more than 15 percent of the industry's annual
total sales. In 2016, the industry's global exports totaled $29.4
billion, of which $9 billion were exports of wood products and $20.4
billion were exports of pulp, paper and packaging. We estimate that our
industry's exports support approximately 135,000 jobs at pulp, paper
and wood products mills and related logging operations in the U.S., as
well as many more jobs in communities where these facilities are
located. At the same time, many of the industry's vital large capital
purchases come from abroad because there is no U.S. manufacturer of
like items.
AF&PA's member companies recognize that comprehensive tax reform will
not be easy. However, the opportunity to increase U.S. economic growth
through tax reform is enormous. We would be pleased to discuss these
priorities with the committee and answer any questions you may have
about our industry. We are eager for tax reform and appreciate the
Finance Committee's attention to the issue.
For more information, please contact:
Elizabeth Bartheld
Vice President, Government Affairs
[email protected]
202-463-2444
______
Beer Institute et al.
September 19, 2018
The Honorable Orrin Hatch
Chairman
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510-6200
The Honorable Ron Wyden
Ranking Member
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510-6200
Dear Chairman Hatch and Ranking Member Wyden:
As you convene a hearing today on Business Tax Reform, we are writing
to express our support for excise tax reform for the beverage alcohol
industry to be part of comprehensive tax reform which the Committee is
considering.
Since its initial introduction in 2015, the Craft Beverage
Modernization and Tax Reform Act (currently S. 236) has enjoyed
overwhelming support in Congress. The legislation currently counts over
260 cosponsors in the House and nearly 50 in the Senate. Additionally,
the bill has the support from a broad array of outside organizations,
including the National Association of Manufacturers, and the American
Farm Bureau. Even the National Taxpayers Union has described the Craft
Beverage Bill as a ``no brainer'' bill that is ``commonsense,
bipartisan legislation that would in some way create a change for the
better.''
Every congressional district in the United States includes a brewery,
winery, distillery, importer, or industry supplier. These businesses
are often cornerstones of their communities. Unfortunately, outdated
regulations and tax laws may impede the growth of these individual
businesses.
The beverage alcohol industry remains one of the most regulated
industries in America. Brewers, winemakers, and distillers pay state,
local and federal taxes on their production. Federal excises taxes,
which are regressive taxes, are simply too high. S. 236 would
recalibrate and simplify federal excise taxes on domestic and imported
beer, wine and spirits sold in the United States. It would also update
and streamline outdated regulations.
The excise tax relief and regulatory reform embodied in S. 236 supports
businesses of many shapes and sizes, both small and large. The broad,
bipartisan, bicameral showing of support for this bill signifies how
important excise tax relief is to many in Congress. We urge you to
consider including S. 236 in any tax package that is slated for
consideration in the 115th Congress and will stand with you to support
its passage.
Sincerely,
Jim McGreevy, President and CEO Bob Pease, President and CEO
Beer Institute Brewers Association
Robert P. ``Bobby'' Koch, President
and Jim Trezise, President
CEO WineAmerica
Wine Institute
Mark Gorman, Senior Vice President Margie A.S. Lehrman, Executive
Director
Government Relations American Craft Spirits Association
Distilled Spirits Council
______
Biotechnology Innovation Organization (BIO)
1201 Maryland Avenue, SW, Suite 900
Washington, DC 20024
202-962-9200 p
202-488-6307 f
https://www.bio.org/
Chairman Hatch, Ranking Member Wyden, and Members of the Committee, the
Biotechnology Innovation Organization (BIO) applauds you for convening
this hearing and for your dedication to reforming America's corporate
tax code to make it competitive on the global stage.
BIO members are discovering groundbreaking cures and treatments for
devastating diseases; developing advanced biofuels, renewable
chemicals, and biobased products for the development of everyday
innovative consumer products which simultaneously provide environmental
benefits; and researching novel gene traits for identifying food
sources that could help combat global hunger. As tax reform takes
shape, it is imperative that Congress modernize the current U.S.
corporate tax code, enabling America to maintain its leadership in
these key 21st century industries in the face of challenges from
foreign competitors.
For the United States to continue to lead the world in the 21st century
innovation economy, tax reform must support the growth of small
business innovators, incentivize investment in breakthrough
technologies, and bolster U.S. companies currently hamstrung by a high
corporate tax rate and a burdensome worldwide tax system out of step
with the rest of the world.
The Impact of Tax Reform on Innovation
The tax code should recognize and promote innovation as fundamental to
the long-term economic growth of the United States. Congress can take
steps toward accomplishing this goal by including a specific section on
innovation and entrepreneurship in any tax reform package. A standalone
section of tax reform dedicated to the promotion of innovation would
send a message to the world that the U.S. will not cede its global
leadership while also ensuring that the drive to lower tax rates does
not leave pre-revenue, emerging businesses behind.
BIO supports your efforts to streamline the tax code in order to
facilitate lower rates and international competitiveness. At the same
time, there are provisions in the current code that stimulate biotech
R&D, and these provisions are vitally important to the scientific
progress of BIO members. Furthermore, Congress has the opportunity in
tax reform to take new steps to inspire innovative science by
supporting the growth of, and incentivizing investment in, pre-revenue
small businesses early in their life cycle. The combination of lower
overall rates, strengthened innovation incentives, and targeted small
business provisions will support breakthrough research and bolster the
21st century innovation economy.
In order to save lives, reduce dependence on foreign oil, build a
biobased economy, and create jobs in innovative businesses, BIO
believes the guiding principle of tax reform should be the promotion of
innovation. BIO supports the following tax reform proposals, and
believes they should be included in any reformed tax code.
International Tax Competitiveness
Lower Corporate Tax Rate
High tax rates impede America's ability to compete with other
industrialized nations on the global stage, and our current corporate
tax system stifles growth. The worldwide average tax rate has declined
from 30 percent to 22.5 percent since 2003, with every region in the
world seeing a decline in the average corporate tax rate in the
previous 14 years. With international competitors gaining ground in the
biotech industry, the U.S. cannot afford to continue this competitive
imbalance. BIO supports efforts to lower the U.S. corporate tax rate to
a competitive level.
To further bolster U.S. leadership in life sciences innovation,
Congress also should consider favorable tax treatment of income derived
from the research and manufacturing of innovative products in the
United States. Such an approach should not affect the design of a
competitive international tax regime or treat income derived from
intangible assets less favorably than other income.
Territorial Tax System
It is vital that Congress take steps to move America to a competitive
territorial tax system, unburdened by overly stringent anti-base
erosion policies and consistent with those in so many other OECD
countries. Freeing up over two trillion dollars that are currently
trapped overseas due to the inefficiencies of the tax code will boost
economic growth and capital investment.
Congress should ensure that a move to a territorial system is truly
competitive for knowledge-based industries like biotechnology. Placing
disproportionate tax burdens on the biotechnology industry harms
America's competitiveness on the world stage and could stymie cutting-
edge R&D critical to meeting our nation's public health, agricultural,
bioenergy, and environmental challenges.
Existing Tax Incentives for Innovation
R&D Tax Credit
BIO supports maintaining the R&D Tax Credit in the reformed tax code,
while at the same time strengthening it by increasing the Alternative
Simplified Credit (ASC) rate. The R&D Credit was made permanent by the
Protecting Americans from Tax Hikes (PATH) Act in December 2015, and
BIO strongly believes it should remain in the reformed tax code.
Studies have shown that the R&D Tax Credit contributes to U.S. job
growth and an increase in the U.S. GDP. However, the U.S. has fallen
behind in its R&D incentive generosity, falling from a leader among
OECD countries in the late 1980s to 25th for large companies and 26th
for small businesses in 2016. Maintaining and strengthening this credit
would recognize its vital role in supporting America's innovation
economy.
PATH Act R&D Credit Reforms
BIO also supports maintaining the PATH Act's reform to the R&D Tax
Credit that allows pre-revenue innovators to take a portion of their
Credit against their payroll tax obligation, an important recognition
that income tax credits do not yet benefit pre-revenue companies.
Under current law, companies in their first 5 years of operation can
utilize up to $250,000 in R&D Credits under the PATH Act reforms. While
BIO believes this change was an important first step, we would also
support expanding the provision, either by extending the eligibility
time period or by expanding the dollar amount of credits available for
use. Given the long development timelines of groundbreaking innovation
and the high costs of biotech research, these targeted expansions to
the payroll credit would ensure that innovative pre-revenue companies
can take full advantage of this new incentive.
Orphan Drug Tax Credit
BIO supports maintaining the Orphan Drug Tax Credit in the reformed tax
code. The Credit, which was enacted in 1983 and made permanent in 1997,
corrects a market failure by removing significant impediments to drug
development for rare diseases that do not exist for diseases with
larger patient populations.
By reducing the costs of developing drugs for smaller patient
populations, the Orphan Drug Tax Credit has encouraged companies to
develop hundreds of new therapies that would otherwise not have been
commercially feasible. Since its enactment, there have been over 600
drugs developed to treat more than 400 rare diseases. According to
recent studies, a third of the existing treatments approved for orphan
indications would not have been developed if not for the Orphan Drug
Tax Credit.
By maintaining the Orphan Drug Tax Credit in the reformed tax code,
Congress can ensure that the Credit will continue to incentivize the
development of drugs to treat rare diseases for which no treatment
currently exists--helping millions of patients suffering from rare
conditions get the new medicines they desperately need, while fostering
economic growth through new and expanding biotech companies with good
jobs and high wages.
Small Business Tax Incentives
By itself, a lower corporate tax rate will not support growth and
innovation in America's small businesses, many of which are pre-
revenue. Comprehensive tax reform should go further than ``broadening
the base and lowering the rate.'' Instead, policymakers should
specifically promote innovative research-intensive businesses through
incentives for other companies, individuals, and funds to invest in
small companies and support their research.
Section 469 R&D Partnership Structures
Prior to 1986 tax reform, many growing companies attracted investors by
using R&D Limited Partnerships, in which individual investors would
finance R&D projects and then utilize the operating losses and tax
credits generated during the research process. These structures gave
investors a tax incentive to support biotech research, which is
entirely dependent on outside investors but often too risky or
expensive to attract sufficient investment capital. The enactment of
the passive activity loss (PAL) rules in 1986 prevented investors from
using a company's losses to offset their other income, thus removing
the incentive to support vital research.
BIO supports targeted reforms to Section 469 to allow a limited
exception from the PAL rules for R&D-focused pass-thru entities. Under
this proposal, small companies would be able to enter into a joint
venture with an R&D project's investors. The losses and credits
generated by the project would then flow through to the company and
investors, who would be able to use the tax assets to offset other
income. Relaxing the PAL rules to allow investors to enjoy a more
immediate return on their investment, despite the long and risky
timeline usually associated with groundbreaking research, would
incentivize them to invest at an earlier stage, when the capital is
most needed.
This proposal has been introduced on a bipartisan basis in both the
House and the Senate. In the 114th Congress, Senators Toomey, Menendez,
Roberts, and Carper introduced the Start up Jobs and Innovation Act,
which would make this vital reform in order to spur investment in
early-stage groundbreaking innovation.
Innovation Investor Tax Credit
Providing a tax credit for individual investors who support research at
its earliest stages could lead to a capital infusion for the small
business innovators at the forefront of scientific advancement. In the
biotech industry, emerging companies are developing 70% of the global
pipeline--including 84% of the industry's product candidates to treat
rare diseases. The vast majority of these clinical programs are still
in early-stage research (only 16% have made it to Phase III clinical
testing), so continued investor support is vital to bring these
potentially life-saving treatments out of the lab, bring them through
the clinic, and ultimately deliver them to patients in need.
A tax credit targeted at early-stage investors in innovative industries
would incentivize the capital infusion necessary to fund 21st century
R&D. In biotechnology, and other innovative industries, early-stage
funding is key to a company's success. Without product revenue for more
than a decade, these small businesses depend on investor capital to
fund their research into life-saving treatments and groundbreaking
technologies. A targeted tax credit, designed to stimulate early-stage
capital, would serve as an important incentive for investment in the
R&D at the foundation of America's innovation economy.
Section 382 NOL Reform
Innovative companies often have a long and capital-intensive
development period, meaning that they can undergo a decade of research
and development without any product revenue prior to commercialization.
During this time period, companies generate significant net operating
losses (NOLs), which can be used to offset future gains if the company
becomes profitable. However, Section 382 restricts the usage of NOLs by
companies that have undergone an ``ownership change.'' The law was
enacted to prevent NOL trafficking, but small biotech companies are
caught in its scope--their reliance on outside financing and deals
triggers the ownership change restrictions and their NOLs are rendered
useless.
BIO supports reform of Section 382 to allow certain NOLs to be carried
forward at companies conducting R&D or in the event of a capital
infusion or financing round. This change would allow small companies
the freedom to raise capital for innovative research without fear of
losing their valuable NOLs. Additionally, the ability of a small
business to maintain its NOLs makes it more attractive to investors and
purchasers looking to take its research to the next level.
Section 1202 Capital Gains Reform
Section 1202 allows investors to exclude from taxation 100% of their
gain from the sale of a qualified small business (QSB) stock if they
hold the stock for five years. This provision was designed to promote
investment in growing businesses, but its overly restrictive size
requirements prohibit innovative companies from accessing valuable
investment capital. Currently, QSBs must have gross assets below $50
million. The high costs of research, coupled with valuable intellectual
property and successive rounds of venture financing, often push growing
innovators over the $50 million gross assets limit and out of the QSB
definition.
In addition to maintaining the 100% exclusion, BIO supports changing
the QSB definition to include companies with gross assets up to $150
million, with that cap indexed to inflation. BIO also supports
excluding the value of a company's IP when calculating its gross
assets. These changes would allow more growing innovators to attract
investors to fund their vital research. Providing incentives to invest
in biotech research will increase the innovation capital available to
research-intensive businesses and speed the development of
groundbreaking medicines.
Biofuels Tax Incentives
Since 2009, the advanced biofuels industry has invested billions of
dollars to build first-of-a-kind demonstration and commercial-scale
biorefineries across the country. Despite the challenges associated
with developing new technologies, as of 2015 there were five commercial
scale cellulosic biorefineries with a combined capacity of more than 50
million gallons within the United States. Unfortunately, policy
instability undermines certainty and predictability for investors and
other market participants. The uncertain cycle of expirations and
reinstatements for tax incentives for advanced and cellulosic biofuels
make it difficult for the industry to take advantage of these tax
incentives that could help move these projects to commercial production
by attracting investment and reducing the cost of production.
The development of advanced and cellulosic biofuels is a difficult and
capital-
intensive enterprise. Despite the recent successes of building
commercial-scale facilities, this is a new and developing industry.
However, there are great benefits to developing these technologies.
Over the past 10 years the biofuels industry has displaced nearly 1.9
billion barrels of foreign oil by replacing fossil fuels with homegrown
biofuels. This has saved consumers an average of $1 a gallon at the
pump. The use of biofuels has also led to a reduction in U.S.
transportation-related carbon emissions of 590 million metric tons over
the past decade--an equivalent of removing more than 124 million cars
from the road. Even with these benefits, this sector needs predictable
federal tax policy to continue to attract investment in order to grow
and compete with incumbent industries that have long received favorable
tax preferences.
Tax Incentives for Biofuel Innovation
BIO has long supported a suite of tax incentives important for the
development of advanced and cellulosic biofuels--the Second Generation
Biofuel Producer Tax Credit (PTC), the Special Depreciation Allowance
for Second Generation Biofuel Plant Property, the Biodiesel and
Renewable Diesel Fuels Credit, and the Alternative Fuel Vehicle
Refueling Property Credit. Unfortunately, the PTC and associated
depreciation provisions have never been enacted for a sufficient length
of time to allow investors to depend upon their existence once the
facilities are eventually placed in service. BIO supports the extension
of these provisions. Further, BIO would encourage Congress to reject
the creation of a phase-out. Ending the tax credits on an arbitrary
date in the near term will hamper the utilization of these incentives
for an industry where financing and constructing new facilities takes
on average 5 to 6 years.
Clean Energy Development
If the Committee determines it could best stimulate investment and
growth of clean energy development and deployment with a simple,
durable, and technology neutral program, it is important the Committee
develops a formula that does not inadvertently discriminate against
technologies. BIO strongly supports the concept of providing tax
incentives on a performance basis rather than arbitrary assignment by
statute. With any energy efficiency formula, it may be necessary to
provide some extra bonus credits to fuels that achieve a ``negative''
carbon emissions rating and to fuels that provide socially valuable
octane enhancements. BIO believes Ranking Member Wyden's Clean Energy
for America Act (S. 1086) is one technology neutral proposal which
could stimulate investment into and growth of biofuels and other forms
of clean energy.
Tax Incentive Eligibility
Technology neutral incentives must also provide developers and
investors confidence in the availability of the tax incentives. The
Department of Treasury process that determines eligibility of fuels
should rely wherever possible upon existing Environmental Protection
Agency (EPA) data. However, due to lengthy and unpredictable
administrative processes with EPA approval of pathways, which would
undermine public confidence in the timely availability of the
incentives, BIO suggests that EPA should be encouraged to provide
interim data wherever possible that would allow the fuels to become
eligible for tax incentives in advance of the multi-year pathway
determinations.
To allow for a smooth transition to the new credit program, the
definition of ``qualifying facility'' should be adjusted to provide a
uniform 10-year stream of production tax credits for each otherwise
eligible facility placed in service before date of enactment.
Facilities placed in service after date of enactment would trigger the
10-year period when placed in service. We would like to continue to
work with Members of Congress to develop a tax incentive regime for
advanced and cellulosic biofuels that reflects the life cycle
environmental benefits of those fuels.
Funding for Infrastructure Investment
Should the Committee consider an increase to the excise tax on gasoline
to fund infrastructure developments and provide greater funding for
highways, which could increase the number of construction and
manufacturing jobs in the economy, BIO encourages the Committee to
carefully balance incentives to develop innovative biofuels and the
necessary distribution infrastructure. Any future increases to the
excise tax on gasoline should include a reduced rate for fuels that
contain higher levels of ethanol and other biofuels, ranging from E15,
which contains 15 percent ethanol, up to E85, which contains 85 percent
ethanol. A rate reduction for higher blends of biofuels in the
transportation fuel supply will spur greater use of domestically
produced renewable fuel. Providing a lower excise tax on fuels
containing higher levels of ethanol will spur investments in
infrastructure to deploy greater volumes of biofuels and grow market
space for advanced and cellulosic biofuels. This will benefit
consumers, the nation's economy, infrastructure, rural communities, and
energy and national security.
Renewable Chemicals and Biobased Products Tax Incentives
Companies are using industrial biotechnologies to help resolve
important challenges in synthesizing new products, whole cell systems,
and other biological processes to improve all types of manufacturing
and chemical processes. This progress is enabling the production of a
new generation of renewable chemicals, biobased products, and
bioplastics produced from renewable biomass, which can supplement or
substitute for traditional petroleum-based chemicals and products.
Given that the U.S. faces the challenge of reducing its costly
dependence on foreign oil and competing in a $2.4 trillion worldwide
clean energy market with a number of countries already implementing
aggressive alternative energy development programs, the emergence of
this technology represents a historic opportunity to reverse job losses
in the U.S. chemicals and plastics sectors while simultaneously
improving energy security and the environment.
Investment and production tax credits are currently offered to
incumbent fossil energy industries. As such, tax incentives for
renewable chemicals and biobased products are critical to our efforts
to attract capital given that these types of incentives are offered to
other U.S. energy sectors. It will be more difficult for renewable
chemical companies to develop projects in the United States if other
nations such as China, Germany, Malaysia, and other BRIC nations offer
attractive investment incentives. To realize the industry's potential
for domestic job creation and reduced reliance on foreign oil, Congress
must ensure that renewable chemical technologies are incentivized in
the tax code, and at a minimum receive tax parity with other renewable
energy technologies.
Production or Investment Tax Credit for Qualifying Renewable Chemicals
BIO supports the enactment of a production or investment renewable
chemicals tax credit, which would create a targeted, short-term tax
credit for the production of qualifying renewable chemicals from
biomass. Applicants for the tax credit would be evaluated on job
creation, innovation, environment al benefits, commercial viability and
contribution to U.S. energy independence. Like current law for
renewable electricity production credits, the credits would be general
business credits available for a limited period per facility. This
renewable chemicals tax credit would support innovation and help
domestic companies compete in a rapidly growing global renewable
chemicals market, revitalize domestic manufacturing, and bring new
energy efficient biobased products for consumers. That, in turn, would
create millions of new jobs and opportunities for economic growth.
To truly achieve energy security, the U.S. must develop biorefineries
that produce alternatives to all of the products made from each barrel
of oil. Industrial biotechnology enables the production of renewable
chemicals and biobased products from biomass, and the total
displacement of fossil fuel products can be accelerated with a
production or investment tax credit. The bipartisan reintroduction of
the Renewable Chemicals Act (H.R. 3149), offers a strong model for
implementation of this proposal.
Master Limited Partnerships Parity Act for Renewable Chemicals and
Biofuel Producers
BIO supports the Master Limited Partnerships Parity Act, previously
introduced in the 113th and 114th Congresses, which would extend the
publicly-traded partnership ownership structure to renewable energy
power generation projects, renewable chemicals, and transportation
fuels. This bill would amend the Internal Revenue Code to extend
availability of the master limited partnership (MLP) business structure
in which renewable chemicals and biofuels investors are treated as
partners for tax purposes but whose ownership interest can be traded
like corporate stock. Availability of the MLP structure would reduce
the cost of private capital for renewable chemicals and biofuels
projects. BIO supports this important effort to modernize MLP, which is
extremely timely given the significant transformation in the nation's
energy mix that has occurred over the past two decades.
Reinstating Sec. 48C and Eligibility for Renewable Chemicals and
Biobased Products
To realize the full potential of the domestic renewable chemicals
industry, existing renewable energy and manufacturing tax incentive
regimes should be opened to renewable chemicals. Renewable chemicals
and biobased products impact everyday products impacting our economy,
such as car parts, cleaning products, soaps, insulation materials,
plastics, foams, fibers, and fabrics. BIO urges Congress to incorporate
the language of the Make It in America Tax Credit Act of 2011 into any
energy or manufacturing tax package discussed and introduced in tax
reform.
Conclusion
Federal tax policy that recognizes the special demands placed on
biotech companies and other highly innovative industries will speed the
development of products to vastly improve the lives of Americans and
people around the world. By recognizing the importance of innovation
and the economic potential of the biotech industry, Congress can
incentivize further development and improve America's economic health.
BIO supports a U.S. tax code that recognizes innovation as a crucial
part of the 21st century American economy and encourages innovative
research and new technologies to enter the market. The tax code should
promote research-intensive and advanced manufacturing businesses as
they continue to create high-quality American jobs, stimulate long-term
economic growth, and bolster America's competitiveness on an
increasingly global stage.
______
BUILD Coalition
805 15th Street, NW, Suite 200
Washington, DC 20005
202-822-1205
September 18, 2017
The Honorable Orrin Hatch The Honorable Ron Wyden
Chairman Ranking Member
Committee on Finance Committee on Finance
U.S. Senate U.S. Senate
219 Dirksen Senate Office Building 219 Dirksen Senate Office Building
Washington, DC 20510 Washington, DC 20510
RE: Senate Finance Committee hearing on ``Business Tax Reform''
(September 19, 2017) and the preservation of full interest
deductibility
Dear Chairman Hatch, Ranking Member Wyden, and Members of the
Committee:
The Businesses United for Interest and Loan Deductibility (BUILD)
Coalition is submitting this letter to reiterate our support for
maintaining full interest deductibility in tax reform. We applaud the
Committee's thoughtful approach to making tax reform a legislative
priority, and we support its commitment to simplifying the code,
creating a system that treats all taxpayers equally, and fostering
sustained economic growth in today's competitive global marketplace.
The BUILD Coalition's members represent critical industries throughout
the American economy, including agriculture, manufacturing, real
estate, retail, and telecommunications. We believe that any measures to
spur long-term, sustainable U.S. economic growth should ensure
companies retain the necessary access to affordable capital for
undertaking new investments, expanding operations, and creating more
jobs.
Therefore, as the Committee determines which of the various elements of
the tax code should remain or be reformed to encourage stronger growth,
we'd like to reinforce the importance of preserving the full
deductibility of interest on borrowing for all U.S. businesses. To
create a tax structure that fulfills America's maximum growth
potential, Congress must avoid any limitation to, or elimination of,
interest deductibility.
Our experience managing the daily operations of our respective
businesses compels us to relay the real-world implications of
eliminating or limiting interest deductibility. It is also essential
that we dispel misconceptions regarding this key part of our tax code,
including the inaccurate notions that limiting, interest deductibility
to finance a lower tax rate for businesses would result in economic
growth, that the interest expense deduction distorts financing
decisions, that interest deductibility can be replaced by immediate
expensing of capital expenditures, and that interest deductibility
encourages excessive risk in the economy.
The deductibility of business interest expense is a well-established,
growth-
promoting component of the tax code. Interest expense is a normal cost
of doing business. The deduction for interest is necessary to measure
income properly and has been present in the tax code since the
implementation of the modern income tax structure roughly a century
ago. Failure to maintain interest deductibility will overstate a
business' taxable income and result in over-taxation. By guaranteeing
businesses will not be taxed on the cost of accessing capital, interest
deductibility affords us the correct tax treatment and encourages us to
continue to invest in growing our businesses and creating more jobs.
