[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
FULL COMMITTEE HEARING ON
MODERNIZING THE TAX CODE:
UPDATING THE INTERNAL REVENUE
CODE TO HELP SMALL BUSINESSES
STIMULATE THE ECONOMY
=======================================================================
COMMITTEE ON SMALL BUSINESS
UNITED STATES HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
APRIL 10, 2008
__________
Serial Number 110-83
__________
Printed for the use of the Committee on Small Business
Available via the World Wide Web: http://www.access.gpo.gov/congress/
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HOUSE COMMITTEE ON SMALL BUSINESS
NYDIA M. VELAZQUEZ, New York, Chairwoman
HEATH SHULER, North Carolina STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona TODD AKIN, Missouri
MICHAEL MICHAUD, Maine BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas STEVE KING, Iowa
DAN LIPINSKI, Illinois JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa DAVID DAVIS, Tennessee
YVETTE CLARKE, New York MARY FALLIN, Oklahoma
BRAD ELLSWORTH, Indiana VERN BUCHANAN, Florida
HANK JOHNSON, Georgia
JOE SESTAK, Pennsylvania
BRIAN HIGGINS, New York
MAZIE HIRONO, Hawaii
Michael Day, Majority Staff Director
Adam Minehardt, Deputy Staff Director
Tim Slattery, Chief Counsel
Kevin Fitzpatrick, Minority Staff Director
______
STANDING SUBCOMMITTEES
Subcommittee on Finance and Tax
MELISSA BEAN, Illinois, Chairwoman
RAUL GRIJALVA, Arizona VERN BUCHANAN, Florida, Ranking
MICHAEL MICHAUD, Maine BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana STEVE KING, Iowa
HANK JOHNSON, Georgia
JOE SESTAK, Pennsylvania
______
Subcommittee on Contracting and Technology
BRUCE BRALEY, IOWA, Chairman
HENRY CUELLAR, Texas DAVID DAVIS, Tennessee, Ranking
GWEN MOORE, Wisconsin ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York SAM GRAVES, Missouri
JOE SESTAK, Pennsylvania TODD AKIN, Missouri
MARY FALLIN, Oklahoma
.........................................................
(ii)
Subcommittee on Regulations, Health Care and Trade
CHARLES GONZALEZ, Texas, Chairman
RICK LARSEN, Washington LYNN WESTMORELAND, Georgia,
DAN LIPINSKI, Illinois Ranking
MELISSA BEAN, Illinois BILL SHUSTER, Pennsylvania
GWEN MOORE, Wisconsin STEVE KING, Iowa
JASON ALTMIRE, Pennsylvania MARILYN MUSGRAVE, Colorado
JOE SESTAK, Pennsylvania MARY FALLIN, Oklahoma
VERN BUCHANAN, Florida
______
Subcommittee on Urban and Rural Entrepreneurship
HEATH SHULER, North Carolina, Chairman
RICK LARSEN, Washington JEFF FORTENBERRY, Nebraska,
MICHAEL MICHAUD, Maine Ranking
GWEN MOORE, Wisconsin ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York MARILYN MUSGRAVE, Colorado
BRAD ELLSWORTH, Indiana DAVID DAVIS, Tennessee
HANK JOHNSON, Georgia
______
Subcommittee on Investigations and Oversight
JASON ALTMIRE, PENNSYLVANIA, Chairman
CHARLIE GONZALEZ, Texas MARY FALLIN, Oklahoma, Ranking
RAUL GRIJALVA, Arizona LYNN WESTMORELAND, Georgia
(iii)
C O N T E N T S
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OPENING STATEMENTS
Page
Velazquez, Hon. Nydia M.......................................... 1
Chabot, Hon. Steve............................................... 2
WITNESSES
PANEL I:
Mackey, Mr. Scott, Economist/Partner, Kimbell Sherman Ellis, LLP,
Montpelier, VT, On behalf of CTIA - The Wireless Association... 4
Hoops, Mr. Jeffrey R., Ernst & Young LLP, New York, NY, On behalf
of the American Institute of Certified Public Accountants...... 6
Lyon, Dr. Andrew B., Principal, National Tax Services NTS,
PricewaterhouseCoopers, LLP, Washington, DC.................... 8
Rosenthal, Mr. Fredrick, President, Jasper's Restaurants,
Beltsville, MD, On behalf of the National Restaurant
Association.................................................... 9
Greenblatt, Mr. Drew, President, Marlin Steel Wire Products,
Baltimore, MD, On behalf of the National Association of
Manufacturers.................................................. 11
APPENDIX
Prepared Statements:
Velazquez, Hon. Nydia M.......................................... 30
Chabot, Hon. Steve............................................... 32
Altmire, Rep. Jason.............................................. 33
Mackey, Mr. Scott, Economist/Partner, Kimbell Sherman Ellis, LLP,
Montpelier, VT, On behalf of CTIA - The Wireless Association... 34
Hoops, Mr. Jeffrey R., Ernst & Young LLP, New York, NY, On behalf
of the American Institute of Certified Public Accountants...... 39
Lyon, Dr. Andrew B., Principal, National Tax Services NTS,
PricewaterhouseCoopers, LLP, Washington, DC.................... 49
Rosenthal, Mr. Fredrick, President, Jasper's Restaurants,
Beltsville, MD, On behalf of the National Restaurant
Association.................................................... 61
Greenblatt, Mr. Drew, President, Marlin Steel Wire Products,
Baltimore, MD, On behalf of the National Association of
Manufacturers.................................................. 72
Statements for the Record:
The Telework Coalition........................................... 76
(v)
FULL COMMITTEE HEARING ON MODERNIZING
THE TAX CODE: UPDATING THE INTERNAL
REVENUE CODE TO HELP SMALL BUSINESSES
STIMULATE THE ECONOMY
----------
Thursday, April 10, 2008
U.S. House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 10:00 a.m., in Room
1539 Longworth House Office Building, Hon. Nydia Velazquez
[chairman of the Committee] presiding.
Present: Representatives Velazquez, Hirono, Chabot, Akin,
Fortenberry, Davis, Fallin, and Buchanan.
OPENING STATEMENT OF CHAIRWOMAN VELAZQUEZ
Chairwoman Velazquez. Good morning, everyone. I now call
this hearing to order on updating the Internal Revenue Code to
help small businesses stimulate the economy.
As we approach April 15th, millions of Americans are
preparing to make the tax filing deadline. Individuals and
businesses are busy working through tax forms and schedules to
determine what they owe the IRS.
For entrepreneurs, however, the tax code has become an
obstacle to success rather than a means of encouraging
expansion of their firms. Today's hearing will look at ways
U.S. tax policy can be improved to provide immediate relief for
these leaders of U.S. economic activity.
While the most recent economic stimulus package was focused
on rebate checks which aimed to boost consumer spending, more
can and must be done to foster sustainable economic growth. The
tax code is often used to influence and encourage individual
and business decisions. In fact, the Internal Revenue Code is
filled with numerous preferences, deductions, credits or
favorable tax rates that boost investment, savings for
retirement, and home ownership.
However, in numerous ways the tax code is stacked against
the average small business owner. Despite a number of changes
in the past ten years, there continue to be an abundance of
inequities and unnecessary complexities in our tax laws.
While fundamental reform may be years away, there is an
opportunity to modernize some of the more antiquated provision
which raise major obstacles and are particularly harmful to
entrepreneurs.
Today's hearing will focus on those aspects of the tax code
that can and should be updated or simplified without delay. In
conjunction with this hearing, the Committee will also release
a report outlining those reforms that will aid small businesses
during the economic downturn and put us on the path to
recovery.
In its review of this nation's tax laws and their impact on
entrepreneurs, the Committee found that a number of provisions
failed to adequately reflect the changing economy. Tax policies
simply have not kept up with the shift to a service-based
economy and lack adequate recognition of the role technology
plays.