Also, a study by Ernst and Young (EY) finds that limiting interest
deductibility to help fund a lower corporate tax rate would negatively
impact economic growth in the long-run.\1\ More specifically, EY found
that a 25 percent across-the-board limitation on corporate interest
expenses can be used to fund an approximate 1.5
percentage-point reduction in the corporate income tax rate. EY's
research found that this trade-off would raise the cost of capital and
result in a decline in long-run GDP of 0.2 percent, with the majority
of this effect occurring in the first 10 years.
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\1\ EY's Quantitative Economics and Statistics (QUEST) Group.
``Macroeconomic Analysis of a Revenue-Neutral Reduction in the
Corporate Income Tax Rate Financed by an Across-the-Board Limitation on
Corporate Interest Expenses.'' EY. July 2013.
In other words, proposals that call for placing limits on interest
deductibility in order to achieve a lower tax rate for businesses run
counter to the Committee's stated goal of achieving pro-growth tax
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reform.
Beyond economic models, the practical implications of limiting or
eliminating interest deductibility for businesses throughout the U.S.
economy raise major cause for concern. As our member organizations
prove, businesses of all sizes borrow in order to finance expansions or
meet obligations and the ability to deduct interest expense gives
business owners the certainty to make critical operating decisions. For
many firms, access to credit is essential for working capital, and many
of these companies use debt to weather shifts in demand.
Our nation's debt capital markets are the most liquid and efficient in
the world. Banks supply the credit that is in turn the life blood of
American businesses of all sizes and types-the businesses that provide
the core growth in our economy.
The impact would be particularly harsh for startups, small businesses,
and other private companies, which do not have ready access to
alternative sources of financing. In fact, research has found that 75
percent of startups and 80 percent of small businesses rely on debt
financing.\2\ In addition to these small businesses, medium and large
enterprises also turn to debt financing in large part because of its
efficiency and relative speed to market compared to equity financing.
Borrowing allows these businesses to respond quickly to market demands
and capitalize on new opportunities, whether through revolving lines of
credit, bonds, or bank loans. Without access to affordable credit,
companies of all sizes will struggle to create jobs and grow the
economy.
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\2\ Cole, Rebel A., ``Why Businesses Use Debt--And How Debt
Benefits Businesses.'' June 2013.
Proponents of eliminating interest deductibility argue that the tax
code favors debt over equity, and that this encourages companies to
take on more leverage. And yet, research by economists from Duke
University, University of Pennsylvania, and Washington University in
St. Louis,\3\ as well as findings by Nobel Prize-winning economist
Merton Miller,\4\ show that the tax code has little to no impact on
companies' leverage ratios. Harvard University finance professor Mihir
Desai confirmed the findings of these earlier studies, noting that the
non-financial sector is ``remarkably underlevered by historical
standards.'' \5\ We believe this is because corporate decisions
regarding the level of debt to assume are impacted by numerous non-tax
market forces, such as analysts, rating agencies, regulators,
investors, and lenders.
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\3\ Graham, John R., Mark T. Leary, and Michael R: Roberts. ``A
Century of Capital Structure: The Leveraging of Corporate America.''
June 2014.
\4\ Miller, Merton. ``Debt And Taxes.'' Journal of Finance. May
1977.
\5\ Desai, Mihir. Testimony of Mihir A. Desai. United States Senate
Committee on Finance and the United States Committee on Ways and Means.
July 2011.
Moreover, the argument that equity and debt financing are similar is a
fallacy. Debt and equity do not serve identical purposes and are not
interchangeable forms of financing. There are a variety of non-tax
reasons that businesses like ours choose debt over equity when raising
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capital. Thus, their differing tax treatment is appropriate.
For one thing, many businesses do not have access to equity markets,
making debt their only option to start and grow enterprises that in
turn create new jobs. In contrast to the dilutive effects of equity,
borrowing allows owners to access capital without diluting control of
their business. Debt is also a cheaper financing solution than equity
because it is more secure for investors, who charge a premium for the
risks associated with equity. Therefore, on both sides of the equation,
debt and equity play separate and distinct roles in capital formation.
To the extent that policymakers would like to incentivize equity
financing, the answer is to reduce or eliminate the tax on dividends,
not to punish and restrict debt financing by removing or limiting
interest deductibility. Any purported debt bias would also be
significantly reduced by lowering the corporate tax rate.
In addition, proposals to offer 100 percent expensing in place of
interest deductibility miss the mark. Such proposals fail to account
for the real-life implications of what such a trade-off means for
businesses, namely that full and immediate capital expensing is not an
acceptable alternative for interest deductibility. Immediate expensing
is a timing difference, while interest deductibility has a permanent
impact and helps ensure income is properly measured.
A recent analysis by Goldman Sachs Economics Research predicts that
proposals to eliminate interest deductibility in favor of 100 percent
expensing ``would raise the user cost of capital and reduce investment
in the longer run.'' While 100 percent expensing might boost cash flows
in the near term by pulling forward depreciation schedules, ``after the
first year, however, the impact on cash flow would begin to decline and
eventually turn negative,'' the Goldman Sachs study warns.\6\
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\6\ Mericle, David, and Daan Struyven. ``U.S. Daily: Corporate Tax
Reform: Trading Interest Deductibility for Full Capex Expensing.''
Goldman Sachs Economic Research. November 2016.
These harmful effects would not be canceled out by lower rates, either.
As University of Pennsylvania professor Chris Sanchirico has explained,
even proposals to lower the tax rate would ``not temper'' the harmful
effects of the proposed trade-off between interest deductibility and
expensing.\7\ As businesses that make these financing decisions every
day, we know firsthand that you can't expense what you can't afford.
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\7\ Sanchirico, Chris William. ``Expensing and Interest in the GOP
Blueprint: Good Deal? Good Idea?'' Tax Notes. April 2017.
Lastly, some have claimed that debt inherently creates risk in the
economy and that steps should be taken to discourage too much borrowing
by businesses. This is by no means a given. In fact, a study published
by the St. Louis Federal Reserve's Brent Glover, Joao F. Gomes, and
Amir Yaron finds that limiting interest deductibility would actually
increase volatility throughout the economy by raising the overall cost
of accessing capital. The authors understand that limiting or
eliminating the deduction for business interest expense would push
firms to intentionally cap their size and rely more on operating
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leverage, making them more susceptible to default.
Glover, Gomes, and Yaron conclude: ``Contrary to conventional wisdom,
we find that eliminating interest deductibility results in an increase
in the default frequency and average credit spreads. The intuition for
this lies in the fact that this policy change makes external financing
more costly, which results in riskier firms and higher credit
spreads.'' \8\
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\8\ Glover, Brent, Joao F. Gomes, and Amir Yarons. ``Corporate
Taxes, Leverage, and Business Cycles.'' St. Louis Fed. July 2011.
All of the arguments against interest deductibility also ignore the
distributional impact of limiting interest deductibility. According to
a report by the Small Business Administration (SBA), woman- and
minority-owned small businesses typically have less access to equity
markets compared to other businesses. Thus, woman- and
minority-owned small businesses turn to bank loans, as well as
alternative lending methods. By limiting interest deductibility,
policymakers would further increase the existing financial burdens that
woman and minority business owners face when trying to raise capital
for investments.\9\
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\9\ Robb, Alicia. ``Access to Capital Among Young Firms, Minority-
owned Firms, Women-owned Firms, and High-tech Firms.'' U.S. Small
Business Administration. April 2013.
These are just the immediate dangers. Numerous policy proposals would
also suffer if interest deductibility is limited. For example,
President Donald Trump has announced his desire for a $1 trillion
infrastructure investment plan based in large part on public-private
partnerships. Congressional leaders have discussed similar proposals,
which also feature a heavy emphasis on the private sector. Of course,
limiting or eliminating the deductibility of interest expense would
undermine these plans by increasing the cost of capital and making such
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investments less feasible for the private sector.
Finally, limiting interest deductibility would directly undermine
``America-First'' goals for tax reform. America's capital markets are
second to none, giving the U.S. a major advantage over other nations in
attracting businesses and investment. Without the ability to deduct
interest expenses, these businesses would look overseas for their
credit needs, weakening U.S. credit markets and hindering job growth.
As the Committee investigates ways to promote stronger economic growth
and faster job creation through tax reform, it must maintain provisions
in the tax code that help achieve these goals. Interest deductibility
is one of these provisions, and has been since the creation of the
modern tax code.
While the BUILD Coalition fully supports the Committee's goal of
achieving pro-growth tax reform, any proposal that places limitations
on interest deductibility will harm these efforts. We strongly
encourage the Committee, in any proposed tax legislation, to maintain
the full deductibility of business interest expense as it exists under
current law. By doing so, policymakers will give the U.S. economy the
opportunity to achieve its full growth potential.
Sincerely,
The BUILD Coalition
______
Business Roundtable
The nation's tax system is in urgent need of reform to boost economic
growth, increase global competitiveness for American companies, and
bring about meaningful improvements in the incomes of American families
through higher wages and more American jobs.
It has been over 30 years since Congress last undertook tax reform. The
United States has failed to act while the rest of the world has
implemented modern tax policies to aggressively compete for jobs and
investment. The urgency of tax reform cannot be overstated.
Tax reform, done right, will be a catalyst for U.S. economic growth,
increased wages and job creation. A recent Business Roundtable survey
found that CEOs believe that tax reform is the single most effective
action that Congress can take to accelerate economic growth. Seventy-
six percent of the CEOs said that they would increase hiring at their
company if tax reform is enacted, and 82 percent would increase capital
spending.
Comprehensive tax reform for both individuals and businesses--including
more competitive rates for non-corporate businesses--is fundamental to
strengthening the U.S. economy, enhancing job creation, increasing wage
growth, and ensuring that American workers and American companies can
successfully compete around the globe. Tax reform should also be used
to give a targeted boost to lower- and middle-income workers by
expanding programs such as the Earned Income Tax Credit (EITC), which
already provides a helping hand to more than 29 million workers.
A comprehensive approach is the best way to create a modern,
competitive tax system for both businesses and individuals. Business
Roundtable calls for the following corporate tax changes:
A corporate tax rate set at an internationally competitive
level; and
A modern international tax system (territorial-like) that
permanently removes the penalty for returning foreign earnings to the
United States, thereby aligning the U.S. system with the tax systems of
our major trading partners.
We believe that these reforms can be achieved in a fair and fiscally
responsible manner. Business Roundtable companies are committed to
putting all corporate tax credits and special deductions on the table
in consideration of an internationally competitive corporate tax
system.
Based on the knowledge and experience of most Business Roundtable CEOs,
the remainder of this submission focuses on reform of the corporate
income tax system.
The Need for U.S. Corporate Tax Reform
The U.S. corporate tax system was last reformed in 1986. It is outdated
and fails to reflect the increased competition American companies face
from their global competitors both at home and abroad. The U.S.
corporate tax rate is the highest among industrialized countries.
Including state taxes, the combined U.S. statutory corporate tax rate
is 38.91 percent, more than 15 percentage points higher than the 23.75
percent average combined national and sub-national statutory corporate
tax rate of the other 34 members of the Organization for Economic
Cooperation and Development.\1\
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\1\ OECD Tax Database, available at: http://stats.oecd.org/
Index.aspx?DataSetCode=TABLE_
II1. The average U.S. state corporate tax rate is 6.01 percent
according to the OECD. Because state corporate income taxes are
deductible against federal corporate income taxes, the combined federal
and state statutory corporate tax rate is .35 + (1 - .35)(.0601 ) =
38.91 percent. If tax reform lowered the U.S. federal corporate tax
rate to 20 percent, it would result in a combined federal and state tax
rate of 24.81 percent--still a full percentage point greater than the
OECD average rate.
While effective tax rates are typically lower than statutory tax rates,
U.S. effective tax rates are consistently found to be among the highest
of developed countries. A recent study conducted for the European
Commission found the corporate effective marginal tax rate for
investments in the United States to be 34.3 percent while the average
of the other 34 surveyed countries (28 EU countries, plus four other
European countries, Canada, and Japan) was 16.0 percent.\2\ Many other
developed countries also have special favorable tax rules for
intellectual property, including so-called ``patent boxes'' or
``innovation boxes,'' with effective tax rates on such income typically
ranging from 5 to 15 percent.\3\
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\2\ Center for European Economic Research (ZEW), ``Effective Tax
Levels Using the Devereux/Griffith Methodology,'' Project for the EU
Commission TAXUD/2013/CC/120, Intermediate Report, October 2015,
available at: http://ec.europa.eu/taxation_customs/sites/taxation/
files/resources/documents/common/publications/studies/
effective_tax_rates.pdf.
\3\ Countries with patent or innovation boxes include Belgium,
France, Hungary, Ireland, Israel, Italy, Korea, Luxembourg, Malta,
Netherlands, Portugal, Spain, Switzerland, Turkey, and the United
Kingdom. For details on qualifying income and tax rates, see PwC,
Global Research and Development Incentives Group, April 2017, available
at: https://www.pwc.com/gx/en/services/tax/international-tax-services/
global-research-and-development-incentives-group.html.
Further, the U.S. international tax system still is premised on rules
first adopted in 1909 that tax the worldwide income of American
corporations. Virtually all other advanced economies--including all
other G7 countries and 29 of the other 34 OECD countries--have adopted
territorial tax rules that ensure that their own companies are as
competitive as possible in the global market place. By contrast, the
U.S. rules place an additional tax on the foreign earnings of U.S.
companies when they are sent home, which discourages the repatriation
of these earnings and has now resulted in $2.6 trillion in foreign
earnings being trapped overseas due to America's anticompetitive tax
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system.
Together, the high U.S. corporate tax rate and outdated international
tax rules make the U.S. corporate tax system an outlier from the rest
of the world, harming the ability of American companies and their
workers to compete successfully. By suppressing investment in the
United States, the corporate income tax lowers worker productivity and
holds back wages. An estimated 75 percent of the corporate income tax
burden falls on workers.\4\
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\4\ For example, a study by the Congressional Budget Office
concludes that 73.7 percent of the burden of the corporate income tax
is borne by workers. See, Congressional Budget Office, ``International
Burdens of the Corporate Income Tax,'' August 2006.
Successful tax reform should end the competitive tax disadvantage that
U.S. companies and American workers face every day in the global
marketplace.
Creating a Competitive Advantage
Our trading partners use their corporate tax systems to achieve
competitive advantage at the expense of the American worker. For
example, Canada has aggressively lowered its combined federal and
provincial corporate tax rate from 42.4 percent to 26.7 percent since
2000, with the federal rate now at 15 percent. As outlined by the
Canadian government in a 2006 policy document, ``Advantage Canada,''
this was part of an explicit Canadian policy to obtain a competitive
advantage over the United States:
To create a Canadian tax advantage over the coming years,
Canada's New Government will . . . [e]stablish a broader
corporate tax advantage for Canada in the treatment of business
investment. Step one is to create a meaningful tax advantage
over the United States, our closest economic partner. Step two
is to achieve the lowest tax rate on new business investment in
G7 countries.\5\
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\5\ ``Advantage Canada: Building a Strong Economy for Canadians,''
Department of Finance Canada, p. 33, available at: https://
www.fin.gc.ca/ec2006/pdf/plane.pdf.
Since 2000, average wages have grown 7 percent faster in Canada than in
the United States.\6\ And even with the substantially lower tax rate,
Canada's federal corporate tax revenues as a share of GDP are greater
than those of the United States and greater than in the 1980s when
Canada's federal tax rate was twice as high.\7\
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\6\ OECD statistics, available at: https://stats.oecd.org/
Index.aspx?DataSetCode=AV_AN_
WAGE.
\7\ See, Fiscal References, Table 4, providing historical data on
Canadian federal tax revenues, available at: http://www.fin.gc.ca/frt-
trf/2016/frt-trf-16-eng.pdf.
Perhaps not surprisingly, Canada understands U.S. tax reform can end
Canada's tax advantage and attract greater investment to the United
States.\8\
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\8\ See recent articles in the Canadian press describing the
potentially adverse impact of U.S. corporate tax reform on Canada's
current tax advantage as well as the benefits to the United States:
``Donald Trump's `big, big' corporate tax cut could `erase Canada's
advantage','' Global News, March 1, 2017; (http://globalnews.ca/news/
3279987/donald-trump-corporate-tax-cut-canada/); ``Trump's corporate
tax cut could end Canada's advantage,'' Toronto Star, April 26, 2017
(https://www.thestar.com/business/2017/04/26/trumps-corporate-tax-cut-
could-end-canadas-advantage.html); `` `A real negative for Canada':
Businesses warn Trump's tax plan would hurt competitiveness,'' National
Post, April 27, 2017 (http://business.financialpost.com/news/economy/a-
real-negative-for-canada-businesses-warns-trumps-tax-cut-plan-would-
hurt-competitiveness/wcm/cOddad77-5698-44b4-8f15-5ac67c9bb059).
The problem for the United States has been that nearly every developed
country has explicitly or implicitly sought to achieve a tax advantage
over the United States. Of the other 34 OECD countries, all but one
have lowered their statutory corporate tax rate since the last U.S. tax
reform--and all have set their corporate tax rate below that of the
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United States.
At the same time, territorial tax systems--under which a company pays
tax in the country in which profits are earned but not a second time
when earnings are brought home to the company's home country--have
become the norm among developed countries. Since 1990, the number of
OECD countries with territorial tax systems has grown from 9 to 29.\9\
Of the 29 countries, 21 provide 100 percent exemption for foreign
qualifying dividends and the other 8 exempt 95 to 97 percent of such
income, resulting in a home-country tax rate of approximately 1 percent
on the foreign dividend.
---------------------------------------------------------------------------
\9\ PwC, ``Evolution of Territorial Tax Systems in the OECD,''
prepared for the Technology CEO Council, April 2013; updated for
accession of Latvia to the OECD in 2016, and Latvia's adoption of
territorial rules in 2013.
U.S. companies operate in an increasingly competitive global market
place. Among companies listed in the Global Fortune 500, the number of
U.S.-headquartered companies declined by 25 percent between 2000 and
2015. U.S. companies competing abroad are virtually certain to be
facing competition from a company headquartered in a territorial
country in addition to locally headquartered companies that face only
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the local country tax.
Both a competitive U.S. corporate tax rate and adoption of a modern
international tax system can turn the current U.S. tax disadvantage
into a U.S. tax advantage. With a competitive 20 percent corporate tax
rate, a new study for Business Roundtable estimates that 4,700
companies would have remained under U.S. ownership over the past 13
years.\10\
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\10\ EY, ``Buying and Selling: Cross-Border Mergers and
Acquisitions, and the U.S. Corporate Income Tax,'' prepared for
Business Roundtable, September 2017.
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The Framework for a Competitive U.S. Corporate Tax System
Current high tax rates discourage investment and hold back wages and
job creation in the United States. Further, the current U.S.
international tax rules hinder American companies in foreign markets
and discourage them from bringing their earnings home for reinvestment.
Business Roundtable believes that reform should include reduction of
the corporate tax rate to a competitive level, taking into
consideration both federal and state corporate tax rates. Additionally,
tax reform should include adoption of a modern international tax
system, consistent with the territorial tax systems of our major
trading partners, to allow U.S. companies to compete on a level playing
field with their foreign competitors and return their foreign earnings
for investment in the U.S. economy.
We also believe these goals can be achieved in a fiscally responsible
manner, taking into account the positive macroeconomic benefits from
tax reform and a realistic budget baseline that acknowledges that
longstanding tax provisions extended repeatedly on a short-term basis
are in reality a permanent feature of current law.
We understand that tax reform will require a careful and balanced
examination of existing tax preferences and that reform of the U.S.
international tax system will be accompanied by appropriate safeguards
to protect America's tax base. However, policymakers must be careful
that proposals intended to protect against loss of the U.S. tax base
are not so broad that they undermine the ability of American companies
to compete against companies not encumbered by such restrictions.
At the end of the day, if U.S. tax reform is to be successful--if the
United States is to end the competitive tax disadvantage that U.S.
companies currently face--the reformed system should result in
companies wanting to be headquartered in the United States over foreign
domiciles. For too long we have observed investment dollars flowing out
of the United States, companies inverting or being acquired by a
foreign competitor, or entrepreneurs founding their new businesses
outside of the United States due to the U.S. tax disadvantage. It is
now time to establish a U.S. tax advantage. Let us once again make the
United States the best place in the world to establish and grow a
business.
* * * *
Business Roundtable, as the leaders of America's largest businesses,
urges Congress and the Administration to work together with the highest
priority to enact permanent, pro-growth tax reform this year in a fair
and fiscally responsible manner. We stand ready to work with you to
achieve this goal and to put America on a path of accelerated economic
growth with higher wages and greater employment opportunities for all
Americans.
______
Center for Fiscal Equity
Statement of Michael G. Bindner
Chairman Hatch and Ranking Member Wyden, thank you for the opportunity
to submit these comments for the record to the Committee on Finance. As
usual, we will preface our comments with our comprehensive four-part
approach, which will provide context for our comments.
A Value-Added Tax (VAT) to fund domestic military spending and
domestic discretionary spending with a rate between 10% and 13%, which
makes sure every American pays something.
Personal income surtaxes on joint and widowed filers with net
annual incomes of $100,000 and single filers earning $50,000 per year
to fund net interest payments, debt retirement and overseas and
strategic military spending and other international spending, with
graduated rates between 5% and 25%.
Employee contributions to Old-Age and Survivors Insurance (OASI)
with a lower income cap, which allows for lower payment levels to
wealthier retirees without making bend points more progressive.
A VAT-like Net Business Receipts Tax (NBRT), which is
essentially a subtraction VAT with additional tax expenditures for
family support, health care and the private delivery of governmental
services, to fund entitlement spending and replace income tax filing
for most people (including people who file without paying), the
corporate income tax, business tax filing through individual income
taxes and the employer contribution to OASI, all payroll taxes for
hospital insurance, disability insurance, unemployment insurance and
survivors under age 60.
Probably the most broken part of our tax code is how businesses are
taxed. Corporations pay separate taxes while sole proprietors and
``pass-throughs'' pay taxes through the personal income taxes of their
owners. This has some people being taxed twice, regardless of whether
this is appropriate to extract taxes on higher incomes not collected
through the business, while others face complexity on their personal
forms, as well as a different set of rules. In 2003, President Bush and
the Congress tried to fix this but could not, settling instead on a
lower rate for dividends and capital gains.
The results of simply cutting rates were not pretty. CEOs and investors
had an incentive to keep labor costs in check and pocket all
productivity gains, which were huge through automation and outsourcing.
Higher tax rates would have put a damper on such behavior. Of course,
because not every rich person can be a CEO and because most companies
borrowed money rather than issued stock, there were few good
investments, which had beneficiaries of the 2001 and 2003 tax cuts seek
more exotic vehicles, like oil futures and mortgage-backed securities.
This (not any action by the GSEs) led to the mortgage boom and the
Great Recession (as well as provisions in the 1986 tax reform that let
homeowners use their houses as ATMs, a provision Trump wants to keep).
The President proposes simply lowering the tax on ``pass-through''
income, which will increase the number of companies fronting what would
have been pay to individuals for salary and rent in order to take
advantage of the lower rates. This is tax DEFORM not reform. We tried
such cuts in 2003 and the proposed cut will yield the same result,
especially if the President succeeds in defanging Dodd-Frank through
regulatory reform (again deform).
There is a better way. Value-Added Taxes and Net Business Receipts
Taxes (Subtraction VAT) will both simplify taxation and treat all
businesses in the same way. While some special tax breaks might be
preserved in the NBRT, most would not because there would be no way to
justify taxing the labor or an activity and not the associated profit
or taxing research salaries one way and production wages another. All
profit and wage would be taxed at the same rate, which also removes the
tax bias against wage income.
The proposed Destination-Based Cash Flow Tax is a compromise between
those who hate the idea of a value-added tax and those who seek a
better deal for workers in trade. It is not a very good idea because it
does not meet World Trade Organization standards, though a VAT would.
It would be simpler to adopt a VAT on the international level and it
would allow an expansion of family support through an expanded child
tax credit. Many in the majority party oppose a VAT for just that
reason, yet call themselves pro life, which is true hypocrisy. Indeed,
a VAT with enhanced family support is the best solution anyone has
found to grow the economy and increase jobs.
Some oppose VATs because they see it as a money machine, however this
depends on whether they are visible or not. A receipt visible VAT is as
susceptible to public pressure to reduce spending as the FairTax is
designed to be, however unlike the FairTax, it is harder to game.
Avoiding lawful taxes by gaming the system should not be considered a
conservative principle, unless conservatism is in defense of entrenched
corporate interests who have the money to game the tax code.
Our VAT rate estimates are designed to fully fund non-entitlement
domestic spending not otherwise offset with dedicated revenues. This
makes the burden of funding government very explicit to all taxpayers.
Nothing else will reduce the demand for such spending, save perceived
demands from bondholders to do so--a demand that does not seem evident
given their continued purchase of U.S. Treasury Notes.
Value-Added Taxes can be seen as regressive because wealthier people
consume less, however when used in concert with a high-income personal
income tax and with some form of tax benefit to families, as we suggest
as part of the NBRT, this is not the case.
This is not to say that there will be no deductions. The NBRT will be
the vehicle for social spending through the tax code.
The NBRT base is similar to a Value-Added Tax (VAT), but not identical.