Furthermore, home-based businesses are unnecessarily
hampered by paperwork burdens and depreciation schedules that
do not reflect the realities of the equipment and buildings
that are part of today's small companies.
Last but not least, there are provisions in existing law
that shift investment away from small firms. The report
outlines reform for each of these problems, while reflecting a
need to update the tax code to spur innovation and growth.
Given that the last major reform of the tax code took place
in 1986, it is clear these changes are long overdue.
Today we will hear from business owners who can provide us
with additional insights into how the tax code is affecting
this important sector of the economy. From what we already
know, the facts are not encouraging. While small firms are
America's job creators, just last week we learned that 80,000
more jobs were lost in March. We must take action to stop these
trends and instead of losing jobs make sure we are creating
them.
I believe there exists an opportunity to implement some
reforms immediately. Doing so will have immediate benefits for
small businesses. It will also insure the nation's long-term
economic growth.
I would like to thank all of the witnesses for testifying
today, and I now yield to the Ranking Member for his opening
statement.
OPENING STATEMENT OF MR. CHABOT
Mr. Chabot. I thank the Chairwoman for yielding, and good
morning to everyone. I thank you all for being here as we
examine ways to simplify the tax code for small businesses.
I want to thank you, Madam Chair, once again for
recognizing this pressing issue and for calling this timely
hearing.
April 15th is right around the corner, and it is this time
of year that we all become more attuned to the tax burden
placed upon all of us by our federal and state governments.
Small business owners feel this burden profoundly as the
question how will this affect my tax bill echoes all year long
in each decision that they make.
The complexity and uncertainty of the tax code limits small
business growth, slows job creation and puts a damper on our
overall economy. In many respects the tax code makes decisions
for entrepreneurs, and all too often those decision are to not
upgrade equipment or offer health insurance or make other key
investments because of the tax complications.
According to the Nonpartisan Tax Foundation, Tax Freedom
Day, the day that we begin to work for ourselves as opposed to
working to pay taxes, falls on April 23rd this year. So that
means that the average person, from January 1st through April
23rd, all of the income that they earn goes to the government,
either the federal government, state government, local
governments, government in one form or another. It is not until
after April 23rd for the rest of the year that the person is
working for themselves or their own family. That is outrageous
as far as I am concerned.
That means we work 113 days of each year to pay Uncle Sam
or the state or local versions of Uncle Sam before we earn a
single dollar for ourselves. In 2001 and 2003, Congress passed
legislation to cut taxes across the board on all Americans.
Unfortunately, these tax cuts are set to expire at the end of
2010. In other words, taxes will go up in two years unless
Congress takes action to prevent that from happening.
That also includes one of the most, I believe, egregious
taxes, and that is the federal inheritance tax or the death tax
in which the federal government can take up to 55 percent of
what a person has when they pass away, and that is generally
property that has already been taxed during a person's
lifetime.
And the two groups that are hit most acutely with this tax
are small businesses and farmers. That is oftentimes why the
business or farm does not make it to the next generation,
because it has to be literally sold in order to pay for the
federal death tax, and those employees lose their jobs
oftentimes.
Higher taxes, particularly on capital, cause the level of
private investment to fall, a devastating blow to the many
small businesses who rely on private investors for their
livelihood.
Before it sunsets, I want to see Congress make this tax
relief permanent. It is not just the added benefit of paying
lower taxes, but the certainty that comes with it. Small
businesses are always better off when they can plan for the
future, and having stable and predictable bills is a big part
of that.
The complexity of our tax code is staggering. At over
54,000 pages or, if you stack it one on top of another, it's
eight Bibles thick, the code is a morass of laws and
regulations that has been bloated to an unmanageable
proportion. For small businesses just starting out, it can be
especially difficult to know exactly what to do and when to do
it. Small businesses simply do not have the technical expertise
and in many cases the financial ability to hire accountants to
help them understand what deductions and benefits they might be
eligible for.