Unlike a VAT, an NBRT would not be visible on receipts and should not
be zero rated at the border--nor should it be applied to imports. While
both collect from consumers, the unit of analysis for the NBRT should
be the business rather than the transaction. As such, its application
should be universal--covering both public companies who currently file
business income taxes and private companies who currently file their
business expenses on individual returns.
In the long term, the explosion of the debt comes from the aging of
society and the funding of their health-care costs. Some thought should
be given to ways to reverse a demographic imbalance that produces too
few children while life expectancy of the elderly increases.
Unassisted labor markets work against population growth. Given a choice
between hiring parents with children and recent college graduates, the
smart decision will always be to hire the new graduates, as they will
demand less money--especially in the technology area where recent
training is often valued over experience.
Separating out pay for families allows society to reverse that trend,
with a significant driver to that separation being a more generous tax
credit for children. Such a credit could be ``paid for'' by ending the
Mortgage Interest Deduction (MID) without hurting the housing sector,
as housing is the biggest area of cost growth when children are added.
While lobbyists for lenders and realtors would prefer gridlock on
reducing the MID, if forced to choose between transferring this
deduction to families and using it for deficit reduction (as both
Bowles-Simpson and Rivlin-Domenici suggest), we suspect that they would
choose the former over the latter if forced to make a choice. The
religious community could also see such a development as a ``pro-life''
vote, especially among religious liberals.
Enactment of such a credit meets both our nation's short term needs for
consumer liquidity and our long term need for population growth. Adding
this issue to the pro-life agenda, at least in some quarters, makes
this proposal a win for everyone.
Our proposals dovetail on our prior comments testimony on Individual
Taxes. Tax benefits and filings that were once found in the individual
code would be moved to the Business code. The most obvious provision is
that most families will no longer have to file individual income taxes.
Most will receive all of their tax benefits through an employer paid
net business receipts tax, which is essentially a subtraction VAT.
Health benefits through the Affordable Care Act or the health insurance
exclusion for corporate income taxes will come through the NBRT, as
will a refundable child tax credit paid through wages or education or
social insurance benefits, rather than through end of the year tax
filing, the EITC, TANF or SNAP.
The NBRT should fund services to families, including education at all
levels, mental health care, disability benefits, Temporary Aid to Needy
Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If
society acts compassionately to prisoners and shifts from punishment to
treatment for mentally ill and addicted offenders, funding for these
services would be from the NBRT rather than the VAT.
The NBRT could also be used to shift governmental spending from public
agencies to private providers without any involvement by the
government--especially if the several states adopted an identical tax
structure. Either employers as donors or workers as recipients could
designate that revenues that would otherwise be collected for public
schools would instead fund the public or private school of their
choice. Private mental health providers could be preferred on the same
basis over public mental health institutions. This is a feature that is
impossible with the FairTax or a VAT alone.
To extract cost savings under the NBRT, allow companies to offer
services privately to both employees and retirees in exchange for a
substantial tax benefit, provided that services are at least as
generous as the current programs. Employers who fund catastrophic care
would get an even higher benefit, with the proviso that any care so
provided be superior to the care available through Medicaid. Making
employers responsible for most costs and for all cost savings allows
them to use some market power to get lower rates, but not so much that
the free market is destroyed. Increasing Part B and Part D premiums
also makes it more likely that an employer-based system will be
supported by retirees.
Conceivably, NBRT offsets could exceed revenue. In this case, employers
would receive a VAT credit.
Business owners, whether sole proprietors, partners, Schedule C or 1099
employees will file through the NBRT and also collect VAT, both of
which will be coordinated with state revenue agencies and forwarded to
the government. Form 1099 employees will not be required to file or get
their own insurance unless they have multiple clients. Even then, the
clients will pay the tax on their value added and provide insurance and
retirement savings as if they were employees. We have inflated the
number of ``small businesses'' for quite too long.
While some employee sole proprietors might like the freedom of multiple
clients, most work for only one and would rather have full benefits and
no tax filing. Congress can do this small thing for them in tax reform.
Indeed, there is no reason to do tax reform without such changes
(especially the child tax credit expansion). The larger firms will
navigate and exploit the tax code regardless of reform, so their
interests are not so important unless campaign contributions are really
bribes.
The VAT and NBRT would eliminate the need for any corporate income tax,
or as they used to be called, corporate profits taxes. Because
consumption taxes burden labor and profit at the same rate, discounted
tax rates on dividends and capital gains would no longer be required.
Any residual income or inheritance surtax would be a way to maintain
progressivity by charging a higher rate or rates for households
receiving higher incomes from the same business activities.
Value-added taxes act as instant economic growth, as they are spur to
domestic industry and its workers, who will have more money to spend.
The Net Business Receipts Tax as we propose it includes a child tax
credit to be paid with income of between $500 and $1,000 per month.
Such money will undoubtedly be spent by the families who receive it on
everything from food to housing to consumer electronics.
The tax reforms detailed here will make the nation truly competitive
internationally while creating economic growth domestically, not by
making job creators richer but families better off. The Center's reform
plan will give you job creation. The current blueprint and the
President's proposed tax cuts for the wealthy will not.
In September 2011, the Center submitted comments on Economic Models
Available to the Joint Committee on Taxation for Analyzing Tax Reform
Proposals. Our findings, which were presented to the JCT and the
Congressional Budget Office (as well as the Wharton School and the Tax
Policy Center), showed that when taxes are cut, especially on the
wealthy, only deficit spending will lead to economic growth as we
borrow the money we should have taxed. When taxes on the wealthy are
increased, spending is also usually cut and growth still results. The
study is available at http://fiscalequity.blogspot.com/ 2011/09/
economic-models-available-to-joint.html.
Our current expansion and the expansion under the Clinton
Administration show that higher tax rates always spur growth, while tax
cuts on capital gains lead to toxic investments--almost always in
housing. Business expansion and job creation will occur with economic
growth, not because of investment from the outside but from the
recycling of profits and debt driven by customers rather than the price
of funds. We won't be fooled again by the saccharin song of the supply
siders, whose tax cuts have led to debt and economic growth more
attributable to the theories of Keynes than Stockman and Gramm.
Thank you for the opportunity to address the committee. We are, of
course, available for direct testimony or to answer questions by
members and staff.
______
Coalition to Preserve Cash Accounting
September 27, 2017
The Honorable Orrin Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance Committee on Finance
219 Dirksen Senate Office Building 219 Dirksen Senate Office Building
Washington, DC 20510-6200 Washington, DC 20510-6200
Dear Chairman Hatch and Ranking Member Wyden:
On behalf of the Coalition to Preserve Cash Accounting (``the
Coalition''), we are writing to explain why it is important to continue
to allow farmers, ranchers, and service provider pass-through
businesses to continue to use the cash method of accounting as part of
any tax reform plan. We appreciate the opportunity to provide these
comments in connection with the Senate Committee on Finance's September
19, 2017 hearing on ``Business Tax Reform.'' The Coalition applauds
your efforts to improve the nation's tax code to make it simpler,
fairer and more efficient in order to strengthen the U.S. economy, make
American businesses more competitive, and create jobs.
The Coalition is comprised of dozens of individual businesses and
trade associations representing thousands of farmers, ranchers, and
service provider pass-through entities across the United States that
vary in line of business, size and description, but have in common that
our members rely on the use of cash accounting to simply and accurately
report income and expenses for tax purposes. Pass-through entities
account for more than 90 percent of all business entities in the United
States. A substantial number of these businesses are service providers,
farmers, and ranchers that currently qualify to use cash accounting.
They include a variety of businesses throughout America--farms,
trucking, construction, engineers, architects, accountants, lawyers,
dentists, doctors, and other essential service providers--on which
communities rely for jobs, health, infrastructure, and improved quality
of life. These are not just a few big businesses and a few well-to-do
owners. According to IRS data, there are over 2.5 million partnerships
using the cash method of accounting, in addition to hundreds of
thousands of Subchapter S corporations eligible to use the cash method.
About the Cash Method of Accounting
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; expenses are deductible even if they have not yet
been paid.
The tax code permits farmers, ranchers, and service pass-through
entities (with individual owners paying tax at the individual level) of
all sizes--including partnerships, Subchapter S corporations, and
personal service corporations--to use the cash method of accounting.
Cash accounting is the foundation upon which we have built our
businesses, allowing us to simply and accurately report our income and
expenses, and to manage our cash flows, for decades. It is a simple and
basic method of accounting--we pay taxes on the cash coming in the
door, and we deduct expenses when the cash goes out the door. No
gimmicks, no spin, no game playing. Cash accounting is the very essence
of the fairness and simplicity that is on everyone's wish list for tax
reform.
Some recent tax reform proposals would require many of our
businesses to switch to the accrual method of accounting, not for any
policy reason or to combat abuse, but rather for the sole purpose of
raising revenues for tax reform. Forcing such a switch would be an
effective tax increase on the thousands upon thousands of individual
owners who generate local jobs and are integral to the vitality of
local economies throughout our nation. It would also increase our
recordkeeping and compliance costs due to the greater complexity of the
accrual method. Because many of our businesses would have to borrow
money to bridge the cash flow gap created by having to pay taxes on
money we have not yet collected, we may incur an additional cost with
interest expense, a cost that would be exacerbated if interest expense
is no longer deductible, as proposed under the House Republicans'
Better Way blueprint (``the blueprint''). Some businesses may not be
able to borrow the necessary funds to bridge the gap, requiring them to
terminate operations with a concomitant loss of jobs and a harmful
ripple effect on the surrounding economy.
Tax Reform Proposals and Cash Accounting
The blueprint moves toward a cash flow, destination-based
consumption tax. The cash flow nature of the proposal suggests that the
cash method of accounting would be integral and entirely consistent
with the blueprint since it taxes ``cash-in'' and allows deductions for
``cash-out,'' including full expensing of capital expenditures. While
we understand that they are different proposals, the ABC Act (H.R.
4377), a cash flow plan introduced by Rep. Devin Nunes (R-CA) in the
114th Congress, required all businesses to use the cash method.
However, the blueprint does not provide details regarding the use of
the cash method, including whether all businesses would be required to
use it, whether businesses currently allowed to use the cash method
would continue to be allowed to do so, whether a hybrid method of cash
and accrual accounting would apply, or some other standard would be
imposed.
President Trump's tax reform plan is not a cash flow plan and takes
a more traditional income tax-based approach, yet the principles
articulated in the administration's plan are entirely consistent with
the continued availability of the cash method of accounting. Growing
the economy, simplification, and tax relief are exemplified by the cash
method of accounting. Requiring businesses that have operated using the
cash method since their inception to suddenly pay tax on money they
have not yet collected, and may never collect, is an effective tax
increase, and will have a contraction effect on the economy as funds
are diverted from investment in the business to pay taxes on money they
have not received or as businesses close because of insufficient cash
flow and inability to borrow. It is important to note that cash
accounting is not a ``tax break for special interests;'' it is a
simple, well-established and long-authorized way of reporting income
and expenses used by hundreds of thousands of family-owned farms,
ranches, businesses, and Main Street service providers that are the
backbone of any community.
Several recent tax reform proposals, including Senator John Thune's
(R-SD) S. 1144, the Investment in New Ventures and Economic Success
Today Act of 2017, would expand the use of cash accounting to allow all
businesses under a certain income threshold, including those businesses
with inventories, to use cash accounting. Such proposals aim to
simplify and reduce recordkeeping burdens and costs for small
businesses, while still accurately reporting income and expenses. A few
of these proposals (not S. 1144) would pay for this expansion 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 the goals of
tax reform to pay for good policy with bad policy that has no other
justification than raising revenues. When cash accounting makes sense
for a particular type of business, the size of the business should make
no difference. Further, there have been no allegations that the
businesses currently using cash accounting are abusing the method,
inaccurately reporting income and expenses, or otherwise taking
positions inconsistent with good tax policy.
Tax reform discussions seem to be trending toward faster cost
recovery than under current law. For example, the blueprint allows for
full expensing of capital investment, Senator Thune's bill makes bonus
depreciation permanent, and comments from administration officials
suggest that President Trump and his team prefer faster write-offs of
capital assets. Such policies benefit capital intensive businesses.
However, service businesses by their very nature are not capital
intensive, so it would be unfair to allow faster cost recovery for some
businesses while imposing an effective tax increase and substantial new
administrative burdens on pass-through service providers who will not
benefit from more generous expensing or depreciation rules by taking
away the use of cash accounting.
Other Implications of Limiting Cash Accounting
In addition to the policy implications, there are many practical
reasons why the cash method of accounting is the best method to
accurately report income and expenses for farmers, ranchers, and pass-
through service providers:
The accrual method would severely impair cash flow. Businesses
could be forced into debt to finance their taxes, including
accelerated estimated tax payments, on money we may never
receive. Many cash businesses operate on small profit margins,
so accelerating the recognition of income could be the
difference between being liquid and illiquid, and succeeding or
failing (with the resulting loss of jobs).
Loss of cash accounting will make it harder for farmers to stay
in business. 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
predictability, flexibility and simplicity of cash accounting
to match income with expenses in order to handle their tax
burden that otherwise could fluctuate greatly from one year to
the next. Cash accounting requires no amended returns to even
out the fluctuations in annual revenues that are inherent in
farming and ranching.
Immutable factors outside the control of businesses make it
difficult to determine income. Many cash businesses have
contracts with the government, which is known for long delays
in making payments that already stretch their working capital.
Billings to insurance companies and government agencies for
medical services may be subject to being disputed, discounted,
or denied. Service recipients, many of whom are private
individuals, may decide to pay only in part or not at all, or
force the provider into protracted collection. Structured
settlements and alternative fee arrangements can result in
substantial delays in collections, sometimes over several
years; therefore, taxes owed in the year a matter is resolved
could potentially exceed the cash actually collected.
Recordkeeping burdens, including cost, staff time, and
complexity, would escalate under accrual accounting. 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, as well as the amounts involved. In order to
comply with the more complex rules, businesses currently
handling their own books and records may feel they have no
other choice than to hire outside help or incur the additional
cost of buying sophisticated software.
Accrual accounting could have a social cost. Farmers, ranchers,
and service providers routinely donate their products and
services to underserved and underprivileged individuals and
families. An effective tax increase and increased
administrative costs resulting from the use of accrual
accounting could impede the ability of these businesses to
provide such benefits to those in need in their local
communities.
Conclusions
The ability of a business to use cash accounting should not be
precluded based on the size of the business or the amount of its gross
receipts. Whether large or small, a business can have small profit
margins, rely on slow-paying 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 the already agreed upon principles of tax reform, which focus on
strengthening our economy, fostering job growth, enhancing U.S.
competitiveness, and promoting 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 the
goal of moving 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 further
disadvantage them in comparison to foreign competitors. It is simply
unfair to ask the individual owners of pass-through businesses to
shoulder the financial burden for tax reform by forcing them to pay
taxes on income they have not yet collected where such changes are
likely to leave them in a substantially worse position than when they
started.
As discussions on tax reform continue, the undersigned respectfully
request that you take our concerns into consideration and not limit our
ability to use cash accounting. We would be happy to discuss our
concerns in further detail. Please feel free to contact Mary Baker
([email protected]) or any of the signatories for additional
information.
Thank you for your consideration of this important matter.
Sincerely,\1\
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\1\ Although not a signatory to this letter, the American Bar
Association (ABA) is working closely with the Coalition and has
expressed similar concerns regarding proposals to limit the ability of
personal service businesses to use cash accounting. The ABA's most
recent letter to the Senate Committee on Finance sent in April 2017 is
available at: http://bit.ly/2xvv6YB.
Americans for Tax Reform
American Council of Engineering Companies
American Farm Bureau Federation
American Institute of Certified Public Accountants
American Medical Association
American Society of Interior Designers
The American Institute of Architects
The National Creditors Bar Association
Akin, Gump, Strauss, Hauer, and Feld LLP
Baker Donelson
Debevoise and Plimpton LLP
Dorsey and Whitney LLP
Foley and Lardner LLP
Jackson Walker LLP
K&L Gates LLP
Kilpatrick, Townsend, and Stockton LLP
Lewis, Roca, Rothgerber, Christie LLP
Littler Mendelson P.C.
Miles and Stockbridge P.C.
Mitchell, Silberberg, and Knupp LLP
Morrison and Foerster LLP
Nelson, Mullins, Riley, and Scarborough LLP
Ogletree, Deakins, Nash, Smoak, and Stewart, P.C.
Perkins Coie LLP
Quarles and Brady LLP
Rubin and Rudman LLP
Squire Patton Boggs (U.S.) LLP
Steptoe and Johnson LLP
White and Case LLP
______
CVS Health
1275 Pennsylvania Avenue, NW, Suite 700
Washington, DC 20004
Chairman Hatch, Ranking Member Wyden, and Members of the Committee,
thank you for the opportunity for CVS Health, on behalf of its
subsidiaries and affiliated entities, to highlight the importance of
comprehensive tax reform. CVS Health believes that tax reform that
includes a significant and meaningful reduction in the corporate tax
rate is the single most effective step Congress can take to strengthen
the economy, create jobs, and foster innovation. CVS Health is
committed to working with Congress and the Administration to advance
tax reform that achieves these goals.
CVS Health is a U.S.-based domestic company with nearly 250,000
employees across the United States. As a pharmacy innovation company,
we are committed to helping people on their path to better health. We
operate 9,600 retail pharmacies and 1,100 Minute Clinics, and cover 90
million lives through our pharmacy benefit management division, in
addition to our home infusion, long-term care, specialty and mail-order
business operations throughout the country. CVS Health helps people,
businesses and communities manage health care in more affordable,
effective ways. One in three Americans have touch points with CVS
Health services each year, and 75 percent of people in the United
States live within 3 to 5 miles of a CVS store. Our unique integrated
model increases access to quality care, delivers better health
outcomes, and lowers overall health-care costs.
The single most important issue in tax reform for CVS Health is a
significant and meaningful reduction in the corporate tax rate. With an
effective federal tax rate of 35 percent, CVS Health pays one of the
highest effective tax rates in the world on our operating income. In
2016, CVS Health's effective federal tax rate was actually greater than
the statutory federal tax rate of 35 percent, and CVS Health paid
nearly 1 percent of all corporate taxes collected in the United States.
CVS Health strongly supports comprehensive tax reform that includes a
meaningful reduction in the corporate rate, and believes that all
corporate credits, preference items, and special deductions should be
closely evaluated and scrutinized in pursuit of achieving a lower rate.
With a lower rate, CVS Health could immediately create new jobs and
help grow the economy. For each single-digit reduction in the corporate
rate, CVS Health could generate more than $90 million in incremental
annual capital to be invested in communities across the United States.
If the corporate rate was reduced to 25 percent, for example, that
would free up $900 million a year that could be used to substantially
increase our annual investments in growth and innovation. With a 25
percent corporate rate, CVS Health could build 50 new pharmacies and
open 100 new Minute Clinics each year, in addition to our current
planned investment and growth. We would also need to accelerate by 2 or
3 years the construction of a new distribution center to support our
additional locations. We would further invest $140 to $200 million in
new technology to improve health-care outcomes and access, including
breakthrough digital tools to address issues like medication adherence.
By increasing our annual investment into new pharmacies, clinics,
supporting facilities, and technologies, CVS Health could create as
many as 3,000 permanent jobs within just 2 to 3 years, as well as up to
4,500 temporary construction jobs per year. In turn, this would
generate more than $42 million in new annual salaries and benefits
every year, significantly increasing employee purchasing power and
spurring growth in local economies.
We support the proposal on corporate integration as a way to reduce
the total tax burden on corporate earnings, and we appreciate your
leadership and work on this issue. Like a reduction in the corporate
rate, we believe that corporate integration would promote economic
growth and competitiveness. Further, corporate integration tends to
encourage equity financing, which reduces the preference for debt
financing without the challenges of limiting the deductibility of
interest expense.
In conclusion, CVS Health strongly supports comprehensive tax
reform that meaningfully lowers the corporate rate. Tax reform is
critical to faster economic growth, and we believe that Congress
currently has a once in a lifetime opportunity to overhaul the tax code
and drive economic growth. CVS Health strongly supports comprehensive
tax reform that meaningfully lowers the corporate tax rate, and
provides certainty and predictability for businesses to invest. CVS
Health is committed to working with the Committee to advance this
important goal.
______
Dwight J. Davis
King Springs Pecans, LLC
Managing Partner
Chairman Hatch, Ranking Member Wyden, Senator Isakson, and members of
the Committee:
Thank you for the opportunity to address this esteemed Committee on the
subject of tax reform and business interest deductibility. As
background, I am the proud co-owner of King Springs Pecans in
Hawkinsville, Georgia. I am also a strong supporter of the effort to
reform our tax system.
Like many pecan farmers in Georgia, my business partner and I have made
a sizeable investment into the production of food for both domestic and
international markets. Also, like most farmers, our expenses in growing
these crops do not occur at or near the time our revenues occur.
Accordingly, we must borrow a sizeable amount of money to operate a
successful family farm. Pecan farmers, like most farmers, have little
or no interest income against which to claim a deduction for the
interest expense associated with the revolving debt. The denial of the
interest deduction will seriously erode the income from farms which, as
is well known, already operate on slim margins. Moreover, the proposal
to allow immediate expensing for one-time asset purchases will not
offset the loss of the tax deduction for recurring interest expense.
The importance of access to debt is even more important during
difficult financial times. As you know, Hurricane Irma ravaged the
southeast and caused severe damage to the agricultural sector. The
Georgia Pecan industry was especially hit hard. It is estimated that
collectively we lost 30% of our yield this year and many pecan farmers
lost 80% of their crops. Literally thousands of producing pecan trees
were destroyed and this will adversely affect crop yields for years to
come. Similar losses have occurred in the peach and blueberry crops.
As for our farm, we look to rebuild and replant any damaged trees. We
will need access to capital for our operations and rebuilding. The
deduction for interest payments will be critical to this recovery.
Thank you for this opportunity to be heard. If I can supply any
additional information, please do not hesitate to contact me.
______
Enterprise Community Partners
10 G Street, NE, Suite 580
Washington, DC 20002
202-842-9190
www.EnterpriseCommunity.com
Enterprise Community Partners thanks Chairman Orrin Hatch and the
Committee for the opportunity to provide feedback on the Senate Finance
Committee's hearing on business tax reform, held Tuesday, September 19,
2017. Enterprise is a national nonprofit organization whose mission is
to create opportunity for low- and moderate-income people through
affordable housing in diverse, thriving communities. We work to achieve
this by introducing solutions through cross-sector public-private
partnerships with financial institutions, governments, community
organizations and other partners that share our vision. Since 1982,
Enterprise has raised and invested $28.9 billion to help finance nearly
380,000 affordable homes across the United States. Two of the primary
tools Enterprise uses to invest in communities are the Low-Income
Housing Tax Credit (Housing Credit) and the New Markets Tax Credit
(NMTC), both of which will be impacted by business tax reform.
Enterprise has invested $12 billion in Housing Credit equity, financing
nearly 150,000 affordable housing homes, and placed more than $700
million of NMTC equity in over 60 commercial and mixed-use developments
nationwide.
We are especially grateful for Finance Committee Chairman Hatch's and
Committee member Senator Maria Cantwell's leadership in championing
legislation to expand and strengthen the Housing Credit, our nation's
primary tool for encouraging private investment in affordable rental
housing. As hearing witness Jeffrey D. DeBoer, President and CEO at the
Real Estate Roundtable, stated in his written testimony, low-income
housing is an example of a tax incentive that is ``needed to address
market failures and encourage capital to flow to socially desirable
projects.'' We strongly urge the Committee to advance the Affordable
Housing Credit Improvement Act of 2017 (S. 548) this year, and protect
both the Credit and multifamily Housing Bonds--a central component of
the Housing Credit program--as part of any tax reform effort considered
by Congress.
We also thank Senator Cantwell for raising the impact of tax reform on
the Housing Credit during the Committee's hearing. As Senator Cantwell
noted, the prospect of lower corporate tax rates has resulted in lower
levels of investment capital in affordable housing development,
impacting production at a time when our nation's shortage of affordable
housing has never been greater. We urge the Senate Finance Committee to
make any adjustments to the Housing Credit needed beyond those proposed
in the Affordable Housing Credit Improvement Act to ensure that
affordable housing production continues at a robust level regardless of
other changes made in tax reform.
Enterprise also urges the Senate Finance Committee to preserve and
expand the NMTC as part of any tax reform effort considered by
Congress. As Chairman Hatch noted in his opening statement, a chief
goal of tax reform should be economic growth, and the NMTC is a proven
and effective tool to spur economic development and revitalize
distressed urban and rural communities. Without the NMTC, low-
income communities across the country will continue to be starved of
the patient capital needed to support and grow businesses, create jobs
and increase economic opportunity. Enterprise urges the committee to
support the New Markets Tax Credit Extension Act of 2017 (S. 384),
introduced by Senators Roy Blunt (R-MO) and Ben Cardin (D-MD), to
indefinitely extend the NMTC. This legislation has bipartisan support,
including the support of several members of the Finance Committee.
THE HOUSING CREDIT
The Housing Credit has a Remarkable Track Record
President Reagan and the Congress showed remarkable foresight when they
created the Housing Credit as part of the Tax Reform Act of 1986. The
Housing Credit is now our nation's most successful tool for encouraging
private investment in the production and preservation of affordable
rental housing, with a proven track record of creating jobs and
stimulating local economies. For over 30 years, the Housing Credit has
been a model public-private partnership program, bringing to bear
private-sector resources, market forces, and state-level administration
to finance more than 3 million affordable apartments--nearly one-third
of the entire U.S. inventory--giving more than 7 million households,
including low-income families, seniors, veterans, and people with
disabilities, access to homes they can afford. Roughly 40 percent of
these homes were financed in conjunction with multifamily Housing
Bonds, which are an essential component of the program's success.