There's also a huge disparity in the way in which smaller
firms compare with larger ones when it comes to tax compliance.
In 2001, the Small Business Administration's Office of Advocacy
released a report on the regulatory cost faced by small firms
that contained an estimate of the paperwork compliance cost.
The report showed that small businesses with fewer than 20
employees spend over $1,200 per employee to comply with tax
paperwork, record keeping, and reporting requirements, more
than double their larger competitors.
Sounder, simpler tax policies would benefit both the
government and small business owners by improving compliance
and lowering cost. A local veterinarian near my district in
Cincinnati found out the hard way just how complex the tax code
is. Last April the practice passed an employee wage threshold
that required it to change how its 941 forms were deposited. Of
course, the IRS didn't notify the veterinarian until August.
She contacted her CPA and followed his advice, but the next
letter from the IRS was a fine. After sending a letter citing
as she put it ignorance as first time business owners--that was
her quote--she received not guidance but a new penalty bill,
bringing her fees to more than $2,400. That is a lot and often
too much for a small business to absorb.
Her biggest argument was that she used the IRS' electronic
federal tax payment system and did not see why there wasn't a
system built in to alert users to things like passing into a
new threshold. Most of all, she just wanted to know why things
could not be simpler.
We are here today because that is a fair question that
deserves an answer. I am looking forward to hearing from our
panel their recommendations for simplifying and modernizing the
tax code. Outdated provisions simply do not reflect real world
experiences and the way business is done domestically and
globally.
Again, I want to thank the Chairwoman for calling this
hearing, and I look forward to working with the Chair to help
our colleagues on the Ways and Means Committee provide real tax
relief, simplification, and certainty to our small businesses.
Once again, thank you, Madam Chair, and I yield back.
Chairwoman Velazquez. Thank you, Mr. Chabot.
And now I recognize our first witness, Mr. Scott Mackey
from the Wireless Association. He is with Kimbell Sherman. He
consults to major wireless telecommunication providers, and is
testifying on behalf of CTIA, the Wireless Association. CTIA
represents all sectors of the wireless communication industry,
including cellular and personal communications services.
Gentlemen, you will have five minutes, and in front of you
there is a timer that will let you know when your time has
expired.
Welcome.
STATEMENT OF MR. SCOTT MACKEY, ECONOMIST/PARTNER, KIMBELL
SHERMAN ELLIS, LLP, ON BEHALF OF CTIA - THE WIRELESS
ASSOCIATION
Mr. Mackey. Thank you very much, Madam Chair, Mr. Chabot,
members of the Committee, for holding this timely and important
hearing.
As you both said, tax policy is very important for small
businesses.
I am a partner at Kimbell Sherman Ellis in Montpelier,
Vermont, and so I am here today wearing two hats, one as a part
owner of a small business that has to comply with the
regulations and provisions that you both mentioned, and also I
have the privilege of representing CTIA, the Wireless
Association and its many, many members that are involved in a
very high tech and competitive business of wireless.
The business that I am in, one of the things we do is
provide an electronic bill tracking system for folks that are
following what is going on in our states in terms of
legislation that affects them in many ways, and so our business
has been able to grow from eight employees in 2006 to 22 today,
which that is not a lot of employees, but for us it is a lot.
And quite simply, we could not have grown our business
without the advances that have taken place in the last few
years in wireless technology, communications technology, and
information services. So when I talk to you about these
provisions that affect the wireless industry, these are also
indirect in our ability to be productive and make money and be
successful in business.
There are many issues I could be talking about today. Some
of the other panelists will address some of these. I am only
going to focus on three. The first one is the issue of cell
phones as listed property. The second is extension of the
research and development tax credit. And the third, which is
slightly off point but very important, is a bill soon to be
introduced which would impose a moratorium on discriminatory
state and local taxes on the wireless industry.
The first issue, listed property, is a very difficult
paperwork burden that is being imposed on small business. I
mean, basically what it says is if you provide a cell phone or
a Blackberry for your employees, that is not deductible as a
business expense unless those employees go through their bill
and identify each and every call and its business purpose.