The Housing Credit is a Proven Solution to Meet a Vast and Growing Need
Despite the Housing Credit's tremendous impact, there are still over 11
million renter households--roughly one out of every four--who spend
more than half of their income on rent, leaving too little for other
necessary expenses like transportation, food, and medical bills. This
crisis is continuing to grow. HUD reports that as of 2015, the number
of households with ``worst case housing needs'' had increased by 38.7
percent over 2007 levels, when the recession began, and by 63.4 percent
since 2001. A study by Harvard University's Joint Center for Housing
Studies and Enterprise Community Partners estimates that the number of
renter households who pay more than half of their income towards rent
could grow to nearly 15 million by 2025.
Without the Housing Credit, there would be virtually no private
investment in affordable housing. It simply costs too much to build
rental housing to rent it at a level that low-income households can
afford. In order to develop new apartments that are affordable to
renters earning the full-time minimum wage, construction costs would
have to be 72 percent lower than the current average.
The Housing Credit Creates Jobs
Housing Credit development supports jobs--roughly 1,130 for every 1,000
Housing Credit apartments developed, according to the National
Association of Home Builders (NAHB). This amounts to roughly 96,000
jobs per year, and more than 3.4 million since the program was created
in 1986. NAHB estimates that about half of the jobs created from new
housing development are in construction. Additional job creation occurs
across a diverse range of industries, including the manufacturing of
lighting and heating equipment, lumber, concrete, and other products,
as well as jobs in transportation, engineering, law, and real estate.
The Housing Credit Stimulates Local Economies and Improves Communities
The Housing Credit has a profound and positive impact on local
economies. NAHB estimates that the Housing Credit adds $9.1 billion in
income to the economy and generates approximately $3.5 billion in
federal, state, and local taxes each year.
Conversely, a lack of affordable housing negatively impacts economies.
Research shows that high rent burdens have priced out many workers from
the most productive cities, resulting in 13.5 percent foregone GDP
growth, a loss of roughly $1.95 trillion, between 1964 and 2009.
Housing Credit development also positively impacts neighborhoods in
need of renewal. About one-third of Housing Credit properties help
revitalize distressed communities. Stanford University research shows
Housing Credit investments improve property values and reduce poverty,
crime, and racial and economic isolation, generating a variety of
socio-economic opportunities for Housing Credit tenants and
neighborhood residents.
Affordable Housing Improves Low-Income Households' Financial Stability
Affordable housing promotes financial stability and economic mobility.
It leads to better health outcomes, improves children's school
performance, and helps low-
income individuals gain employment and keep their jobs. Affordable
housing located near transportation and areas with employment
opportunities provides low-income households with better access to
work, which increases their financial stability and provides employers
in those areas with needed labor.
Families living in affordable homes have more discretionary income than
low-income families who are unable to access affordable housing. This
allows them to allocate more money to other needs, such as health care
and food, and gives them the ability to pay down debt, access
childcare, and save for education, a home down payment, retirement, or
unexpected needs.
The Housing Credit is a Model Public-Private Partnership
The Housing Credit is structured so that private sector investors
provide upfront equity capital in exchange for a credit against their
tax liability over 10 years, which only vests once the property is
constructed and occupied by eligible households paying restricted
rents. This unique, market-based design transfers the risk from the
taxpayer to the private sector investor. In the rare event that a
property falls out of compliance during the first 15 years after it is
placed in service, the Internal Revenue Service can recapture tax
credits from the investor. Therefore, it is in the interest of the
private sector investors to ensure that properties adhere to all
program rules, including affordability restrictions and high-quality
standards--adding a unique accountability structure to the program.
The Housing Credit is State-Administered With Limited Federal
Bureaucracy
The Housing Credit requires only limited federal bureaucracy because
Congress wisely delegated its administration and decision-making
authority to state government as part of its design. State Housing
Finance Agencies, which administer the Housing Credit in nearly every
state, have statewide perspective; a deep understanding of the needs of
their local markets; and sophisticated finance, underwriting, and
compliance capacity. States develop a system of incentives as part of
their Qualified Allocation Plans (QAP), which drives housing
development decisions, including property siting, the populations
served and the services offered to residents. States are also deeply
involved in monitoring Housing Credit properties, including compliance
audits and reviews of financial records, rent rolls, and physical
conditions.
The Housing Credit is Critical to Preserving Our Nation's Existing
Housing Investments
The Housing Credit is our primary tool to preserve and redevelop our
nation's current supply of affordable housing. For every new affordable
apartment created, two are lost due to deterioration, abandonment, or
conversion to more expensive housing. Without the Housing Credit, our
ability to revitalize and rehabilitate our nation's public housing and
Section 8 housing inventory, decades in the making, would be
significantly diminished. In addition to putting the residents of these
properties at risk of displacement, we would lose these investments
that taxpayers have already made. Preservation is also more cost-
effective, costing 33 percent less than new construction.
The Housing Credit is the Single Largest Financing Source for
Affordable Rural Homes
Since it was created, the Housing Credit has developed or preserved
270,000 affordable homes in rural communities, supporting 1.15 million
jobs and generating $86.9 billion in local income. In rural areas,
where direct funding for rural housing programs has been cut
significantly, the Housing Credit is the backbone for preservation and
capital improvements to the existing housing stock, comprising nearly
half of all financing. Low-income rural residents ' incomes average
just $12,960, and they are often living in areas with extremely limited
housing options, making preservation of the existing housing stock
crucial.
The Demand for Housing Credits Exceeds the Supply
Viable and sorely needed Housing Credit developments are turned down
each year because the cap on Housing Credit authority is far too low to
support the demand. In 2014--the most recent year for which data is
available--state Housing Credit allocating agencies received
applications requesting more than twice their available Housing Credit
authority. Many more potential applications for worthy developments are
not submitted in light of the intense competition, constrained only by
the lack of resources. A recent analysis by accounting firm CohnReznick
finds that there is a 97.8% occupancy rate for Housing Credit
properties, underscoring the successful operation of Housing Credit
properties and the need for more resources to meet the nation's growing
demand for affordable housing.
The scarcity of Housing Credit resources forces state allocating
agencies to make difficult trade-offs between directing their extremely
limited Housing Credit resources to preservation or new construction,
to rural or urban areas, to neighborhood revitalization or developments
in high opportunity areas, or to housing for the homeless, the elderly,
or veterans. There simply is not enough Housing Credit authority to
fund all of the properties needed, but with a substantial increase in
resources, many more of these priorities would be addressed--and the
benefits for communities would be even greater.
Though the need for Housing Credit-financed housing has long vastly
exceeded its supply, Congress has not increased Housing Credit
authority permanently in 17 years.
We Urge Congress to Expand and Strengthen the Housing Credit
To meaningfully grow our economy and address our nation's growing
affordable housing needs through tax reform, we urge Congress to
increase the cap on Housing Credit authority by 50 percent. Such an
expansion would support the preservation and construction of up to
400,000 additional affordable apartments over a 10-year period.
S. 548, which would authorize such an expansion, has earned strong
bipartisan support in the Senate and among Senate Finance Committee
members. This legislation would increase Housing Credit allocation
authority by 50 percent phased in over 5 years, and enact roughly two
dozen changes to strengthen the program by streamlining program rules,
improving flexibility, and enabling the program to serve a wider array
of local needs. For example, S. 548 would encourage Housing Credit
development in rural and Native communities, where it is currently more
difficult to make affordable housing developments financially feasible;
Housing Credit developments that serve the lowest-income tenants,
including veterans and the chronically homeless; the development of
mixed-income properties; the preservation of existing affordable
housing; and development in high-opportunity areas. The legislation
would also generate a host of benefits for local communities, including
raising local tax revenue and creating jobs.
We also call on Congress to retain the tax exemption on multifamily
Housing Bonds, which are essential to Housing Credit production. In
addition, we encourage Congress to make any adjustments needed in order
to offset the impact of a lower corporate tax rate on Housing Credit
investment and subsequent affordable housing production, a concern that
Senator Cantwell voiced during the hearing.
An investment in the Housing Credit is an investment in individuals,
local communities, and the economy. It transforms the lives of millions
of Americans, many of whom are able to afford their homes for the first
time--and it transforms their communities and local economies.
Enterprise applauds the leadership the Senate Finance Committee has
shown in support of the Housing Credit to date and urges the Committee
to expand and strengthen the Housing Credit and multifamily Housing
Bonds in tax reform.
NEW MARKETS TAX CREDIT
The NMTC is a Successful Component of the Business Tax System and
Should Be Preserved
The NMTC encourages private capital to flow to some of the most
economically distressed communities in the country, both urban and
rural, by providing a modest tax incentive to investors who provide
capital to qualified Community Development Entities (CDEs). The NMTC
enjoys bipartisan support because it is an effective, targeted and
cost-efficient financing tool valued by businesses, communities and
investors. At the end of 2016, the NMTC had financed over 5,400
businesses, creating 178 million square feet of manufacturing, office
and retail space in distressed communities that would not have been
possible without the Credit. In 2010 alone, NMTC investments in
operational activities generated almost $1.1 billion in federal tax
revenue, easily offsetting the estimated $720 million cost of the
program for the federal government.
As the Committee considers reforms to the nation's tax code that
incentivize economic growth and job creation, our nation's most
distressed communities should remain at the forefront of the
conversation. The NMTC has proven to be a successful component of the
current business tax system that should be preserved as the tax code is
modernized.
The NMTC Incentivizes Investments That Would Not Have Been Made Without
the Credit
In 2007, the U.S. Government Accountability Office surveyed investors
and reported that 88 percent indicated they would not have made the
investment without the NMTC, and almost two-thirds said they increased
their investments in low-income communities because of the NMTC. The
NMTC makes it possible to invest in low-income communities with better
rates and terms, and more flexible features, than would be available in
the market. Without the NMTC, urban and rural communities across the
country would continue to suffer from disinvestment and continue to be
starved of the capital needed to spur economic growth.
The NMTC Attracts Capital to Some of the Nation's Most Distressed
Communities
Many of the nation's low-income communities, both urban and rural,
struggle to access the capital necessary to support a business, create
jobs or sustain a healthy economy. These communities have such a dearth
of resources--including vacant properties, neglected infrastructure and
limited education opportunities--that investments are not feasible
without a tax incentive. The NMTC encourages private investment in
these communities by providing a modest tax incentive that attracts the
patient capital that is necessary to revitalize these severely
distressed communities.
By law, NMTC investments must be made in census tracts where the
individual poverty rate is at least 20 percent or where median family
income does not exceed 80 percent of the area median, but the majority
of NMTC investments are made in communities exhibiting even more severe
economic distress. These low-income urban and rural communities face
diminishing jobs, high-unemployment, and bleak opportunities for
economic advancement. The NMTC provides these communities with the
access to patient capital that is needed to support and grow
businesses, create jobs, and sustain healthy local economies.
The NMTC Leverages $8 of Private Capital for Every $1 in NMTC
Investment
Between 2003 and 2015, NMTC investments directly created over 750,000
jobs and leveraged over $80 billion in capital investment in credit-
starved businesses in communities with high poverty and unemployment
rates. According to the Treasury Department, every $1 in investment
from the NMTC program leverages approximately $8 of private capital. A
recent analysis of Treasury Department data indicates that NMTC-
financed businesses and jobs generate more income tax revenue than the
NMTC actually costs. Additionally, the NMTC creates jobs at a cost to
the federal government of less than $20,000 per job.
The NMTC Jumpstarts Rural Manufacturing
The NMTC has had a profoundly positive impact in rural communities
across the country. The most popular use of the NMTC in rural America
is to support the manufacturing sector. NMTC financing typically goes
to business expansions, new equipment and facilities, and working
capital. Between 2003 and 2014, the NMTC financed 223 rural
manufacturing projects totaling $4.8 billion.
The NMTC Should Be a Permanent Part of the Tax Code
The NMTC was authorized in the Community Renewal Tax Relief Act of 2000
with bipartisan support and has been reauthorized numerous times since
its initial temporary authorization, most recently in the 2015 PATH
Act, which extended the NMTC through 2019. As a proven public-private
partnership that leverages private investment to grow local economies,
create jobs and transform neighborhoods, the NMTC should be a permanent
part of the tax code. In addition to allowing the program to lift up
more distressed communities, permanence would provide stability and
certainty to this critical community development tool for low-income
communities. NMTC equity pricing would subsequently increase, providing
for greater program efficiency and increased leveraging of private
capital.
Senators Roy Blunt (R-MO) and Ben Cardin (D-MD) introduced the New
Markets Tax Credit Extension Act of 2017 (S. 384) to provide an
indefinite extension to the NMTC, increase the annual NMTC allocation
and index the allocation to inflation and provides Alternative Minimum
Tax (AMT) relief for NMTC investments. Enterprise urges Congress to
enact this legislation through tax reform.
We thank you for this opportunity to share comments on tax reform. If
you have any questions regarding these comments, please do not hesitate
to reach out to me at [email protected], or Emily
Cadik, Director of Public Policy, at [email protected].
Sincerely,
Marion McFadden
Vice President, Public Policy
Enterprise Community Partners
______
Like-Kind Exchange Stakeholder Coalition
September 27, 2017
The Honorable Orrin Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance Committee on Finance
219 Dirksen Senate Office Building 219 Dirksen Senate Office Building
Washington, DC 20510-6200 Washington, DC 20510-6200
Dear Chairman Hatch and Ranking Member Wyden:
We are submitting the following statement for the record in response to
the Senate Committee on Finance's hearing on September 19, 2017
entitled ``Business Tax Reform.'' As you consider ways to create jobs,
grow the economy, and raise wages through tax reform, we strongly urge
that current law be retained regarding like-kind exchanges under
section 1031 of the Internal Revenue Code (``Code''). We further
encourage retention of the current unlimited amount of gain deferral.
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 taxpayers 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 U.S. by allowing funds to be reinvested back into the enterprise,
which is the very reason section 1031 was enacted in the first place.
This continuity of investment not only benefits 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 like-kind
exchanges or restricting their use would have a contraction effect on
our economy by increasing the cost of capital, slowing the rate of
investment, increasing asset holding periods and reducing transactional
activity.
A 2015 macroeconomic analysis by Ernst and Young found that either
repeal or limitation of like kind exchanges could lead to a decline in
U.S. GDP of up to $13.1 billion annually.\1\ The Ernst and Young study
quantified the benefit of like-kind exchanges to the U.S. economy by
recognizing that the exchange transaction is a catalyst for a broad
stream of economic activity involving businesses and service providers
that are ancillary to the exchange transaction, such as brokers,
appraisers, insurers, lenders, contractors, manufacturers, etc. A 2016
report by the Tax Foundation estimated even greater economic
contraction--a loss of 0.10% of GDP, equivalent to $18 billion
annually.\2\
---------------------------------------------------------------------------
\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/Ling-
Petrova-Economic-Impact-of-Repealing-or-Limiting-Section-1031-in-Real-
Estate
.pdf.
\2\ ``Options for Reforming America's Tax Code,'' Tax Foundation
(June, 2016) at p. 79, available at: http://taxfoundation.org/article/
options-reforming-americas-tax-code.
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 real estate, construction, agricultural,
transportation, farm/heavy equipment/vehicle rental, leasing and
manufacturing--provide essential products and services to U.S.
---------------------------------------------------------------------------
consumers and are an integral part of our economy.
A microeconomic study by researchers at the University of Florida and
Syracuse University, focused on commercial real estate, supports that
without like-kind exchanges, businesses and entrepreneurs would have
less incentive and ability to make real estate and other capital
investments.\3\ 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. This study further found
that taxpayers engaged in a like-kind exchange make significantly
greater investments in replacement property than non-exchanging buyers.
---------------------------------------------------------------------------
\3\ 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.
Both studies support that jobs are created through the greater
investment, capital expenditures and transactional velocity that are
associated with exchange properties. A $1 million limitation of gain
deferral per year, as proposed by the Obama Administration,\4\ would be
particularly harmful to the economic stream generated by like-kind
exchanges of commercial real estate, agricultural land, and vehicle/
equipment leasing. These properties and businesses generate substantial
gains due to the size and value of the properties or the volume of
depreciated assets that are exchanged. A limitation on deferral would
have the same negative impacts as repeal of section 1031 on these
larger exchanges. Transfers of large shopping centers, office
complexes, multifamily properties or hotel properties generate economic
activity and taxable revenue for architects, brokers, leasing agents,
contractors, decorators, suppliers, attorneys, accountants, title and
property/casualty insurers, marketing agents, appraisers, surveyors,
lenders, exchange facilitators and more. Similarly, high volume
equipment rental and leasing provides jobs for rental and leasing
agents, dealers, manufacturers, after-market outfitters, banks,
servicing agents, and provides inventories of affordable used assets
for small businesses and taxpayers of modest means. Turnover of assets
is key to all of this economic activity.
---------------------------------------------------------------------------
\4\ ``General Explanations of the Administration's Fiscal Year 2017
Revenue Proposals,'' at 107, available at: https://www.treasury.gov/
resource-center/tax-policy/Documents/General-Explanations-FY2017.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,
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job creation and increased competitiveness.
Thank you for your consideration of this important matter.
Sincerely,
Air Conditioning Contractors of America
American Car Rental Association
American Farm Bureau Federation
American Rental Association
American Seniors Housing Association
American Truck Dealers
American Trucking Associations
Associated Equipment Distributors
Associated General Contractors of America
Avis Budget Group, Inc.
Building Owners and Managers Association (BOMA) International
C.R. England, Inc.
Equipment Leasing and Finance Association
Federation of Exchange Accommodators
International Council of Shopping Centers
Investment Program Association
NAIOP, the Commercial Real Estate Development Association
National Apartment Association
National Association of Home Builders
National Association of Real Estate Investment Trusts
National Association of Realtors
National Automobile Dealers Association
National Business Aviation Association
National Multifamily Housing Council
National Ready Mixed Concrete Association
National Stone, Sand, and Gravel Association
Truck Renting and Leasing Association
______
National Association of Realtors
500 New Jersey Avenue, NW
Washington, DC 20001-2020
202-383-1194 Fax 202-383-7580
www.realtors.org/governmentaffairs
Introduction
The nearly 1.3 million members of the National Association of Realtors
(NAR) thank the U.S. Senate Committee on Finance for holding this
hearing on ``Business Tax Reform.''
NAR is America's largest trade association, including our eight
affiliated Institutes, Societies, and Councils, five of which focus on
commercial transactions. Realtors are involved in all aspects of the
residential and commercial real estate industries and belong to one or
more of some 1,400 local associations or boards, and 54 state and
territory associations of Realtors.
Tax Reform
NAR acknowledges the complexity of the current tax system and seeks tax
reforms that support the goals of homeownership and freedom to buy,
maintain and sell real estate. At the same time, the current real
estate tax provisions are among the most widely used and most readily
understood tax provisions. Millions of real estate investment decisions
have been made with the current tax law factored in. Adversely changing
the rules on existing investments could harm economic recovery and
future job creation and would be unfair to those who relied on those
rules.
Income-producing real estate is vital for strong economic growth and
job creation, and great care must be taken in tax reform to ensure that
current provisions that encourage those results not be weakened or
repealed. Commercial real estate adds value to the places that we work,
conduct commerce, live, and play.
I. Section 1031 Like-Kind Exchanges
Since 1921, U.S. tax law has recognized that the exchange of one
investment or business-use property for another of like-kind results in
no change in the economic position of the taxpayer, and therefore,
should not result in the immediate imposition of income tax. The like-
kind exchange rules permit the deferral of taxes, so long as the
taxpayer satisfies numerous requirements and consummates both a sale
and purchase of replacement property within 180 days.
NAR strongly believes that the like-kind exchange provision in current
law is vital to a well-functioning real estate sector and a strong
economy, and must be preserved in tax reform. The like-kind exchange is
a basic tool that helps to prevent a ``lockup'' of the real estate
market. Allowing capital to flow more freely among investments
facilitates commerce and supports economic growth and job creation.
Real estate owners use the provision to efficiently allocate capital to
its most productive uses. Additionally, like-kind exchange rules have
allowed significant acreage of environmentally sensitive land to be
preserved.
Section 1031 is used by all sizes and types of real estate owners,
including individuals, partnerships, LLCs, and corporations. Moreover,
a recent survey of our members indicated that 63 percent of Realtors
have participated in a 1031 like-kind exchange over the past 4 years.
A 2015 study \1\ found that in contrast to the common view that
replacement properties in a like-kind exchange are frequently disposed
of in a subsequent exchange to potentially avoid capital gain
indefinitely, 88 percent of properties acquired in such an exchange
were disposed of through a taxable sale. Moreover, the study found that
the estimated amount of taxes paid when an exchange is followed by a
taxable sale are on average 19 percent higher than taxes paid when an
ordinary sale is followed by an ordinary sale. A second study by EY
concluded that new restrictions on Section 1031 would increase the cost
of capital, discourage entrepreneurship and risk taking, and slow the
rate of investment.\2\
---------------------------------------------------------------------------
\1\ ``The Economic Impact of Repealing or Limiting Section 1031
Like-Kind Exchanges in Real Estate,'' David C. Ling and Milena Petrova,
March 2015, revised June 22, 2015.
\2\ ``Economic Impact of Repealing Like-Kind Exchange Rules,'' EY,
November 2015.
If one of the goals of tax reform is to boost economic growth and job
creation, any repeal or limitation of the current-law like-kind
exchange provision is a step in the wrong direction.
II. Business Interest Deduction
Another recent tax reform idea with the potential to cause very serious
disruption to the commercial real estate sector is the proposal to
eliminate the deduction for net investment expense included in the
House Republican Blueprint. The ability to finance productive
investment and entrepreneurial activity with borrowed capital has
driven economic growth and job creation in the United States for
generations. Since its inception, our tax system has appropriately
allowed business interest expense to be deducted as an ordinary and
necessary business expense.
Repealing or imposing limits on the deductibility of business interest
would fundamentally change the underlying economics of business
activity, including commercial real estate transactions. This could
lead to fewer new projects being developed, fewer jobs being created,
and fewer loans being refinanced. Legislation altering the tax
treatment of existing debt could harm successful firms, pushing some
close to the brink of insolvency or even into bankruptcy.
Tax reform must preserve the current tax treatment of business
interest. By increasing the cost of capital, limitations on business
interest deductibility could dramatically reduce real estate
investment, reducing property values across the country, and
discouraging entrepreneurship and responsible risk-taking.
III. Carried Interest
Many real estate partnerships utilize the common practice of providing
additional incentives for a general partner to perform well by sharing
some of the profits above a certain rate with them via a carried
interest, even when they contributed little or no capital to the
enterprise. The general partner's interest is ``carried'' with the
property until it is sold, which can be a number of years after the
enterprise is formed and limited partners have received profit
distributions. That carried interest is then taxed at the capital gains
rate, as a reward for entrepreneurs (general partners, in this case)
who take the risks inherent in new projects.
The carried interest provision is an integral product of the
flexibility Congress imbued in the tax rules for partnerships more than
50 years ago. The current tax treatment of carried interests is based
on the established partnership tax principle that partners are taxed
based on their share of partnership income (ordinary or capital gains),
rather than based on the character of the partner (general or limited)
to whom the income is allocated. The partnership structure has been a
huge success, giving investors and entrepreneurs in many industries the
tools to create and grow businesses, build shopping centers, found
technology companies, and create millions of jobs.
Increasing the tax burden on these real estate partnerships, and
particularly on those with operational expertise, by changing the
treatment of a general partner's carried interest from capital gains to
ordinary income would make real estate a less attractive investment.
When the value of real estate investment is impaired, there is an
indirect impact on all real estate. The character of real estate-
related income, including carried interest, should continue to be
determined at the partnership level and the new regime should continue
to recognize that entrepreneurial risk-taking often involves more than
just the contribution of capital.
IV. Depreciation
The current law depreciation rules are out of date and do not reflect
the actual economic life of structures. The 27.5- and 39-year cost
recovery periods should be shortened to a depreciable life for real
estate that more accurately reflects the economic life of the property.
Independent studies indicate that the economic life of real property
ranges between 18 and 30 years. Economic depreciation is more than just
physical wear and tear, but also includes adjustments to the value of
real property caused by changes in tastes, new technology, and by
improvements in the quality of new assets relative to old assets
(obsolescence).
NAR and several other real estate-related trade associations funded
academic research on the actual rate of economic depreciation of
commercial and investment real property. The study results,\3\ released
in early 2016, showed that the economic depreciation of real property
is much shorter than the current tax rules provide, and is evidence
that depreciable lives should not be extended in tax reform. Rather, we
urge Congress to shorten the depreciable lives of structures to better
reflect their true economic lives.
---------------------------------------------------------------------------
\3\ ``Tax Policy Implications of New Measures of Economic
Depreciation of Commercial Structures,'' PwC, April 2016.
---------------------------------------------------------------------------
Conclusion
Thank you for the opportunity to submit these comments. NAR appreciates
the Senate Committee on Finance for its open and collaborative process
as it seeks to reform our Nation's tax code. In order to devise a
fairer and simpler tax code, the input of stakeholders at all levels is
imperative to avoid unintended consequences.
Commercial real estate adds value to the U.S. economy at every level,
and a well- tuned tax policy can help it continue to innovate, create
jobs and add wealth to every community in the U.S. NAR looks forward to
continued collaboration with this Committee as it works to devise a
fairer and simpler tax code that boosts the overall economy.
______
National Mining Association (NMA)
101 Constitution Avenue, NW, Suite 500 East
Washington, DC 20001
Tax Policies Should Keep U.S. Mining Globally Competitive
The National Mining Association is pleased to offer its recommendations
in connection with the Senate Finance Committee's hearing on Business
Tax Reform. NMA strongly supports a substantial reduction in the
corporate tax rate; the current federal rate of 35 percent coupled with
state taxes are a detriment to our industry.
NMA believes that Congress should reject unwarranted proposals that
would significantly harm the competitiveness of domestic miners by
eliminating or reducing the present-law percentage depletion tax
deduction for mining activities, by eliminating the net interest
expense deduction, or by otherwise increasing taxes on miners. U.S.
mineral and coal producers play an integral role in fostering continued
American economic prosperity and energy security.
Background on U.S. Mining Industry
U.S. mineral and coal miners play an integral role in fostering
continued American economic prosperity by meeting, through domestic
production, much of the nation's growing energy needs and by producing
important minerals for commercial use as cost-effective inputs for
farms, factories and other job creators. Mined products are used in
every part of the economy.
Mining producers are vital to continued economic prosperity by
providing 30% of the nation's electricity through affordable coal power
and another 20% through uranium powered nuclear plants--totaling 50% of
our nation's electricity supply. While coal-based electricity has
increased by more than 170 percent over the past four decades,
emissions have decreased by 90 percent. New high-efficiency coal plants
can further reduce emissions by more than 30 percent.
Hardrock miners provides essential minerals for commercial use as cost-
effective inputs for farmers, national defense systems, and high
technology such as smart phones, hybrid cars and minerals for the
manufacturing base. Domestic mining products are used in virtually
every part of the economy. Ores and metals are used in the production
of capital goods for manufacturing and construction. Essential
electronic, telecommunications and medical processes depend on metals.
Non-metallic minerals are used in agriculture as fertilizers, in
medicine as pharmaceuticals and in construction and other industrial
processes.
The United States needs the public policies that unlock, and do not
hamper, the full potential of our immense mineral endowment in a highly
competitive world economy in which the demand for minerals continues to
grow.
The mining industry, comprised of both coal and hardrock minerals
miners, has a combined direct and indirect employment of almost 1.7
million jobs in all 50 states--with one of the highest paying private
sector average wages at: $74,695 per year.
U.S. mining's total direct and indirect economic contribution to GDP
was over $220 billion in 2015--generating almost $44 billion in tax
payments to federal, state, and local governments. The value added to
GDP by major industries that consume processed mineral materials was
$2.4 trillion in 2014. Mining exports made significant positive
contributions to America's balance of trade.
Capital Costs
It is important to recognize the unique nature of mining investments.
Mining requires significant financial commitments to long-term projects
to deliver a competitive product at a low margin. Enormous amounts of
capital must be expended at the front end of mining projects to realize
future returns. For example, a number of mines in the Western states
have capital costs around $500 million or more, and it is not unusual
for a world-class mining project today to require $1 billion in
engineering, development, construction and other costs to commence and
sustain the enterprise.
Additionally, current laws result in a process that takes 5 to 10 years
to navigate, putting the U.S. dead last among top mining countries when
ranked on permitting delays.
Competitiveness
Many American mines have large reserves, but often of lower ore grades
than other mines around the world. Many U.S. mines cannot bear large
tax increases and still remain globally competitive. Other U.S. mines
would have their productive lives significantly shortened by major tax
increases. As the U.S. economy is recovering from the recession, the
mining industry is hiring and is poised to expand production and
increase hiring. The industry is a major job creator, but tax increases
would jeopardize that hiring.
Tax Reform
It has been suggested that tax reform could involve the elimination of
various so-called ``tax expenditures.'' The Joint Committee on Taxation
has identified tax expenditures specifically related to mining. These
provisions are not ``loopholes'' but are instead essential components
of domestic mineral and coal mining operations. Elimination of the
priorities listed below could result in a net tax increase on the
mining industry if the corporate tax rate is not lowered enough to
offset these provisions.
Percentage Depletion. A key tax provision incentivizing mining in the
U.S. is percentage depletion. Under longstanding law, taxpayers
producing from mines, wells, and other natural deposits are allowed to
claim as a deduction for depletion a percentage of the gross income
from these mining properties. This deduction is known as ``percentage
depletion.''
It should be noted that percentage depletion is applied to all
extractive industries, including many independent oil and gas
producers. Internal Revenue Code section 613 lists percentage depletion
rates for more than 100 different products from mines wells and other
natural deposits, including gold, silver, copper, iron ore, and other
metal mines, sulphur, uranium, clay, bauxite, coal, lignite, rock
asphalt, gravel, pumice, and sand.
The percentage depletion deduction is an essential component of
domestic mineral and coal mining operations and must be retained. The
percentage depletion tax deduction recognizes the unique nature of
mining investments and recognizes that the next ore body or coal mine
to be mined will be more costly since the reserve may be smaller and
the geology more difficult. Mining requires significant financial
commitments to long-term projects to deliver a competitive product at a
low margin. Enormous amounts of capital must be expended at the front
end of mining projects to realize future returns. With such sizable
capital costs, cost recovery through percentage depletion has a
significant effect on the margins and prices at which minerals can be
profitably sold. The present-law percentage depletion deduction is
vitally important to the competitiveness of the domestic mining
industry and to the U.S. economy, it must be retained.
Interest Expense. The House tax reform blueprint proposes eliminating
the net interest expense deduction on business indebtedness. Miners
strongly believe that the interest deduction should be retained for
both existing and new debt. Companies invest a tremendous amount of
capital to start up new and replacement mines with some of the most
modern equipment. In addition, maintaining existing mines also requires
significant capital outlays due to the nature of mining. Consequently,
the ability to obtain debt and restructure existing debt is a
fundamental business need to the mining industry and too many domestic
manufacturers beyond the mining sector. The loss of net interest
expense deduction could devastate many mining companies.
Summary
Tax increases would jeopardize hiring in the mining industry and put
the jobs, salaries and benefits of hundreds of thousands of miners at
risk. Increased taxes on the miners through elimination of longstanding
tax rules such as percentage depletion and the deduction for interest
expense, would likely result in increased electricity prices and higher
prices for consumers, sending crippling effects throughout the U.S.
economy. Tax increases would not only affect the hundreds of thousands
of people that the industry directly employs, but also negatively
impact the additional secondary employment that is generated through
demand for mining support services and generated by consuming
industries through processing and refining activities and manufacturing
operations.
______
National Multifamily Housing Council and National Apartment Association
NMHC/NAA Joint Legislative Program
1775 Eye Street, NW, Suite 1100
Washington, DC 20006
202-974-2300
https://www.nmhc.org/NMHC-Policy-Agenda/
The National Multifamily Housing Council (NMHC) and the National
Apartment Association (NAA) respectfully submit this statement for the
record for the Senate Finance Committee's September 19, 2017, hearing
titled ``Business Tax Reform.''
For more than 20 years, the National Multifamily Housing Council (NMHC)
and the National Apartment Association (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 more
than 160 state and local affiliates, NAA encompasses over 73,000
members representing nearly 9 million apartment homes globally.
Background on the Multifamily Housing Sector
Prior to addressing the multifamily housing industry's recommendations
for tax reform, it is worthwhile to note the critical 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, 111 million Americans, over one-third of all Americans, live in
rental housing (whether in an apartment home or single-family home).\1\
There are 18.7 million renter households, or nearly 16 percent of all
households, who live in apartments (buildings 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 38.8 million residents
contributed $1.3 trillion to the national economy in 2013 while
supporting 12.3 million jobs.\4\
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\1\ 2015 American Community Survey, 1-Year Estimates, U.S. Census
Bureau, ``Total Population in Occupied Housing Units by Tenure.''
\2\ 2015 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 Multifamily Housing Council and National Apartment
Association.
The U.S. is in the midst of a fundamental shift in our housing dynamics
as changing demographics and housing preferences drive more people
toward renting as their housing of choice. Today, demand for apartments
is at unprecedented levels as the number of renters has reached an all-
time high. Since 2010, the number of renter households has increased by
an average of more than 800,000 annually--almost as much as 1.2 million
a year, by some measures.\5\ Meanwhile, apartment vacancy rates as
measured by MPF Research fell or remained the same for 7 straight years
from 2009 to 2016.\6\
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\5\ NMHC tabulations of American Community Survey and Current
Population Survey microdata.
\6\ MPF Research.
Changing demographics are driving the demand for apartments. Married
couples with children now represent only 19 percent of households.
Single-person households (28 percent), single parent households (9
percent) and roommates (7 percent) collectively account for 43 percent
of all households, and these households are more likely to rent.\7\
Moreover, the surge toward rental housing cuts across generations. In
fact, nearly 73 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.\8\ Over half (58.6 percent) of the net increase in renter
households from 2006 to 2016 came from householders 45 years or
older.\9\
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\7\ 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.
\8\ Annual Estimates of the Resident Population by Single Year of
Age and Sex for the United States: April 1, 2010 to July 1, 2015, U.S.
Census Bureau. Baby Boomers are defined as those born 1946 through
1964.
\9\ NMHC tabulations of 2016 Current Population Survey, Annual
Social and Economic Supplement, U.S. Census Bureau.
Unfortunately, the supply of new apartments is falling well short of
demand. Just-released research by Hoyt Advisory Services, Dinn Focused
Marketing, Inc. and Whitegate Real Estate Advisors, LLC, U.S. Apartment
Demand--A Forward Look, commissioned by NMHC/NAA shows that the nation
will need 4.6 million new apartments by 2030, or an average of 328,000
units a year.\10\ Just 244,000 apartments were delivered from 2012-
2016.\11\
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\10\ Hoyt Advisory Services, Dinn Focused Marketing, Inc., and
Whitegate Real Estate Advisors, LLC, ``U.S. Apartment Demand--A Forward
Look,'' May 2017, p. 38.
\11\ NMHC tabulations of 2016 Current Population Survey, Annual
Social and Economic Supplement, U.S. Census Bureau.
The bottom line is that the multifamily industry provides housing to
tens of millions of Americans while generating significant economic
activity in communities nationwide. Changing demographics and growing
demand will only cause the industry's footprint to expand in the coming
years. As will be described below, tax policy will have a critical role
to play in ensuring the multifamily industry can efficiently meet the
needs of America's renters.
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. Federal taxes are paid when properties are
built, operated, sold, or transferred to heirs.
In providing our recommendations, 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 by
statutory tax rates standing alone. 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 the Finance Committee and Congress 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. We also urge the Committee to be mindful
about how tax reform could impact existing investment and to focus on
the critical transition rules that will be necessary to avoid
disturbing the value of current assets. As outlined in the pages below,
NMHC/NAA believe that any tax reform proposal must:
Protect pass-through entities from higher taxes or compliance
burdens;
Retain the full deductibility of business interest;
Ensure depreciation rules avoid harming multifamily real estate;
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; and
Repeal or reform the Foreign Investment in Real Property Tax Act
to promote investment in the domestic apartment industry.
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) rather than publicly held
corporations (i.e., C corporations). Indeed, over three-quarters of
apartment properties are owned by pass-through entities.\12\ This means
that a company's taxable income is passed through to the owners, 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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\12\ U.S. Census Bureau and U.S. Department of Housing and Urban
Development, Rental Housing Finance Survey, 2015.
In addition to pass-through entities, a significant number of industry
participants are organized as REITs. So long as certain conditions are
satisfied, REITs pay no tax at the entity level. Instead, REIT
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shareholders are taxed on distributed dividends.
The multifamily industry opposes any tax reform effort that would lead
to higher taxes or compliance burdens for pass-through entities or
REITs. For example, 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.
Additionally, the multifamily industry would be extremely concerned by
proposals that would arbitrarily limit the ability of current and
future pass-through entities to fully utilize lower tax rates and other
benefits tax reform may provide. Specifically, we would be troubled by
proposals that would force pass-through income to be taxed at both the
entity and individual levels or that would subjectively deem only a
portion of such income received to qualify for a business tax rate that
may be lower than individual tax rates. In other words, all legitimate
business income, regardless of source (but taking into account
reasonable compensation rules), should be eligible for a preferential
business income tax rate.
Priority 2: Retain the Full Deductibility of Business Interest
Under current law, business interest is fully deductible. However,
efforts to prevent companies from overleveraging are in part leading to
an examination of whether the current 100 percent deduction for
business interest expenses should be curtailed. Unfortunately,
curtailing this deductibility--either in whole or in part--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, many of which do not have access to
public equity markets. Although such entities can access some equity
from investors that are largely private, they must generally borrow a
significant portion of the funds necessary to finance a multifamily
development. A typical multifamily deal might consist of 65 percent
debt and 35 percent equity. Indeed, according to the Federal Reserve,
as of March 31, 2017, total multifamily debt outstanding was $1.21
trillion.\13\ 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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\13\ Board of Governors of the Federal Reserve System, ``Mortgage
Debt Outstanding,'' by type of property, multifamily residences,
2017Q1, June 2017.
Finally, in addition to the harm it would cause, there is little policy
justification for curtailing interest deductibility for the multifamily
industry. Multifamily real estate is generally not held through
corporations. As a result, there is no preference in the tax code for
debt over equity. In other words, corporations favor debt over equity
because they are able to deduct interest but not dividends. That is
simply not an issue for the pass-through entities that dominate the
real estate industry. With no problem to be solved, there is no need to
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effectively penalize the multifamily industry.
Priority 3: 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 are not longer than the
economic life of assets by taking into account natural wear and tear
and technological obsolescence.
In this regard, 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 Geltner 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.\14\ 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 by
nearly 9 years.
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\14\ David Geitner and Sheharyar Bokhari, MIT Center for Real
Estate, ``Commercial Buildings Capital Consumption in the United
States,'' November 2015.
Additionally, 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 and 23.8 percent for a limited partner.
Second, the portion of the gain attributable to prior depreciation
deductions is generally subject to a 25 percent tax. This second tax is
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referred to as depreciation recapture.
NMHC/NAA believe that depreciation recapture taxes as they stand today
can have a pernicious effect on property investment and should be made
no worse. After decades of operations, many multifamily owners have a
very low tax basis in their properties. If sold under current law,
owners would have to pay large depreciation recapture taxes. To avoid
this huge tax bill, many current owners of properties with low tax
basis will not only avoid selling their properties, but they will also
be reluctant to make additional capital investments in properties. 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
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.
Finally, the multifamily industry would like to commend Senators Thune
and Roberts for introducing the Investment in New Ventures and Economic
Success Today Act of 2017 or the INVEST Act of 2017 (S. 1144). By
enhancing and making permanent Section 179 small business expensing and
50 percent bonus depreciation, the bill would encourage multifamily
firms to increase investment. We particularly support the bill's
provision to modify current-law Section 179 rules to enable property
used in rental real estate, such as appliances and furnishings, to
qualify for this incentive.
While we support the INVEST Act of 2017, we would note that we would be
extremely concerned if Congress opted to enact the measure while
curtailing the full deductibility of business interest. This is
particularly the case because while the INVEST Act is a worthy piece of
legislation that would promote business investment, it does not
accelerate the depreciation period of real property, including
multifamily buildings. Additionally, depending on the details of final
legislation, it may be the case that benefits gained from accelerated
depreciation--even if it encompasses real property--could fall short of
losses brought on by the curtailment of interest deductibility. The
multifamily industry asks to work with the Finance Committee to ensure
that tax reform--with all provisions taken as a whole--spurs investment
rather than unintentionally impedes real estate activity.
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,\15\ and it is one of many non-recognition provisions in the
Code that provide for deferral of gains.\16\
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\15\ 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.
\16\ 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.
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:\17\
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\17\ 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.
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.
Governments collect 19 percent more taxes on commercial
properties sold following a like-kind exchange than by an ordinary
sale.
Additional 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 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 by $8.1 billion each year and $6.1
billion each year, respectively.\18\ 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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\18\ Ernst and Young LLP, ``Economic impact of repealing like-kind
exchange rules,'' March 2015 (revised November 2015).
Ernst and Young LLP summed up its analysis of how repealing like-kind
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 income tax
rate and reduces GDP in the long run.'' \19\ 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.
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\19\ Ibid.
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Priority 5: Maintain the Current Law Tax Treatment of Carried Interest
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
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.
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.\20\
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\20\ 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.
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 3 million units since its inception in 1986.\21\ The LIHTC
program also allocates units to low-income residents while helping to
boost the economy. 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 \22\ with
just under two-thirds of residents earning 40 percent or less of area
median income.\23\ 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.\24\
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\21\ National Council of State Housing Agencies, ``2016 Housing
Credit FAQ,'' February 25, 2016, https://www.ncsha.org/resource/2016-
housing-credit-faq.
\22\ 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.
\23\ Ibid, p. 24.
\24\ 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 45 affordable units for every 100 very low-income
households (those earning up to 50 percent of area median income) in
the United States in 2015.\25\
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\25\ NMHC tabulations of 2015 American Community Survey public use
microdata, IPUMS-USA, University of Minnesota, www.ipums.org.
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. Meanwhile, 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
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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 tax
reform legislation. In so doing, Congress must take care to offset any
reduction in equity LIHTC could raise attributable to a reduction in
the corporate tax rate. Furthermore, 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. Additionally, 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.
In this regard, the multifamily industry strongly supports the
Affordable Housing Credit Improvement Act of 2017 (S. 548) and commends
Senators Cantwell and Hatch for its introduction. We also thank Finance
Committee Senators Wyden, Bennet, Heller, Isakson, and Portman for
their cosponsorship. Finally, we would also urge the Committee to
strongly consider the Middle-Income Housing Tax Credit Act of 2016 (S.
3384) that Ranking Member Wyden introduced during the 114th Congress to
address the shortage of workforce housing available to American
households. We believe that this bill would be a worthy complement of
measures to expand and improve LIHTC.
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 2017, there is a $5.49
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
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. Notably, a recent study finds that
repealing FIRPTA would increase international investment in U.S. real
estate by between $65 billion and $125 billion while generating between
$26 billion and $49 billion in economic activity and creating between
147,000 and 284,000 direct and indirect jobs.\26\
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\26\ Kenneth T. Rosen, Randall Sakamoto, David Bank, Brett Fawley,
Adam Eckstein, and Michael Stern, ``Unlocking Foreign Investment in
U.S. Commercial Real Estate,'' June 2017.
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
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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 subject to 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 mandates onerous administrative
obligations that further deter 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
solely for 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.\27\
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\27\ Public Law 114-113, Consolidated Appropriations Act, 2016,
Division Q, Protecting Americans from Tax Hikes Act of 2015.
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Conclusion
NMHC/NAA look forward to working with the 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.
______
National Retail Federation (NRF)
1101 New York Avenue, NW, Suite 1200
Washington. DC 20005
www.nrf.com
September 19, 2017
The Honorable Orrin 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: Hearing on ``Business Tax Reform''--September 19, 2017
Dear Chairman Hatch and Ranking Member Wyden:
The National Retail Federation (NRF) strongly supports
comprehensive reform of the federal income tax by lowering tax rates
and broadening the tax base. Tax reform is vitally important to the
U.S. economy and to retailers specifically, as consumer spending
constitutes more than two-thirds of the U.S. economy. The U.S. economy
cannot thrive when we have the highest corporate tax rate in the
industrialized world. Income tax reform can have an immediate positive
impact on economic growth, real wages and consumer spending. The NRF is
opposed to efforts to shift the tax burden from businesses to
consumers.
By way of background, NRF is the world's largest retail trade
association, representing discount and department stores, home goods
and specialty stores, Main Street merchants, grocers, wholesalers,
chain restaurants and Internet retailers from the United States and
more than 45 countries. Retail is the nation's largest private-sector
employer, supporting one in four U.S. jobs--42 million working
Americans. Contributing $2.6 trillion to annual GDP, retail is a daily
barometer for the nation's economy.
NRF supports business income tax reform that eliminate tax credits
and incentives that favor some industries over others, and supports
replacing these ``tax expenditures'' with substantially lower tax
rates, freeing businesses to make the most economically prudent
investment decisions rather than having the tax code drive
decision-making. Business tax reform should be neutral among different
types of businesses, so that businesses are not favored based on their
form of legal entity (e.g., C corporation vs. pass-through), how they
own their property (e.g., leased stores vs. owned stores), or
distribution channel (e.g., brick and mortar sale vs. remote sale). In
addition, tax reform should provide adequate transitions rules, so that
businesses do not face large tax burdens based on investment decisions
made in years prior to the enactment of tax reform.
A substantial reduction in the high U.S. corporate tax rate will
drive economic growth. Because the U.S. corporate tax rate is the
highest in the industrialized world, U.S. companies are choosing to
make more investments outside of the United States and foreign
companies are choosing to make more investments in countries with lower
corporate tax rates rather than the United States, where they can
achieve a better return on their investment (ROI). In 2016, the average
statutory foreign corporate income tax rate in the OECD was 24.7% and
several countries have enacted laws that schedule additional rate cuts
over the next few years. Meanwhile, the United States has the highest
statutory corporate tax rate in the OECD at 35% and when average state
corporate taxes are added in that rate rises to almost 39%. According
to an NRF analysis, in 2015 corporate taxes cost American workers up to
$4,690 in wages.
The United States has not reduced its corporate tax rate in more
than 30 years. At the same time other industrialized nations have
reduced their tax rates and in some cases, multiple times. Americans
cannot sit by any longer and watch other nations continue to reduce
corporate tax rates and attract our businesses and jobs. We must
compete for this investment in our country and our workers.
The National Retail Federation urges the Finance Committee to work
expeditiously on tax reform and offers our full support in this
endeavor.
Sincerely,
David French
Senior Vice President
Government Relations
______
Nonprofit Data Project
Aspen Institute
One Dupont Circle, NW, Suite 700
Washington, DC 20036
ELECTRONIC FILING OF THE FORM 990 WILL INCREASE
NONPROFIT TRANSPARENCY AND ACCOUNTABILITY,
WHILE SAVING TAXPAYER MONEY
Thank you for this opportunity to submit a statement for the record on
business tax reform. The Nonprofit Data Project of the Aspen
Institute's Program on Philanthropy and Social Innovation brings
together the major nonprofit research and data providers in the United
States, including the Foundation Center, GuideStar, the Indiana
University Lilly Family School of Philanthropy, and the Johns Hopkins
Center for Civil Society Studies.
The Nonprofit Data Project writes to strongly support electronic filing
of the Form 990 by all nonprofit organizations that file, and the
release of these data in an open, machine-readable format by the
Internal Revenue Service (IRS) to increase transparency and save
taxpayer money.
This non-controversial, revenue-neutral provision (as rated by JCT) has
been embraced by lawmakers on both sides of the aisle. It has been
included in the:
CHARITY Act of 2017, introduced by Senators John Thune and Bob
Casey and co-sponsored by Senators Ron Wyden, Pat Roberts, and others;
Taxpayer Protection Act of 2016, marked up by the Senate Finance
Committee in April 2016;
Business Income Tax Bipartisan Tax Working Group report,
published by the Senate Finance Committee in 2015;
Taxpayer Bill of Rights Enhancement Act of 2015, sponsored by
Senators Thune and Grassley;
Tax Reform Act of 2014, introduced by the former Chair of the
House Ways and Means Committee, Representative David Camp; and
Presidential budgets, from FY 2014-2017.
We urge you to make this commonsense proposal a part of business tax
reform.
WHY 990 E-FILING MATTERS
The nonprofit sector is an invaluable resource in our society. Not only
does the sector help millions of individuals in need, it represents 5
percent of the nation's gross domestic product (GDP) and is a major
source of jobs. According to the Bureau of Labor Statistics, nonprofits
account for over 10% of all private sector employment.
One of the best sources of information on nonprofits is the Form 990,
which most nonprofit organizations are required to file annually with
the IRS and make publicly available upon request. Current law already
requires very large nonprofit organizations (those that file at least
250 returns during the calendar year and have over $10 million in
assets) and very small nonprofit organizations (those with gross
receipts of less than $50,000 annually) to file their tax returns
electronically. Those in between are not subject to this requirement.
Until last year, the IRS made 990 forms available to the public by
providing images of them in TIF format (Tagged Image File) via DVDs. A
year's worth of 990s, both e-filed and paper-filed, cost over $2,000.
Once purchased, the image-based 990s had to be re-processed to render
them searchable, a practice that was not only expensive and
inefficient, but also delayed access to the information and increased
the potential for errors and omissions.
In June 2016, the IRS--in response to a federal lawsuit--began
releasing electronically filed Form 990s as open, machine-readable data
for free to Amazon Web Services. Today, this covers approximately 60%
of all Form 990s. The remaining 40% of 990s are still paper-filed and
are not released as open data.
The benefits of universal e-filing and open nonprofit data include:
Increased Transparency: Nonprofit leaders, donors, businesses,
policymakers, and the public can make better decisions, understand
trends in the field and gauge where some nonprofits stand in comparison
to their peers.
Improved Efficiency/Cost-Reductions: Electronic filing lowers
the cost of processing returns, saving the IRS and taxpayer money,
while also enabling the agency to use resources more efficiently.
Reduction of Fraud: E-filing makes it easier to detect and
locate potential problems through computer analysis. More timely and
accessible data will not only help the IRS and state charity officials
address compliance concerns (as the National Association of State
Charity Officials has noted), but it will also boost the public's
ability to monitor charities. Furthermore, the Advisory Committee on
Tax Exempt and Government Entities (ACT) observed in its 2015 report
that the IRS utilized less than half of the information from the Form
990 for data analytics functions, due to the constraints of manually
entering data from paper forms. Electronic filing by all nonprofits
will result in more information being available for electronic review,
and thus higher utilization of 990 data for tax compliance and
analytical purposes.
Improved Accuracy/Reduced Errors: E-filed returns, as opposed to
paper-filed returns, reduce inaccurate calculations and cut down on
mistakes. Fewer errors and better front-end identification of such
errors also reduce taxpayer burden in the filing process.
More Innovation/Business Opportunities: Entrepreneurs and
innovators will have data available to develop new, useful ``apps'' and
products that can help solve problems in our communities and contribute
to the economy.
Improved Information for the Public: The development of tools
that use, aggregate and combine Form 990 data with other data sets can
provide a wealth of information, such as, pinpointing nonprofit trends,
tracking the flow of philanthropic giving relative to need, and
determining how the nonprofit sector impacts local economies.
CONCLUSION
We thank the Senate Finance Committee for its past support and
appreciate this opportunity to submit a statement for the record on
business tax reform. Adoption of mandatory Form 990 e-filing coupled
with the release of the forms as open, machine-readable data will
benefit the public and the nonprofit sector, while strengthening law
enforcement and enhancing sector wide accountability.
Please contact Cinthia Schuman Ottinger at [email protected] for
further information about Form 990 e-filing or the Nonprofit Data
Project of the Aspen Institute.
Sincerely,
Nonprofit Data Project of the Aspen Institute
______
Reforming America's Taxes Equitably (RATE) Coalition
P.O. Box 33817
Washington, DC 20033
866-832-4674
www.RATEcoalition.com
[email protected]
Written Testimony of Dr. Elaine C. Kamarck and James P. Pinkerton
Co-Chairs
Thank you, Chairman Hatch and Ranking Member Wyden, for convening this
critical hearing today on America's broken business tax system.
It's a simple fact that at 35 percent, the U.S. has the highest
statutory corporate tax rate in the industrialized world. Indeed, our
combined state and federal corporate tax rate of 39.1 percent is almost
50 percent higher than the OECD average of 24.1 percent. Yet, the rub
comes when we compare the statutory tax rate with the effective tax
rate. And here we sometimes see a dramatic difference. That is, despite
the high ``sticker rate,'' some corporations are paying an effective
rate in the single-digit range, sometimes, even, zero--or less.
Conversely, most corporations--especially those with mostly domestic
operations--pay a much higher rate. That is, up there in the 30s, well
beyond the international average.
It's this discrepancy--this unfairness--between tax rates that helps
animate the drive for tax reform, including corporate tax reform.
To put it bluntly, it's crazy to let some companies pay tax at well
below the international average, and others pay tax at well above the
international average.
Companies that exploit our broken system to avoid paying taxes through
loopholes should pay their fair share. Americans deserve the kind of
reform that makes single digit--even zero--percent tax rates a thing of
the past.
Yet, at the same time, many American companies--both large and small--
are paying abundantly more than their fair share. As such, it is clear
that America's business tax system is broken.
As Washington prepares to consider the high cost of that broken tax
system on businesses of all sizes and the workers they employ across
the country, we are guided by a fundamental belief that America cannot
continue to allow a higher tax rate to lower our position in today's
globalized marketplace.
We have therefore made it our mission to reform the tax code by
reducing the corporate income tax rate. Here's why:
A September 2017 analysis conducted by the National Retail
Federation found that high corporate tax rates push down wages of the
average corporate worker by as much as $4,690 annually.
The NRF found that in 2015, workers bore between $86
billion and $257 billion of the corporate tax burden.
A September 2017 report by the Heritage Foundation found that
``the corporate income tax harms workers through lower wages.''
A 2015 NRF analysis conducted by EY found that the failure to
reduce the U.S. corporate tax rate costs U.S. families $3,000 a year in
spending power.
A March 2013 study conducted by EY found that in the long run,
the U.S. economy, as measured by U.S. GDP, would be smaller by between
1.5% and 2.6% if the current corporate income tax rates remain in place
(equivalent to a reduction in U.S. GDP of roughly $235 billion to $345
billion each year.)
A 2015 Business Roundtable report conducted by EY found that
with a 25% tax rate, U.S. companies would have acquired $590 billion in
cross-border assets over the past 10 years instead of losing $179
billion in assets--a net shift of $769 billion in assets from foreign
countries to the United States.
The report also found that a 25% tax rate would have kept
1,300 companies in United States.
A January 2015 National Association of Manufacturers study found
that over a 10-year period, a pro-growth tax reform plan would increase
GDP by more than $12 trillion relative to CBO projections, increase
investment by more than $3.3 trillion, and add more than 6.5 million
jobs to the U.S. economy.
A September 2012 analysis by the American Action Forum estimated
that a comprehensive tax reform plan that includes a move to a
territorial tax system, with a statutory tax rate of at least 25%
(revenue neutral--inclusive of growth effects) would lift economic
growth by 1 percentage point. In the near term, this would translate to
roughly 1 million more jobs.
A 2015 simulation conducted by the Tax Foundation's TAG Model
found that our GDP would increase by 3.3% or 4.3% if our corporate
income tax rate mirrored the levels enjoyed in the UK and Canada
respectively.
Put simply: Because American companies are paying the highest corporate
tax rate in the industrialized world, the American worker is paying a
steep price in the form of lower wages and lost opportunities. As a
result, our federal government isn't just collecting taxes--it is also
constricting our economy by keeping it on the wrong side of a global
zero-sum game in which our loss can become quite literally any other
country's gain.
It is therefore long past time to enact meaningful tax reform with a
rate that is as competitive as our spirit--one that unleashes, not
undercuts, American prosperity. The bipartisan resolve in your
Committee and among your colleagues to seize this once-in-a-generation
opportunity is a telling testament to the importance of doing so.
As more and more American businesses flee to more economical shores
overseas, our global competitors--each and every country the world
over--aren't just counting on Washington's continued inaction--they're
hoping for it.
Let's prove them wrong by doing right by the American worker.
______
R&D Credit Coalition
1101 New York Avenue, NW, 4th Floor
Washington, DC 20005
202-293-7474
www.investinamericasfuture.org
Introduction
The R&D Credit Coalition appreciates the opportunity to provide
comments to the Senate Finance Committee as part of the hearing on
``Business Tax Reform.'' The R&D Credit Coalition is a group of trade
and professional associations along with small, medium and large
companies that collectively represent millions of American workers
engaged in U.S.-based research throughout major sectors of the U.S.
economy, including aerospace, agriculture, biotechnology, chemicals,
electronics, energy, information technology, manufacturing, medical
technology, pharmaceuticals, software and telecommunications. The
Coalition welcomes the opportunity to provide comments regarding
incentives for research and development.
Although the R&D Credit Coalition is diverse, the member companies
which the coalition represents share a major characteristic: they
collectively spend billions of dollars annually on research and
development, which provides high-wage and highly skilled jobs in the
United States. The high U.S. corporate income tax rate and, until
recently, the temporary nature of the U.S. R&D tax credit, compared to
the lower corporate income tax rates and more stable and robust
research incentives in most other developed countries, are key factors
that companies consider in determining where they are going to create
and maintain R&D jobs.
Under current law, a taxpayer can deduct the cost of research expenses
in the year incurred (Section 174 of the Internal Revenue Code
(hereinafter referred to as ``the Code'')). In addition, the tax code
provides an incremental R&D tax credit for up to 20% (14% under an
easier to calculate elective Alternative Simplified Credit (``ASC''))
of qualified research costs over a base amount; 20% of ``basic
research'' payments; and 20% for amounts for energy research (Section
41 of the Code). However, if the taxpayer elected to utilize the R&D
tax credit, the taxpayer's deduction is reduced by the amount of any
R&D tax credit (Section 280C of the Code). For 2016 and beyond, certain
small business taxpayers can claim the R&D credit against their
Alternative Minimum Tax liability and qualified small businesses can
use their R&D credit to offset a portion of their payroll tax
liability, subject to limits.
The Coalition believes that the U.S. economy has benefited greatly from
tax policies, such as the deduction under Section 174 and the R&D tax
credit under Section 41, that incentivize investments in innovative
research activities that create new and higher wage jobs. These
investments and the innovations and advancements derived from the
research have beneficial spillover effects to the economy and society.
The Coalition strongly believes Congress should support a strengthened
and permanent R&D tax credit as well as continue with the current law
practice of allowing R&D costs to be deducted in the year incurred.
In particular, the Coalition has strongly advocated for bipartisan
legislation in both the Senate and House to make the R&D tax credit
permanent and increase to 20% the ASC. The Coalition appreciates the
longstanding support of Chairman Hatch, Ranking Member Wyden, and other
Finance Committee members for the R&D tax credit. The Coalition is
pleased that the Congress, with the enactment of the PATH Act (Pub. L.
114-113), permanently extended the current law R&D credit to provide
much needed certainty to taxpayers engaged in research activities. In
addition, the Coalition supports legislation introduced in the 115th
Congress by Representatives Pat Tiberi (R-OH) and John Larson (D-CT),
the Research and Experimentation Advances Competitiveness at Home
(REACH) Act of 2016 (H.R. 2821), to increase the ASC to 20% and make
needed clarifications to the credit to ease the administration and
compliance of the credit for both taxpayers and the IRS.
As the Administration and Congress consider tax reform alternatives,
the Coalition recommends adopting proposals, such as H.R. 2821, that
make the credit more effective at incentivizing additional research
activities and rejecting proposals that would limit or hinder companies
from making research investments.
The R&D tax credit is a proven incentive to maintain and create high-
paying jobs and stimulate positive economic benefits. The Coalition
recommends increasing the ASC rate from 14% to 20% as a means to both
enhance the benefits of the credit and improve efficiency and credit
compliance. The calculation for the ASC is much simpler for taxpayers
to comply with compared to the regular credit and using the ASC would
help improve credit administration. Importantly, given that Congress
has made the regular credit option and the ASC option permanent,
providing parity for both options at a 20% rate would enhance the
incentive effect of the credit.
Additionally, the Coalition is concerned about proposals that would
reduce the attractiveness of investing in U.S. research projects such
as previous proposals to limit the use of the R&D tax credit or require
lengthy amortization of research costs.
Discussion
The Coalition appreciates that an objective of tax reform is to achieve
a reduction in the corporate statutory rate and balance the rate
reduction with offsetting reforms. Reducing the U.S. corporate tax rate
from the highest in the world is a necessary reform to enhance the
competitiveness of U.S. based businesses and to attract investment. In
today's global economy with greater demand for investment in research
activities, there is significant global competition for R&D jobs.
Companies have an array of choices on where to locate such jobs and
where to invest research dollars as many countries have highly educated
and skilled workforces. It is clear that investments in research and
innovation have positive spillover effects in the U.S. economy.
Likewise, tax or other incentives to attract that investment enhance
those spillover effects.
With increased global competition, it is vital to ensure that the
United States is the best place for companies to do business and
conduct research. There are many other countries that offer both lower
corporate tax rates and more attractive R&D incentives.\1\ For example,
Australia provides a 40% tax credit for all eligible R&D expenditures
and a corporate tax rate of 30%. If the United States is to retain and
attract global R&D activities across all sectors of the economy, there
is a growing need for the certainty provided by a tax code that is
favorable to R&D investment. Retaining current year expensing and
providing a strengthened R&D tax credit would enhance the
attractiveness of the United States for investment and stimulate job
creation to grow the economy and keep the U.S. competitive.
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\1\ Deloitte, ``Global Survey of R&D Tax Incentives,'' December
2015.
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R&D Tax Credit as an Economic Incentive
The United States must maintain a globally competitive tax system that
supports high-skilled, high-paying jobs. The R&D tax credit, originally
enacted in 1981, was designed to be an important incentive in spurring
private sector investment in innovative research by companies of all
sizes and in a variety of industries. The enactment of this incentive
helped establish the United States as a world leader in
cutting-edge research that created high-paying jobs here in the United
States. During the 1980s, the United States was the leader among OECD
countries in providing the best R&D incentives for companies. However,
in recent years, many other countries have instituted more generous R&D
incentives. For example, South Korea has a 40% tax credit for current
year R&D spending that exceeds the 3-year average and Canada has a 15%
tax credit for all eligible R&D spending. As a result, according to an
OECD study in 2016, the United States ranked 25th for large firms and
26th for small and medium-sized enterprises in research incentives
among industrialized countries.\2\
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\2\ OECD, ``Measuring Tax Support for R&D and Innovation,'' http://
www.oecd.org/sti/rd-tax-incentive-indicators.htm; ITIF, ``Why Expanding
the R&D Tax Credit is Key to Successful Corporate Tax Reform,'' July
2017.
Several OECD countries have enacted a variety of tax incentives to
attract research activities, including tax credits that can be as high
as 50% of research expenses, super deductions that can be as high as
300% of research expenses, extending the credit to providers of
contract research services, as well as other incentives to encourage
research spending.\3\ A National Science Board report concluded that
the United States' lead in science and technology is ``rapidly
shrinking'' as R&D jobs and overall R&D spending continue to increase
faster outside the United States than here at home. The report shows
that ``between 1999 and 2009 . . . the United States share of global
research and development (R&D) dropped from 38 percent to 31 percent,
whereas it grew from 24 percent to 35 percent in the Asia region during
the same time.'' \4\
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\3\ Deloitte, ``2017 Survey of Global Investment and Innovation
Incentives,'' March 2017.
\4\ National Science Foundation press release, ``New Report
Outlines Trends in U.S. Global Competitiveness in Science and
Technology,'' January 17, 2011.
The R&D tax credit has a significant impact on private R&D spending and
the creation of valuable research jobs. According to a study by Ernst
and Young (EY), ``In total, the overall policy--the existing credit
plus strengthening the ASC--is estimated to increase annual private
research spending by $15 billion in the short term and $33 billion in
the long term.'' \5\ Moreover, it is important to note that the R&D tax
credit is largely a jobs credit--70 percent of credit dollars are used
to pay the salaries of high-skilled R&D workers in the United States.
The EY study also stated that, ``the credit and its enhancement is
estimated to increase research-related employment by 140,000 in the
short term and 300,000 in the long term.'' \6\
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\5\ Ernst and Young, ``The R&D Credit: An effective policy for
promoting research spending,'' September 2011, p. i.
\6\ Ernst and Young, ``The R&D Credit: An effective policy for
promoting research spending,'' September 2011, p.11.
The Coalition supports a permanent R&D credit that strengthens the ASC
to 20 percent to encourage more domestic innovation, job creation,
economic growth, and to enhance U.S. competitiveness. Along with
enhancing the credit, current eligibility for the types of research
---------------------------------------------------------------------------
expenditures that qualify for the credit must be retained.
For example, software development activities contribute billions of
dollars to the U.S. economy and employ millions of highly skilled
workers. Companies, universities and other organizations spend billions
of dollars a year in research activities to develop new computer
software and create new applications for existing software that is
innovative. Software development is a critical component of numerous
products and services and is critical to just about every industry
segment, including medical, manufacturing, automotive, aerospace and
defense, telecommunications, and others. In particular, software is a
key element in advanced manufacturing and the United States is a leader
in software development. The Coalition recommends that research
expenditures related to the use and development of computer software
continue to be treated as qualified research expenditures eligible for
the credit.
In addition, research activities require people, mainly highly skilled
scientists, to conduct research, but also require testing equipment,
raw materials, instruments, and a variety of inputs necessary to carry
out the process of experimentation. Since the original enactment of the
credit, Congress has recognized that supplies can be an integral part
of conducting scientific research and thus are treated as qualified
research expenses. While it has been clear that supplies qualify for
the credit, the lack of clear guidance on the issue has created
uncertainty in complying with the credit. Recent guidance has helped to
clarify the prior uncertainties regarding the treatment of supplies.
Given this history and the fact that companies must continually invest
in process and product improvements to maintain competitiveness in the
worldwide market, the Coalition recommends that research expenditures
related to supplies continue to be treated as qualified expenditures
eligible for the credit.
Section 174 Deduction
In enacting section 174 to allow research costs to be deducted in the
year incurred, ``Congress was pursuing two related objectives. . . .
One was to encourage firms to invest more in R&D than they otherwise
would. The second objective was to eliminate or lessen the
difficulties, delays, and uncertainties encountered by businesses
seeking to write off their research expenditures. . . .'' \7\ Expensing
R&D costs reflects the tax and accounting realities inherent in
bringing a new product to market. With R&D, amounts are expended to
create an asset with a future benefit. In most other instances this
would result in the capitalization and recovery through amortization of
such costs. The inherent issue with expenses incurred in research and
development is whether an asset of any value is being (or will be)
created. At the time the amounts are expended, such a determination is
often impossible. Further, research and development costs usually are
incurred with the goal of creating a new or improved product, service,
process or technique, but more often than not, the efforts do not
result in success. As such, U.S. Generally Accepted Accounting
Principles (``GAAP'') do not require the capitalization and
amortization of R&D costs on company financial statements.
---------------------------------------------------------------------------
\7\ Senate Budget Committee, ``Tax Expenditures, Compendium of
Background Material on Individual Provisions,'' 2012, p. 90 (The
Compendium).
Continuing the expensing of research costs is consistent with the
proposals put forward to allow all investment costs to be immediately
expensed. Proposals to limit the ability of companies to deduct the
costs of U.S. based research activities for tax purposes will act as a
disincentive to research investment, particularly for small firms with
limited cash flow, some of which may not benefit from the credit and
---------------------------------------------------------------------------
further risks the movement of investments and jobs abroad.
The Coalition believes that, given the inherent uncertainly around
experimental research, these costs should continue to be allowed to be
immediately expensed as under current law.
Conclusion
R&D incentives, such as the R&D tax credit and the expensing of
research costs, are designed to ensure that companies from varied
industries, including manufacturers and services businesses, conduct
their research activities in the United States and create highly paid,
highly skilled jobs. The original purpose of the tax credit still holds
true today. It is vitally important that U.S. policy makers support
proposals that enhance the attractiveness of the United States as a
place to invest in research activities. A strengthened research and
development tax credit, such as increasing the ASC to 20%, that is
enacted as soon as possible and the continued ability to deduct
research expenses are critical to competitiveness, innovation and U.S.
jobs. In the global economy many companies have a choice as to where
they are going to do their research--and with many other countries
offering both lower corporate income tax rates and more robust R&D
incentives, the U.S. tax system must provide globally competitive R&D
incentives that can be counted on by businesses. Broad and sweeping
changes to the tax credit that leave out innovative research activities
and diminish the value of the credit reduce its effectiveness. The R&D
Credit Coalition looks forward to assisting the Administration and
Congress in gaining a more detailed understanding of the competitive
pressures faced by companies as well as of the research and development
tax credit and its impact on U.S. jobs. We also look forward to working
together to advance legislation to enhance the U.S. position as an
attractive location for investment and a leader in research and
innovation.
Links to Studies:
Ernst and Young, ``The R&D Credit: An effective policy for promoting
research spending,'' http://www.investinamericasfuture.org/PDFs/
EY_R&D_Credit_Report_
2011_09_16.pdf.
OECD, ``Measuring Tax Support for R&D and Innovation,'' http://
www.oecd.org/sti/rd-tax-incentive-indicators.htm.
ITIF, ``Why Expanding the R&D Tax Credit is Key to Successful Corporate
Tax Reform,'' July 2017, https://itif.org/publications/2017/07/05/why-
expanding-rd-tax-credit-key-successful-corporate-tax-reform.
Deloitte, ``2017 Survey of Global Investment and Innovation
Incentives,'' https://www2.deloitte.com/content/dam/Deloitte/us/
Documents/Tax/us-tax-surveyof-global-investment-and-innovation-
incentives.pdf.
National Science Foundation press release, ``New Report Outlines Trends
in U.S. Global Competitiveness in Science and Technology,'' http://
www.nsf.gov/nsb/news/news_summ.jsp?cntn_id=122859&org=NSB&from=news.
OECD, Ministerial Report on the OECD Innovation Strategy, May 2010,
http://www.oecd.org/dataoecd/51/28/45326349.pdf.
OECD, ``Science, Technology, and Industry Scoreboard,'' October 2015,
http://www.oecd.org/sti/scoreboard.htm.
U.S. Department of the Treasury, ``Investing in U.S. Competitiveness:
The benefits of Enhancing the Research and Experimentation (R&E) Tax
Credit,'' http://www.investinamericasfuture.org/PDFs/
TreasuryRDReportMarch25.PDF.
______
Retail Industry Leaders Association (RILA)
1700 North Moore Street, Suite 2250
Arlington, VA 22209
703-600-2057
[email protected]
The Retail Industry Leaders Association (RILA) applauds the Committee
for holding this hearing on business tax reform and welcomes this
opportunity to express our strong support for the enactment of
comprehensive tax reform. We appreciate your leadership and that of the
Committee as you engage on the critical work to enact comprehensive tax
reform.
RILA is the trade association of the world's largest and most
innovative retail companies. RILA members include more than 200
retailers, product manufacturers, and service suppliers, which together
account for more than $1.5 trillion in annual sales, millions of
American jobs, and more than 100,000 stores, manufacturing facilities,
and distribution centers located both domestically and abroad.
The retail industry supports more than 42 million American jobs. With
more than $553 billion in labor income and more than $3.8 trillion in
sales, retail is one of America's most powerful economic engines. In
fact, consumer spending represents two-thirds of U.S. gross domestic
product (GDP).
Addressing Global Anti-Competitiveness Faced by U.S. Companies
Retailers have long supported comprehensive tax reform that will
benefit industry and consumers alike. We continue to call for a
significant reduction in the corporate tax rate with a fresh scrutiny
of all deductions and credits in the code, particularly ones that are
not applicable to all taxpayers.
American companies are at a huge competitive disadvantage with our
international competitors. This is directly a result of the U.S.
statutory corporate tax rate being extremely high by international
standards. The U.S. top combined federal and average state corporate
income tax rate of 38.9 percent is the highest among the 35 member
countries of the Organisation for Economic Co-operation and Development
(OECD) and is 14.7 percentage points above the OECD average of 24.2
percent. In fact, the U.S. corporate tax rate is the third highest
among countries throughout the world. Furthermore, the United States
stands virtually alone among countries in taxing companies on their
worldwide income rather than just on income earned domestically.
The retail industry's treatment under the current tax code belies its
prominent place in the economy and stifles job creation, investment,
and consumer spending/savings. A few years ago, RILA commissioned
PricewaterhouseCoopers (PwC) to conduct a study on the tax rates paid
by the retail industry. The study, entitled ``U.S. Retail Trade
Industry: Employment, Taxes, and Corporate Tax Reform,'' concluded that
the retail industry's effective tax rate of 36.4 percent is the fourth
highest domestic effective tax rate of all the 18 major U.S. industrial
sectors--nearly 10 percentage points higher than the average rate.
The high effective tax rate imposed on the retail industry largely
undermines U.S. competitiveness. A growing number of U.S. retailers are
expanding into the global marketplace through the establishment of both
retail operations in other countries as well as subsidiaries that
strengthen the supply chain of goods and services they provide to their
customers in this country. Our current system in the U.S. of taxing
worldwide income not only constrains a retailer's ability to grow but
also costs the U.S. well-paying jobs that a company must add to oversee
such global operations.
Similarly, foreign-based retailers are entering the U.S. market with
advantages over U.S. businesses due to a favorable tax structure in
their home country. While these foreign-based companies compete on a
level playing field in the United States, the favorable tax conditions
under which they operate in their home country ease the task of
generating profits there, and those profits are in turn invested in
U.S. expansion and aggressively competing with U.S. based retailers.
To improve U.S. international competitiveness, RILA supports
comprehensive tax reform that includes the following principles:
significantly reduces the corporate tax rate; eliminates special
credits and deductions in the code that favors some industries at the
expense of others; addresses the tax rules applicable to all business
types, as well as to individuals; simplifies and stabilizes the tax
code; and institutes a territorial tax system, where the U.S. taxes
corporate income earned only in the United States.
In addition, RILA is opposed to any limitation on the deduction for
business interest expense. Businesses, large and small alike, borrow to
finance their operations. The tax code has long recognized this,
treating interest expense as an ``ordinary and necessary'' deductible
business expense. Some have argued that interest expense should be
eliminated and ``traded'' for 100 percent expensing of capital
equipment. This misses the key point that expensing is an accounting/
timing difference while the interest deduction has a permanent impact
on financial statements for companies and ensures the proper
measurement of income.
Retail Sector's Role in the Economy and in the Community
There are few industries that have a greater impact on the United
States economy than retail. The retail industry employs millions of
Americans throughout the supply chain and provides American consumers
with the products they want to buy at the price they want to pay on
demand. Retailers pay billions of dollars in federal, state, and local
taxes each year, and collect and remit billions more in sales taxes to
state and local governments. Brick and mortar retailers, large and
small, provide a significant tax base for core local and state services
such as police, fire and rescue, and schools.
According to the September Bureau of Labor Statistics jobs report,
87,000 retail workers lost their jobs so far in 2017. In addition, over
5,000 stores have closed or will close in 2017, an increase of 165
percent compared to last year. Given the enormous employment footprint
of the retail industry, comprehensive tax reform that significantly
reduces the corporate tax rate could stimulate job growth in the retail
sector and the industries supported by retail.
Retailers often serve a central role as stewards of communities. Beyond
investing resources in store operations and job creation, brick and
mortar retailers: provide billions of dollars annually to tens of
thousands of local and national charities; hire American veterans;
sponsor local sports and recreation teams; provide tangible goods
donations to schools and homeless shelters; support community workforce
development and training programs; and often provide shelter during
storms and are the first on the ground after disasters strike to
provide families with relief and help communities rebuild.
Additionally, even the largest retailers rely on small business vendors
in communities, such as plumbers and electricians, to keep stores open
and operating.
Conclusion
No industry supports and desires comprehensive tax reform more than the
retail sector. For retailers, as a driver of the U.S. economy and one
of America's largest job creators, operating under the current high
effective tax rate is growing untenable. The retail industry is on the
front lines with the U.S. consumer and undergoing rapid transformation
to compete in the 21st-century marketplace--the U.S. federal tax code
should help foster this growth, innovation and investment, not kill it.
RILA and its member companies are eager to work with Members of the
Senate Finance Committee in this once in a generation effort to reform
the tax code in a comprehensive manner that promotes economic growth
and enhances U.S. competitiveness.
______
Small Business Council of America (SBCA)
4800 Hampden Lane, 6th Floor
Bethesda, MD 20814
The Small Business Council of America (SBCA) appreciates the
opportunity to submit this statement.
The SBCA is a national nonprofit organization which has represented the
interests of privately held and family-owned businesses exclusively on
federal tax, health care and employee benefit matters since 1979. The
SBCA, through its members, represents well over 20,000 enterprises in
retail, manufacturing and service industries, virtually all of which
provide health insurance and retirement plans.
When embarking on business tax reform, the SBCA urges the Committee to:
Not make changes to the small business retirement plan system that
could destroy the retirement security of millions of employees and
protect the federal tax laws that the system depends on.
The qualified retirement plan system, has been very successful in
providing retirement security for a significant number of Americans.
One of the primary things that motivates small business owners to
establish, and continue sponsoring, retirement plans are the current
tax incentives associated with doing so. Most small business owners
view the administrative costs associated of maintaining a plan and the
meaningful contributions that they make for non-key employees as the
price of being able to save in a qualified retirement plan for
themselves. If the tax laws are changed by reducing the amount that a
small business owner can save in a qualified retirement plan or the
financial appeal of saving in a plan or by making owners concerned
about saving too much in a plan, the owners will be much less likely to
continue an existing plan or start a new plan. The same will be true if
small business owners are given other, more favorable options for
saving, such as through the proposed creation of a pre-tax savings
account with no withdrawal limitations.
When a small business closes down its retirement plan, the owners are
not likely to increase the pay of the non-key employees to account for
the loss of the plan contributions, meaning that these employees will
be losing a valuable benefit that would provide them with needed funds
during their retirement but will not gain any more disposable income.
Protect the deductions for retirement plan contributions and health
insurance premiums.
Under the current tax system, when an employer contributes towards an
employee's health insurance premiums and/or retirement plan, it is a
win-win for the employer and the employee. The employer gets to deduct
the contributions and the employee gets the benefit of being able to
exclude the contribution from his or her income, in the case of health
insurance premiums, or defer taxes on the contribution and allow it to
grow tax free, in the case of a retirement contributions. The non-zero-
sum nature of this arrangement is a big reason why many employers make
these types of contributions. In short, with no detriment to
themselves, employers are able to provide a big benefit to employees,
many of whom would not be able to afford health insurance or to
significantly save for retirement without their employer's
contribution.
If the tax laws are modified to either eliminate the benefit employers
get from making the contributions (by eliminating or reducing their
deductibility) or reduce the benefit that these contributions provide
to the employee (by making them taxable to the employee) it would cause
employers, particularly small business employers who tend to work on
narrower margins, to reduce, or think twice, about making the
contribution. Health insurance and retirement savings are critical to
the economic stability of this country and the precious equilibrium
that allows many individuals to get these benefits, when they otherwise
might not, should not be disturbed in an effort to raise revenue for
other tax cuts.
Moreover, when it comes to contributions to retirement plans, there is
a major distinction between a tax expenditure where the tax is never
recaptured by the system and the qualified retirement system where all
of the funds in the plan are taxed--just usually outside the budget
window because of the long-term nature of retirement savings. It would
be fundamentally bad policy to eliminate the retirement plan deduction
simply because it helps to raise money within the budget window when it
does not result in any long term revenue gain outside the budget window
and doing so could greatly harm the retirement security of many
Americans.
Ensure that the impact of changing the tax rate for pass-through
entities does not bring an end to the small business retirement plan
system.
Both the President and the House have proposed reducing the tax rate
for pass-through entities by introducing a distinction between ``active
business income'' and ``reasonable compensation for services.'' The
SBCA is generally in favor of reducing tax rates for pass-through
entities and creating greater parity between pass-through entities and
C corporations. However, we have two primary concerns about these
proposals.
First, retirement plan contributions need to be deducted from the
reasonable compensation for services tranche. Under this proposed
change, small business owners would be required to treat a certain
portion of the money they receive from the business as reasonable
compensation for services which would be taxed at the individual tax
rates and the remaining amount would be treated as active business
income and taxed at a lower rate--possibly as low as 20%-25%. If
contributions that are made to the retirement plan do not count against
the amount allocated to the reasonable compensation for services
portion before they get to the lower active business income rate, there
will be no motivation for small business owners to make contributions
to the retirement plan because they will instead be able to take that
money and only pay minimal taxes on it and then reinvest it in an area
with greater potential for earnings and more favorable tax treatment
than a retirement plan. In other words, few small business owners will
make contributions into a retirement plan system for themselves and
their employees where the deduction is going against a 20%-25% tax rate
when it will come out and be taxed at a far higher rate. Economically,
this would make no sense and the fuel behind the small business
retirement plan system is tax incentives. As discussed further below,
few small business owners will sponsor a retirement plan when they will
get no financial benefit from saving in it. Rather, the small business
retirement system is dependent on small business owners seeing the
retirement plan as a way to secure their own future.
Additionally, if Congress is going to move towards establishing a
distinction of ``active business income'' and ``reasonable compensation
for services'' the statute itself needs to clearly delineate how this
distinction is made. Simply creating the distinction and leaving it to
the IRS to promulgate rules to help businesses determine how to
navigate it is a prime recipe for increasing the complexity of the tax
system in this area and increasing the burden on pass-through entities.
Throughout any tax reform bill, the SBCA strongly encourages Congress
to be specific in its statutory language and to avoid delegating the
authority to IRS to flesh out all of the rules by regulation in order
to avoid efforts towards simplification being marred in the future by
complex regulations. As discussed below, small business is still trying
to figure out how to deal with the hundreds of pages of regulation that
were promulgated under the brief statutory language of IRC Sec. 409A.
This type of absurdly complex regulation comes about far more easily
when IRS is given little direction in the statutory language.
Reject the idea of excluding certain types of pass-through entities
from receiving a lower pass-through rate.
If Congress enacts a new lower rate for pass-through income, this rate
should equally applicable to all pass-through entities.
Treasury Secretary Steven Mnuchin has suggested excluding certain types
of professional service firms from a new lower pass-through rate. Not
only would this proposal be unfair to certain types of businesses, it
would directly undermine the goal of simplifying the tax code.
Professional service firms play a critical role in providing essential
services and growing the economy. Despite common misconceptions, these
businesses make significant investments in equipment and resources to
keep their businesses running and there is no reasonable justification
for treating them differently.
Moreover, establishing different rates for different types of pass-
throughs and determining which pass-throughs are eligible for which
rates would add an unnecessary level of complexity to an already
complicated tax area and require small businesses to spend even more on
accounting and compliance costs than they already do.
The SBCA strongly urges Congress to reject the notion of stratifying
the pass-through rates and urges Congress to enact a single lower rate
for all pass-through entities.
Amend Section 409A to exclude small businesses from its
requirements.
Section 409A was introduced to stop public companies, like Enron, from
manipulating deferred compensation to avoid creditors and obtain lower
tax rates. Unfortunately, the broad drafting of Section 409A means that
small businesses, that were not the culprits of the type of abuses that
Section 409A was designed to stem, get caught up in its onerous
penalties and excessive compliance costs. The restrictions of Section
409A prevent small businesses from being nimble and entering into
compensation arrangements with employees that appropriately reflect the
nature of the new or growing business. Worse, many small businesses and
their advisors do not even realize that Section 409A applies to them
because they've been told it only applies to deferred compensation
plans which, due to the tax code, are seldom adopted by small
businesses. We think this phantom code section in the small business
world could eventually become a huge and unnecessary trap for small
business employees.
To eliminate burdensome and unnecessary restraints on business growth,
Section 409A should be modified to apply only to publicly traded
companies or, at very least, to include an exception for small
businesses.
Protect the cash method of accounting.
Over the past number of years there have been multiple proposals to
limit the availability of the cash method of accounting for certain
pass-through entities and personal service organizations. Proposals
like these are a step in the wrong direction and would be harmful to
small business.
Particularly for service based companies that often do not receive
payment for their services until months or even years after they are
performed (and worse often do not receive full or any payment for
services rendered), forcing these businesses to use the accrual method
of accounting would be very challenging, as well as basically unfair.
Without the availability of the cash method, these businesses would
need to set aside money to pay the tax liability for services rendered
but not paid for yet, if ever.
There is little justification for requiring pass-through entities or
personal service organizations to be forced to move to the accrual
method of accounting, for example, because their average gross annual
receipts are in excess of a certain amount. Moreover, such a change
would force dollars that are needed to run the business to be paid
instead to internal and external staff and professionals to navigate
the much more complex tax situation that the businesses would face
under the accrual method.
The SBCA strongly urges Congress to keep the existing rules on cash
method of accounting for pass-through entities and professional service
organizations. If anything, Congress should increase the annual income
threshold for which corporations can use the cash method of accounting
above $5 million to ensure that this simpler method is available for
all small businesses.
Reject proposals to reduce the amount that individuals can save in
retirement plans pre-tax or subject existing retirement plan savings to
taxes.
There have recently been proposals to try to move the bulk of the
defined contribution retirement plan system towards Roth--i.e., to
limit how much can be saved in a defined contribution plan pre-tax or
subject existing defined contribution plan balances to taxes now,
rather than waiting for them to be taxed at the time of withdrawal.
The SBCA strongly urges the Committee to reject these proposals.
According to a 2011 EBRI study, over 60 percent of respondents
indicated that the ability to contribute to a retirement plan pre-tax
was ``very important'' to encouraging them to save for retirement (see
EBRI Notes, Vol. 32, No. 3). The same study found that over 25% of
respondents would reduce their retirement plan savings or stop them
altogether if they were no longer able to contribute to a retirement
plan on a pre-tax basis.
If small business owners aren't able to contribute to a retirement plan
pre-tax, they will be less likely to sponsor one and, even if they do,
employees will be less likely to save in the plan if they are unable to
do so pre-tax. In short, it will decrease the perceived benefit of an
employer-sponsored retirement plan for both employer and employees.
Given that employees are far more likely to save in an employer-
sponsored plan than to set up an IRA for themselves to save in, this is
very concerning. America is aging and we need to do everything we can
to increase retirement savings. Proposals like these, that would
eliminate the motivation to save, could be truly catastrophic.
Increase the availability of cafeteria plans for small business
employees by allowing small business owners to be eligible to
participate in cafeteria plans.
While employees of large businesses, mid-size employers, non-profits,
schools, universities, and the federal government can take advantage of
the valuable benefits provided by cafeteria plans, only small business
owners are not allowed to participate in a cafeteria plan. As with
retirement plans, small business owners will be disinclined to take on
the administrative costs and concerns to sponsor a plan that they can't
participate in. Cafeteria plans provide a wide array of meaningful
benefits for employees and it is unfortunate that the exclusion of
small business owners from plan participation has resulted in many
small business employees not being offered these benefits.
During the tax reform process, the SBCA urges Congress to resolve this
inequity and to allow small business owners to participate in the
cafeteria plans that they would be more likely to sponsor.
Protect the business interest deduction.
Both the President and the House have proposed to eliminate the
business interest deduction and instead move towards a system of full
and immediate expensing. While the SBCA has no problem with the concept
of immediate expensing, eliminating the business interest deduction
would represent a large change to the tax laws that could strike a
significant blow to America's small businesses and make it more
difficult for new businesses to get started.
Small businesses rely heavily on traditional debt financing, rather
than equity financing. Alternative, or creative, funding options are
often not available to small businesses, particularly in their early
years. Moreover, debt financing does not require small businesses to
give up ownership interests in the way that equity financing does.
Eliminating the business interest deduction would mean that the amount
paid out in interest would continue to be taxable income to the small
business and then also be taxed as income to the lender. In other
words, the interest would be taxed twice. Because of this treatment and
increased costs, the borrowing options offered by those lenders that
typically service small business clients, such as community banks, are
likely to be reduced, making it more difficult for small businesses
owners to get a traditional loan to get their business started or keep
it afloat. The SBCA does not believe there is a valid reason to link
the provisions for immediate expensing and the loss of the interest
deduction.
As the expression goes, the devil is in the details. Tax reform could
help small businesses thrive and continue to provide jobs and
meaningful benefits for millions of Americans. However, if not properly
and thoughtfully crafted, tax reform could instead prove to be
catastrophic to small businesses and their employees, leaving them to
bear the burden of tax reform that is targeted at benefiting large
businesses. We urge this Committee to be mindful of the role that small
business plays in our economy and ensure that small business interests
are considered and protected in any efforts towards business tax
reform.
______
Small Business Legislative Council (SBLC)
4800 Hampden Lane, 6th Floor
Bethesda, MD 20814
Please accept the foregoing statement of the Small Business
Legislative Council (SBLC) for the record in response to the U.S.
Senate Finance Committee's September 19, 2017 hearing on ``Business Tax
Reform.''
The SBLC is a 35-year-old permanent, independent coalition of over
40 trade and professional associations that share a common commitment
to the future of small business. SBLC members represent the interests
of small businesses in such diverse economic sectors as manufacturing,
retailing, distribution, professional and technical services,
construction, transportation, and agriculture. SBLC policies are
developed by consensus among its membership.
While the SBLC strongly supports efforts to make the tax system
simpler and more manageable, it is critical that tax reform not come at
the expense of small businesses and their employees. Already, in the
House Blueprint and the President's outline, there have been proposals
that are deeply concerning for small business and that could undermine
small business' role as a critical driver of growth and job creation in
this country. As discussed further below, the SBLC urges the Committee
to reject these problematic ideas and use tax reform as a vehicle to
help, rather than hinder, small businesses.
Tax Rates for Pass-Through Entities
Greater parity is needed between the tax rates for pass-through
entities and C corporations. However, if a new system is created for
taxing pass-through entities, the new lower rates should be available
to all pass-through entities and the applicable rules should be clearly
outlined in the legislation itself and structured to ensure that they
do not have the unintended effect of disrupting the small business
retirement plan system.
Under the current tax laws, pass-through businesses, which
constitute the large majority of business enterprises and employ over
half of the employees in the United States,\1\ are at a disadvantage
when compared to publicly and privately held C corporations. Unlike
pass-through entities, regular C corporations separately report their
taxable income and pay income tax on that taxable income. Under current
law, the top marginal rate for C corporations is 35%, whereas the top
marginal rate for income earned through S corporations, partnerships
and sole proprietorships is 39.6% (passive investors are also subject
to an additional 3.8% net investment tax). This gap needs to be
narrowed or eliminated. If the C corporation rate is going to be
reduced through tax reform, the rate for income from pass-through
entities must be as well.
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\1\ Drs. Robert Carroll and Gerald Prante, ``The Flow-Through
Business Sector and Tax Reform,'' at pg. 5, Appendix B, Ernst and Young
(April, 2011).
Both the President's outline and the House's Blueprint include
proposals to reduce the tax rate for pass-through entities by creating
a distinction between ``active business income'' and ``reasonable
compensation for services.'' This type of system would require owners
of pass through entities to take compensation for their services, which
would be taxed at their personal income tax rate, and then allow them
to receive other business income subject to a much lower tax rate.
Provided that the reservations discussed below are adequately
---------------------------------------------------------------------------
addressed, the SBLC strongly supports this concept.
First and foremost, if a new structure, like the one noted above,
is going to be introduced for taxing pass-through entities, it is
essential that the rules for its application be clear and outlined in
the legislation itself. While the concept of distinguishing between
``active business income'' and ``reasonable compensation for services''
sounds relatively simple, the rules for determining what constitutes
reasonable compensation for services have the potential to become very
complex. Small businesses do not have the same financial or
administrative capacity to navigate complicated rules that their larger
counterparts do. It is therefore important that the rules be clear and
easily understood and applied. To ensure that this is the case, it is
important that Congress clearly articulate the framework in the law
itself rather than delegating the power to the IRS to do so. Even if
the current Administration has given assurances that new tax
regulations will not be overly complex, delegating authority to the
agencies to add detail to a tax reform law leaves open the possibility
(and we would argue makes it likely) that, over time, the law's goal of
simplification will be lost amidst increasingly complex regulations.
Another consideration that the SBLC urges the Committee to address
in considering a new tax system for pass-through entities, is the
implications that a reduced tax rate for business profits could have on
the small business retirement plan system. Most small business owners
view the administrative costs associated with maintaining a plan and
the meaningful contributions that they make for non-key employees as
the price of being able to save in a qualified retirement plan for
themselves. If the small business owner has the opportunity to take
profits out at a rate that is significantly lower than his or her
individual tax rate that would apply to retirement funds at the time
they are withdrawn, the small business owner is going to take the money
out of the business at the reduced rate and invest it elsewhere. In
turn, if the small business owner has no financial motivation to save
in a retirement plan, the small business is much less likely to create
a new plan or continue to offer an existing plan. This would be a
significant blow to employees and be counter to the goal of encouraging
increased retirement savings. To avoid this problem, if a small
business owner is going to be required to take a certain amount from
the business as ``reasonable compensation for services'' before the
reduced tax rate will apply, it is important that the contributions
towards the retirement plan count towards reasonable compensation for
services. Logically, this makes sense as the idea behind the
distinction is to ensure that a certain amount of the business' income
is being taxed at the business owner's standard individual rate and
anything that is saved in a retirement plan will be subject to the
individual rate when it is withdrawn. Additionally, it will continue to
motivate small business owners to sponsor retirement plans that will
allow them, and their employees, to save for the future.
Finally, if a new system is introduced to provide lower rates for
certain pass-through income, that lower rate should be available for
all pass-through businesses. Attempting to exclude certain types of
pass-through businesses from a new lower rate would be unjust and would
require the introduction of yet more complex tax rules that small
businesses already struggle to navigate.
Business Interest Deduction
Small businesses rely on debt financing not equity to establish
themselves and survive. The elimination of the business interest
deduction would therefore be severely damaging to small business growth
and success.
Both the President's outline and the House Blueprint have proposed
to eliminate the business interest deduction in lieu of a move towards
allowing full and immediate expensing. While the SBLC supports
immediate expensing, eliminating the business interest deduction would
result in dramatic loss of financing options for small businesses,
making it much more difficult for new businesses to start and existing
businesses to thrive.
Small businesses rely heavily on traditional debt financing. Unlike
equity financing, debt financing allows small business owners to
maintain their ownership of, and control over, their businesses.
Moreover, many alternative or creative funding options aren't available
to small businesses, particularly in their early years. Eliminating the
business interest deduction would result in a double tax on the
interest itself. Without the business interest deduction, before being
paid as interest, the amount would be taxable to the business, but then
would still be taxed as income to the lender. As the result of this
treatment, and the increased costs and decreased gains that it will
cause, those lenders that traditionally service small business clients,
like community banks, are likely to reduce their borrowing options.
This will make it more difficult for small businesses to get the debt
financing they need and will strike a significant blow to the small
business economy on which a huge part of the national economic
stability depends.
Last In First Out (LIFO)
The last in first out method of inventory accounting (or LIFO)
allows businesses in industries that face rising prices to most closely
match the cost of goods sold with the cost of replenishing inventory.
In other words, LIFO helps businesses maintain the status quo. Without
LIFO, by allowing businesses to avoid being taxed on the portion of
their sales attributable to inflation and instead use that money to
acquire or produce inventory to replace that which was sold.
The majority of the businesses using the LIFO inventory method are
organized in the form of pass-through entities, such as partnerships or
S corporations and are therefore taxed at the individual rate.
Proposals to fund a reduction in the corporate tax rate by repealing
LIFO would leave pass-through entities shouldering most of the burden
of a rate reduction while receiving none of the gain.
Moreover, looking to prior proposals to eliminate LIFO, most of the
revenue would be raised by a one-time recapture tax. This is a short
sited approach that would be devastating for a wide range of
businesses. Specifically, not only will the long term revenue stream
created by a LIFO repeal be significantly smaller than the one-time
recapture, but the one time recapture will also result in an
unprecedented retroactive tax on businesses using LIFO. These
businesses, have relied on existing tax laws, including the
availability of LIFO, to manage their revenue streams, inventories and
expenditures. Requiring them to go back and pay taxes on the past
benefits that they received from the use of LIFO would wreak havoc on
cash flows, capital reserves, expansion opportunities and job creation
for American businesses using this method of accounting.
Health Insurance Premium Deduction/Exclusion
The current system which allows employers to deduct health
insurance premiums and employees to exclude health insurance premiums
from their income, has the very positive effect of encouraging
employers to contribute towards health insurance premiums, and should
be maintained.
Under the current system, an employer contribution towards an
employee's health insurance premium provides a win for both the
employer and the employee. The contribution helps the employee get
health insurance and can be excluded from the employee's income. In
turn, the employer gets to deduct the contribution, so, although it is
providing a huge benefit to its employees, it is able to do so at a
lower cost.
If the tax laws are changed in a way that would eliminate or reduce
the benefit that employers get from contributing towards employee
health insurance or reduce the benefit of these contributions to
employees by making them taxable, it would cause many small business
employers to give second thought to making such contributions. Employer
contributions towards health insurance premiums are critical to helping
many Americans afford health insurance and any change that would deter
employers from making these contributions would be a move in the wrong
direction.
The Small Business Retirement Plan System
The qualified retirement plan system has been very successful in
providing retirement security for a significant number of Americans. It
is important that those provisions that have encouraged plan
sponsorship among small businesses and saving by small business
employees are not negatively impacted by tax reform.
As noted above, most small business owners are motivated to
establish plans, and make contributions for their employees, by a
desire to save for their own retirement. If the tax laws are changed to
reduce the ability or appeal of saving in a retirement plan, small
business owners will be much less likely to continue an existing plan
or start a new plan.
Accordingly, so as not to disturb the current successful small
business retirement system, the SBLC urges Congress to:
- Reject attempts to decrease the amount that can be saved in a
qualified plan. If the amount that small business owners can save in a
qualified plan is reduced, small business owners will be motivated to
freeze or terminate plans once they themselves have hit that cap. This
will mean that less small business employees will be offered a plan.
- Avoid changes that would quickly force saving out of a plan
after the owner's death or otherwise do anything to make owners fearful
of saving too much in a retirement plan. If small business owners are
concerned that at their descendants who inherit their plans will be
forced to take the money out over a short period of time and therefore
face negative tax consequences, the owner will save less in the plan.
This means that retirement savings overall will decrease, as will plan
sponsorship.
- Protect the deductibility of employer contributions. As with
health insurance, under the current tax system, when an employer
contributes to an employee's retirement plan it is a win-win because
the employer gets a deduction and the employee grows his or her
retirement plan balance. If the deduction for the employer contribution
is eliminated, employers will be far less likely to contribute towards
an employee's retirement savings.
- Reject proposals to try to limit how much can be saved in a
defined contribution plan pre tax or subject existing defined
contribution plan balances to taxes now, rather than at the time of
their withdrawal (i.e., to move the bulk of the defined contribution
retirement plan system towards Roths). Again, if small business owners
don't see a tax benefit for themselves to save in the plan, they will
be less likely to sponsor a plan. Moreover, if employees are taxed on
contributions to a plan, they will be less likely to save, which, given
that people are far more likely to save in employer-sponsored
retirement plans than in any other vehicle, would reduce retirement
savings overall.
Conclusion
As Congress tackles the challenge of tax reform this fall, we urge
the Committee to consider how each proposed change could impact small
businesses and their employees. Tax reform that pursues a lower
corporate rate at the cost of eliminating the critical provisions that
small businesses rely on to grow and succeed will be a move in the
wrong direction. We look forward to working with this Committee to
achieve meaningful tax reform that will benefit businesses of all
sizes.
For more information, please contact Paula Calimafde, President and
General Counsel, 301-951-9325, [email protected].
______
Letters Submitted by the Tax Ag Coalition
September 19, 2017
U.S. Senate
Committee on Finance
Dirksen Senate Office Bldg.
Washington, DC 20510-6200
Re: Senate Finance Committee Hearing on Business Tax Reform
Dear Chairman Hatch and Ranking Member Wyden:
The Tax Ag Coalition commends the Senate Finance Committee for your
recent hearing on reforming the business tax code, and would like to
participate by offering comments on several items of particular
interest to agricultural producers and rural small business owners.
While it is not our intent to offer a comprehensive statement on tax
reform, the Tax Ag Coalition firmly believes that a fair and equitable
tax code must recognize the unique financial challenges of agricultural
production. Below is a list of our Coalition priorities and additional
information can be found in the enclosed letters.
1. The Coalition supports a full, permanent repeal of the federal
estate tax. The benefits of repeal should not be eroded by elimination
of or any restrictions to the use of stepped-up basis.
2. The Coalition supports maintaining interest deductions as a
legitimate business expense.
3. The Coalition supports maintaining critical provisions in the tax
code that allow farmers and ranchers to match income with expenses and
manage through low income years, such as cash accounting, like-kind
exchanges, and income averaging.
4. The Coalition supports reducing the capital gains tax.
5. The Coalition supports maintaining the Section 199 deduction for
domestic production activities.
6. The Coalition supports several tax provisions related to renewable
energy and environmental mitigation.
Thank you for your time and attention to this matter.
Sincerely,
Danielle Beck
Director of Government Affairs
National Cattlemen's Beef Association
1275 Pennsylvania Ave., NW, Suite 801
Washington, DC 20004
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
On behalf of our nation's family farmers and ranchers, the undersigned
agricultural producer groups urge your support for maintaining the
Section 199 deduction for domestic production activities income as part
of any tax reform plan.
The Section 199 deduction was enacted as part of the American Jobs
Creation Act of 2004 as a domestic production and jobs creation
measure. The deduction applies to proceeds from agricultural or
horticultural products that are manufactured, produced, grown, or
extracted in the United States, including dairy, grains, fruits, nuts,
soybeans, sugar beets, oil and gas refining, and livestock. Farmer-
owned cooperatives are able to apply their wages to the calculation of
the deduction, and then choose to pass it through to their farmer
members or keep it at the cooperative level, making it extremely
beneficial to both.
The Section 199 deduction is limited to the lesser of 9 percent of
adjusted gross income or domestic production activities income or 50
percent of wages paid to produce such income. Reducing or eliminating
the domestic activities deduction would result in a significant
increase in taxable income for all farms that currently employ non-
family labor. On the other hand, the benefit of the deduction would
increase if agricultural producers were able to count non-cash wages
paid, such as crop share payments of commodities.
The Section 199 deduction serves as both a domestic production and jobs
creation incentive and has provided needed relief for producers in
times when prices are depressed. Section 199 benefits are returned to
the economy through job creation, increased spending on agricultural
production, and increased spending in rural communities.
Thank you for your continued efforts in support of our nation's
agricultural producers. We look forward to working with you on this
important issue.
Respectfully,
Agricultural and Food Transporters
Conference National Pork Producers Council
Agricultural Retailers Association National Potato Council
American Farm Bureau Federation National Renderers Association
American Mushroom Institute National Sorghum Producers
American Sheep Industry Association Panhandle Peanut Growers
Association
American Soybean Association Southwest Council of Agribusiness
American Sugarbeet Growers
Association South East Dairy Farmers
Association
California Association of Winegrape
Growers United Egg Producers
Cobank United Fresh Produce Association
National Barley Growers Association U.S. Canola Association
National Cattlemen's Beef
Association U.S. Rice Producers Association
National Corn Growers Association U.S. Sweet Potato Council
National Cotton Council USA Rice Federation
National Council of Farmer
Cooperatives Western Growers
National Milk Producers Federation Western Peanut Growers Association
National Peach Council Western United Dairymen
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
America's farmers and ranchers rely on various tax code provisions to
survive the constant financial and economic ups and downs that come
with farming and ranching. The undersigned agricultural groups ask for
your robust support of these critical provisions that ensure their
long-term financial well-being.
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 provides the flexibility needed to plan for future
business investments and in many cases provides guaranteed availability
of agricultural inputs. Loss of cash accounting would create a
situation where a farmer or rancher would have to pay taxes on income
before receiving payment for sold commodities.
Like-kind exchanges help farmers and ranchers operate more efficient
businesses by allowing them to defer taxes when they sell land,
buildings, equipment, and livestock or purchase replacement property.
Without like-kind exchanges some farmers and ranchers would need to
incur debt in order to continue their farm or ranch businesses or,
worse yet, delay mandatory improvements to maintain the financial
viability of their farm or ranch business.
Farm and ranch businesses operate in a constant world of uncertainty
with ongoing expenses and a fluctuating income. Income averaging, which
permits revenue to be averaged over 3 years, allows farmers and
ranchers to level out their tax liability and produces a more
dependable and consistent revenue stream that aids financial
management.
As Congress moves forward with its tax reform proposals and debate, we
urge your support for these important tax provisions. Thank you for
your continued efforts to support our nation's farmers and ranchers
whose work allows us to enjoy the safest, most abundant and affordable
food supply in the world. We look forward to working with you on these
important issues.
Sincerely,
Agricultural and Food Transporters
Conference National Potato Council
Agricultural Retailers Association National Renderers Association
American Farm Bureau Federation National Sorghum Producers
American Mushroom Institute Panhandle Peanut Growers
Association
American Sheep Industry Association Southwest Council of Agribusiness
American Soybean Association South East Dairy Farmers
Association
American Sugarbeet Growers
Association United Egg Producers
California Association of Winegrape
Growers United Fresh Produce Association
Cobank U.S. Apple Association
National Barley Growers Association U.S. Canola Association
National Cattlemen's Beef
Association U.S. Rice Producers Association
National Corn Growers Association U.S. Sweet Potato Council
National Cotton Council USA Rice Federation
National Council of Farmer
Cooperatives Western Growers
National Peach Council Western Peanut Growers Association
National Pork Producers Council Western United Dairymen
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
The undersigned agricultural organizations urge your support for
several tax provisions related to renewable energy and environmental
mitigation as part of any broader tax reform plan taken up by Congress.
U.S. farmers and ranchers and the companies that process agricultural
products provide food, feed, fiber, and fuel for our nation and the
world. Like all businesses, we must continue to innovate, establish new
markets, and improve efficiency to remain viable and competitive in
today's global market. Whether it is to help reduce regulatory
compliance costs or to incentivize renewable energy and conservation
benefits, there are a number of tax provisions that have been
implemented or proposed for agricultural products and practices.
In recent years, regulators have applied increasing pressure on the
agriculture sector to reduce output of nutrients like nitrogen and
phosphorus to improve water quality in various watersheds around the
country, from the Chesapeake Bay to the Great Lakes region. To help
solve this problem, tax-writers in Congress have introduced bipartisan
legislation to spur adoption and help cover the upfront capital costs
of nutrient recovery technologies, as well as biogas systems that
mitigate the environmental impacts of farming by transforming manure
into stable fertilizer for crops, bedding for cows, and fuel and
electricity for farms and nearby homes.
Tax incentives, such as the biodiesel tax credit, have also existed to
support renewable energy and fuel derived from agricultural feedstocks,
including animal fats. These renewable energy sources help diversify
our fuel supply, establish new markets and add value to farm products,
create jobs, and boost economic development, particularly in rural
America. U.S. biodiesel producers have unused production capacity that
stands ready to be utilized. Putting that capacity to work will
encourage further market growth for agricultural products and create
thousands of new jobs and billions of dollars in economic activity.
As you move forward with tax proposals, U.S. farmers and ranchers
support the inclusion of these tax provisions that help our businesses
meet regulatory requirements, provide conservation benefits and
incentivize renewable energy production. Thank you for your continued
efforts in support of our nation's farmers and ranchers. We look
forward to working with you as the process on tax reform continues.
Respectfully,
Agricultural and Food Transporters
Conference National Renderers Association
Agricultural Retailers Association Panhandle Peanut Growers
Association
American Farm Bureau Federation Southwest Council of Agribusiness
American Mushroom Institute South East Dairy Farmers
Association
American Sheep Industry Association United Egg Producers
American Soybean Association United Fresh Produce Association
American Sugarbeet Growers
Association U.S. Canola Association
Cobank U.S. Rice Producers Association
National Barley Growers Association U.S. Sweet Potato Council
National Corn Growers Association USA Rice Federation
National Council of Farmer
Cooperatives Western Growers
National Milk Producers Federation Western Peanut Growers Association
National Peach Council Western United Dairymen
National Pork Producers Council
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
On behalf of the nation's farmers and ranchers, the organizations
listed below are writing today regarding one of our priorities for
federal tax reform: a reduction in capital gains taxes.
Capital gains taxes have a significant impact on production agriculture
and producers' long-term investments in land, breeding livestock and
buildings. We believe a reduction of the tax rate on capital gains and
assets indexed for inflation would enable producers to better respond
to new market opportunities and facilitate the transfer of land to
young and beginning farmers.
Taxation for capital gains upon the sale of farm assets creates a
number of problems, particularly when an asset sale causes a sharp
transitory spike in income that pushes farmers and ranchers into a
higher than usual tax bracket. USDA has found that 40 percent of family
farms have reported some capital gains or losses, compared to 13.6
percent for an average individual taxpayer.
Another problem is the ``lock-in'' effect where the higher the capital
gains tax rate, the greater disincentive to sell property or
alternatively to raise the asking price. in today's agriculture
economy, starting a farm or ranch requires a large investment due to
the capital-intensive nature of agri-business, with land and buildings
typically accounting for 79 percent of farm and ranch assets. Given the
barrier created by the capital gains tax, landowners are discouraged to
sell, making it even more difficult for new farmers to acquire land and
agriculture producers who want to purchase land to expand their
business to include a son or daughter. This lose-lose scenario also
interferes with capital that would otherwise spur new and more
profitable investments.
At a time of heightened financial stress in our agriculture economy, it
is more critical now for farmers and ranchers to have the flexibility
to change their operations to respond to consumer demand in an
increasingly dynamic market. Because of the capital gains taxes imposed
when buildings, breeding livestock, farmland and agricultural
conservation easements are sold, the higher the tax rate the more
difficult it is for producers to cast off unneeded assets to generate
revenue, upgrade their operations and adapt to changing markets.
As you continue your work on legislation to reform the tax code, we
urge you to carefully consider our recommendations to address these
concerns regarding the inadequacies and inefficiencies of current
capital gains tax provisions. We acknowledge the extremely complex task
of crafting legislation to adopt comprehensive tax reform and
appreciate your support of America's farmers and ranchers.
Sincerely,
Agricultural and Food Transporters
Conference National Corn Growers Association
Agricultural Retailers Association National Cotton Council
American Farm Bureau Federation National Council of Farmer
Cooperatives
American Farmland Trust National Milk Producers Federation
American Mushroom Institute National Peach Council
American Sheep Industry Association National Pork Producers Council
American Soybean Association National Potato Council
American Sugarbeet Growers
Association National Renderers Association
California Association of Winegrape
Growers National Sorghum Producers
Cobank Panhandle Peanut Growers
Association
National Barley Growers Association Southwest Council of Agribusiness
National Cattlemen's Beef
Association South East Dairy Farmers
Association
United Egg Producers U.S. Sweet Potato Council
United Fresh Produce Association USA Rice Federation
U.S. Apple Association Western Growers
U.S. Canola Association Western Peanut Growers Association
U.S. Rice Producers Association Western United Dairymen
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
On behalf of our nation's family farmers and ranchers, the undersigned
groups would like to thank you for your efforts to reform the U.S. tax
code in a meaningful way for individuals, corporations, and small
businesses alike, including the 3.2 million farmers who generate food,
fuel, and fiber for Americans and people around the world. With that in
mind, we write today to express our concerns regarding the House
Committee on Ways and Means blueprint proposal to eliminate the
deduction for interest payments as a business expense.
Agricultural production is capital-intensive. While financing
requirements will vary among the different commodities, the majority of
family-owned farming operations are heavily reliant on credit. Even for
everyday business, agricultural producers utilize credit in the form of
operating and inventory loans. According to the United States
Department of Agriculture (USDA), net farm income in 2017 is forecast
to decline for the fourth consecutive year by 8.7 percent to $62.3
billion. In a weak farm economy, income is restricted to cover family
farmers' living expenses and the repayment of debt. During tough times,
producers are often forced to take on substantial annual interest
expense. Interest paid on these loans should be deductible because
interest is, and has historically been, considered a legitimate
business expense.
In addition, family farmers continue to grow their operations in order
to remain profitable. Equipment and land acquisition necessary for
long-term expansion is only possible through financing. USDA predicts
that in 2017, farm real estate debt will reach a historic high of
$240.7 billion, a 5.2 percent increase from 2016. Eliminating the
interest deduction will place further financial stress on an already
debt-burdened industry, and prevent producers from staying profitable
in challenging economic times.
Finally, the need for debt financing is particularly important for the
next generation of agricultural producers. Less than 2 percent of the
U.S. population is directly employed in agriculture. Consistent with a
30-year trend, the average age of principal farm operators is 58,
making farmers and ranchers among the oldest workers in the nation. As
older producers exit the workforce, financing will be critically
important for new and beginning farmers and ranchers looking to
establish businesses. Eliminating interest deductions creates a
significant barrier for the next generation.
As Congress works to enact comprehensive tax legislation, the positive
reforms made should not be undermined by negative, unintended
consequences as a result of eliminating the business interest deduction
for agricultural entities. It is our hope that future legislative
proposals do not ignore this important sector of the nation's economy,
and that they will consider the unique utilization and importance of
credit management across the entire agriculture sector.
Thank you for your continued efforts in support of our nation's
agricultural producers. We look forward to working with you on this
important issue.
Respectfully,
Agricultural and Food Transporters
Conference National Barley Growers Association
Agricultural Retailers Association National Cattlemen's Beef
Association
American Farm Bureau Federation National Corn Growers Association
American Mushroom Institute National Cotton Council
American Sheep Industry Association National Council of Farmer
Cooperatives
American Soybean Association National Peach Council
American Sugarbeet Growers
Association National Pork Producers Council
California Association of Winegrape
Growers National Potato Council
Cobank National Renderers Association
Farm Credit Council National Sorghum Producers
Panhandle Peanut Growers
Association U.S. Rice Producers Association
Southwest Council of Agribusiness U.S. Sweet Potato Council
South East Dairy Farmers
Association USA Rice Federation
United Egg Producers Western Growers
United Fresh Produce Association Western Peanut Growers Association
U.S. Apple Association Western United Dairymen
U.S. Canola Association
______
September 19, 2017
The Honorable Orrin G. Hatch The Honorable Ron Wyden
Chairman Ranking Member
U.S. Senate U.S. Senate
Committee on Finance 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:
On behalf of our nation's family farmers and ranchers, we come together
now to ask your support for including permanent repeal of the estate
tax in any tax reform legislation moving through Congress this year. In
addition, we ask your help to make sure that the benefits of repeal are
not eroded by the elimination of or restrictions to the use of the
stepped-up basis.
Family farmers and ranchers are not only the caretakers of our nation's
rural lands but they are also small businesses. The estate tax is
especially damaging to agriculture because we are a land-based,
capital-intensive industry with few options for paying estate taxes
when they come due. Unfortunately, all too often at the time of death,
farming and ranching families are forced to sell off land, farm
equipment, parts of the operation or take out loans to pay off tax
liabilities and attorney's fees.
As you know, the American Taxpayer Relief Act of 2012 (ATRA)
permanently extended the estate tax exemption level to $5 million per
person/$10 million per couple indexed for inflation, and maintained
stepped up basis. While we are grateful for the relief provided by the
ATRA, the current state of our economy, combined with the uncertain
nature of our business has left many agricultural producers guessing
about their ability to plan for estate tax liabilities and unable to
make prudent business decisions. Until the estate tax is fully repealed
it will continue to threaten the economic viability of family farms and
ranches, as well as the rural communities and businesses that
agriculture supports.
In addition to full repeal of the estate tax, we believe it is equally
as important for Congress to preserve policies which help keep farm
businesses in-tact and families in agriculture. As such, tax reform
must maintain stepped-up basis, which limits the amount of property
value appreciation that is subject to capital gains taxes if the
inherited assets are sold. Because farmland typically is held by one
owner for several decades, setting the basis on the value of the farm
on the date of the owner's death under stepped-up basis is an important
tax provision for surviving family members.
U.S. farmers and ranchers understand and appreciate the role of taxes
in maintaining and imp roving our nation; however, the most effective
tax code is a fair one. For this reason, we respectfully request that
any tax reform legislation considered in Congress will strengthen the
business climate for farm and ranch families while ensuring
agricultural businesses can be passed to future generations.
Thank you for your continued efforts in support of our nation's
agricultural producers. We look forward to working with you on this
very important issue.
Respectfully,
Agricultural and Food Transporters
Conference National Milk Producers Federation
Agricultural Retailers Association National Peach Council
American Farm Bureau Federation National Pork Producers Council
American Sheep Industry Association National Potato Council
American Soybean Association National Renderers Association
American Sugarbeet Growers
Association National Sorghum Producers
Livestock Marketing Association National Turkey Federation
National Association of State
Departments of Agriculture Panhandle Peanut Growers
Association
National Barley Growers Association South East Dairy Farmers
Association
National Cattlemen's Beef
Association Southwest Council of Agribusiness
National Cotton Council U.S. Apple Association
National Council of Farmer
Cooperatives U.S. Canola Association
U.S. Sweet Potato Council U.S. Rice Producers Association
United Egg Producers Western Growers
United Fresh Produce Association Western Peanut Growers Association
USA Rice Federation Western United Dairymen
______
Tax Innovation Equality (TIE) Coalition
Washington, DC 20005
[email protected]
202-530-4808 ext. 109
The Tax Innovation Equality (TIE) Coalition\1\ is pleased to provide
this statement for the record of the Finance Committee's hearing on
Business Tax Reform. The TIE Coalition comprises leading U.S.
technology and bio-pharma companies that rely on and invest in
intellectual property and intangible assets. Such investments help make
companies innovative, successful, and globally competitive. The TIE
Coalition supports comprehensive tax reform that will modernize the
U.S. tax system and help American businesses compete in a global
market. The TIE Coalition believes that the U.S. must: (i) implement a
competitive territorial tax system; (ii) lower the U.S. corporate tax
rate to a globally competitive level; and (iii) not pick winners and
losers in the tax code by discriminating against any particular
industry or type of income--including income from intangible property
(IP).
---------------------------------------------------------------------------
\1\ The TIE Coalition is comprised of leading American companies
and trade associations that drive economic growth here at home and
globally through innovative technology and biopharmaceutical products.
For more information, please visit www.tiecoalition.com.
Unfortunately, some past proposals would tax IP income adversely
compared to income from other types of assets, creating an unfair
advantage for companies who don't derive their income from IP, and
significantly disadvantaging innovative U.S. companies, especially
compared to their foreign competition. For example, the Tax Reform Act
of 2014 (H.R. 1) as introduced by former House Ways and Means Chairman
Camp would seriously disadvantage innovative American companies. Under
that proposal, Chairman Camp chose the anti-base erosion option known
as ``Option C.'' The problem with ``Option C'' is that it would
significantly disadvantage U.S. IP-based companies who compete globally
and it would result in more inversions of U.S. companies and more
foreign acquisitions of U.S. companies. The TIE Coalition is opposed to
``Option C'' because it would have a devastating impact on both
innovative technology companies and the nation's leading
---------------------------------------------------------------------------
biopharmaceutical companies.
Section 4211 of H.R.1 specifically targets ``foreign base company
intangible income'' for higher taxation by creating a new system in
which that income will be immediately taxed in the United States at
much higher rates (15% or 25%) rather than the 1.25% tax rate for all
other foreign income, which is only taxed upon distribution back to the
United States. The provision does not provide a definition of an
intangible asset. Instead it uses a formula which essentially provides
that if a company earns more than a 10% return on its foreign
depreciable assets, the income over the 10% threshold will be
considered ``intangible income'' and subject to the higher immediate
U.S. tax. Many innovative companies have higher margins and earn more
than 10% on their depreciable assets, so they will be
disproportionately affected by this adverse provision.
To understand the full scope of ``Option C,'' the TIE Coalition
commissioned a study by Matthew Slaughter, the Dean of the Tuck School
of Business at Dartmouth. See, ``Why Tax Reform Should Support
Intangible Property in the U.S. Economy,'' by Matthew J. Slaughter,
http://www.tiecoalition.com/wp-content/uploads/2015/07/IP-White-
Paper_January-2015.pdf. According to the study, ``Policymakers should
understand the long-standing and increasingly important contributions
that IP makes to American jobs and American standards of living--and
should understand the value of a tax system that encourages the
development of IP by American companies'' (Executive Summary).
The study found that ``Option C'' in the Camp legislation would
fundamentally (and adversely) change the measurement and tax treatment
of IP income earned by American companies abroad and would disadvantage
IP income earned abroad by U.S. companies in three ways. First, it
would tax IP income at a higher rate than under current law. Second, it
would tax IP income more than other types of business income. Third, it
would impose a higher tax burden on the IP income of U.S. companies
compared to their foreign competitors. As a result, the study found
that ``Option C'' ``would aggravate the nettlesome issue of corporate
inversions and would create additional incentives for foreign
acquisitions of U.S.-based IP-intensive companies'' (Executive
Summary).
According to the Slaughter study, since globally engaged U.S. companies
have long performed the large majority of American's IP discovery and
development, it is increasingly important to America's economic success
that these companies operate profitably overseas. The Slaughter study
finds that the ``United States, not abroad, is where U.S.
multinationals perform the large majority of their operations. Indeed,
this U.S. concentration is especially pronounced for R&D, which
reflects America's underlying strengths of skilled workers and legal
protections such as IP rights that together are the foundation of
America's IP strengths, as discussed earlier'' (page 30). The Slaughter
study concludes that the overseas operations of these companies
complement their U.S. activities and support, not reduce, the inventive
efforts, related jobs, and positive economic impact of their U.S.
parents on the U.S. economy.
In addition to ``Option C,'' other international tax reform proposals
have singled out income from IP for adverse treatment. In 2012, Senator
Michael Enzi (D-WY) introduced an international tax reform bill, S.
2091. While the Enzi bill did not propose lowering the corporate tax
rate, it did propose a territorial system with a 95% dividends received
deduction (DRD) for qualified foreign-source dividends. Unfortunately,
while the bill reduced the scope of the current law Subpart F regime in
some respects (by eliminating the current foreign base company sales
and services income rules under Section 954), it proposed creating a
new category of Subpart F income under which all income of a controlled
foreign corporation (CFC) would be immediately taxable in the U.S. at
the full U.S. rate unless the CFC's effective tax rate (ETR) exceeded
half of the maximum U.S. corporate rate. Under Senator Enzi's bill, the
ETR in the foreign country would have to be more than 17.5% to qualify
for territorial tax treatment with a 95% DRD and avoid immediate
taxation at the maximum U.S. tax rate.
However, ``qualified business income'' (as defined in the bill) would
be excluded from this punitive tax treatment and qualify for the 95%
DRD. But, ``qualified business income'' specifically would not include
``intangible income'' as defined in Section 936(h)(3)(B). As such,
Senator Enzi's proposal effectively repeals deferral for intangible
income earned by CFC's and denies territorial tax treatment with the
95% DRD for intangible income, clearly discriminating against income
from intangible assets. In addition to discriminating against income
from intangible assets, the Enzi bill would result in significant
additional disputes between the IRS and taxpayers regarding whether
income is from intangible property as broadly defined in Section
936(h)(3)(B) and if so, how much of that income is attributable to
intangible property.
In designing a competitive territorial tax regime, both Congressman
Camp and Senator Enzi decided that anti-base erosion provisions needed
to be included to protect the U.S. tax base, but they both chose
options that discriminate against IP income. The TIE Coalition has
offered several anti-base erosion proposals that do not discriminate
against income from intangibles. Two anti-base erosion measures that we
could support are ``Option D'' and ``Option RS.'' If base erosion is a
concern, it is a concern for all income, not just income from
intangibles.
``Option D'' proposes a territorial system with a graduated DRD based
upon the effective tax rate paid by the CFC. The general rule of a 95%
DRD would apply to foreign source dividends paid from a CFC that has an
effective tax rate equal to or greater than 15%. But if the effective
tax rate of the CFC is less than 15%, the DRD exemption would be
reduced using a simple sliding scale. Under ``Option D,'' if the CFC
tax rate is at least 7.5% but less than 15%, the DRD would drop to 85%.
If the CFC effective tax rate is less than 7.5%, the DRD would be 75%.
If the CFC effective tax rate is less than 7.5% and the CFC is
domiciled in a jurisdiction that does not have a tax treaty/possession
status/TIEA (or similar relationship) with the United States, the DRD
would be 60%. All low-tax active foreign income is treated similarly.
Income from intangibles is not singled out for especially harsh
treatment.
Under ``Option RS,'' low-taxed foreign income of a CFC would be subject
to immediate U.S. tax unless it is derived from a substantial local
business in the foreign jurisdiction where the income is reported and
subject to tax in that jurisdiction. Income would be considered low
taxed if the foreign effective tax rate (ETR) is 15% or less. The
substantial local business activity test would be met if all three of
the following tests are met: (1) the income is derived in the active
conduct of a trade or business in the foreign country; (2) substantial
local activities are conducted in the foreign jurisdiction; and (3) the
income is treated as taxable in the foreign country.
In conclusion, the TIE Coalition supports comprehensive tax reform that
modernizes the U.S. tax system, allowing American businesses to compete
in global markets in a manner that does not discriminate against any
particular industry or type of income, including income from intangible
property. At a time when many other countries are adopting tax rules
designed to attract IP companies to their shores, it would be
especially harmful to the U.S. economy to adopt a tax policy that will
hurt, not help, American IP companies who compete globally. Now is not
the time to drive high paying American jobs overseas.
[all]