Now, we have ten employees that have cell phones. The time
that it would take for those employees to go through and look
through hundreds and hundreds of calls, it is just a paperwork
nightmare, and the issue is that if the IRS were to audit us,
they would say that this is not a nontaxable fringe benefit. It
is a taxable item, and therefore, we would have to collect back
payroll taxes, Social Security and other taxes, and so this
issue needs to be addressed.
Small businesses, most of the folks I talk to, do not even
know it exists, and yet on audit potentially they could be
paying hundreds or thousands of dollars in back taxes. So this
issue needs to be addressed, and fortunately there is a bill
pending, H.R. 5450, by Representatives Johnson and Pomeroy that
would fix this, and we urge this Committee to support that.
The second issue is the research and development tax
credit. Many folks may not view the wireless industry as small
business because of the number of customers that subscribe to
wireless technologies, but having just come back from the CTIA
show in Las Vegas, there were thousands and thousands of small
entrepreneurs that are developing little niche products and
services that were run over wireless networks, and the R&D
credit is very important to those small businesses that are
really on the cutting edge of technology and innovation.
And while our firm does not use the R&D credit, we rely on
those innovations and technologies that are coming out of the
industry to provide us new tools to do business and be more
productive and profitable. So I think all small businesses
whether they claim the credit or not benefit from the
innovation in technology that comes from providing that credit
to our smaller entrepreneurs and other businesses as well.
And then the final issue is a moratorium on discriminatory
state and local taxes on wireless service. I recently published
a study which found that a typical wireless consumer pays
double the rate of taxes that other taxable goods and services
that are taxed in the states, and so this is a very important
issue for businesses like mine and other small businesses that
end up having to pay a lot of money in state and local taxes on
their wireless service.
Fortunately, Representatives Lofgren and Cannon will be
introducing either this week or next week, I hear, a five-year
moratorium on discriminatory taxes. So this would allow states
to tax wireless service if they are taxing other goods and
services under the same tax, but would present the singling out
of wireless services and wireless consumers for taxes just
because 20 years ago telecom was a monopoly and, therefore,
these old taxes are still on their books.
So this is a very important piece of legislation that,
while not covered under the Internal Revenue Code, is something
that members of Congress could do to help small businesses that
rely on wireless technologies to compete.
So in conclusion, thank you very much for the opportunity
to testify on these issues. I look forward to any questions
that you might have at the conclusion of the panel.
And, again, thank you.
[The prepared statement of Mr. Mackey may be found in the
Appendix on page 34.]
Chairwoman Velazquez. Thank you, Mr. Mackey.
Our next witness is Mr. Jeffrey Hoops. He is with Ernst &
Young in New York. He is here representing the American
Institute of Certified Public Accountants. AICPA has served the
accounting profession since 1887. The association has more than
350,000 members, including CPAs in business and industry,
public practice, government, education, and international
associates.
Welcome, sir.
STATEMENT OF MR. JEFFREY R. HOOPS, PARTNER, ERNST & YOUNG, LLP,
ON BEHALF OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC
ACCOUNTANTS
Mr. Hoops. Good morning. Thank you for inviting me.
Madam Chairwoman Velazquez and Ranking Member Chabot and
other distinguished members of the Committee, I am here on
behalf of the American Institute of CPAs. Our 300,000 members
represent literally millions of small businesses, and at this
time of the year especially we see first hand both the
staggering complexity that you mentioned and the unnecessary
complexities that you mentioned that face small businesses when
trying to comply with the tax laws.
We have submitted a number of important changes that we
think could be made to modernize the tax code and help small
businesses be more competitive, especially in a global
marketplace, and I would request that our previously submitted
testimony be include in the official record of this hearing.
Today I would like to focus on a few of those items that we
believe could make the tax code simpler, as you suggested. Some
of those have to do with S corporations. As you probably know,
S corporations are a very popular vehicle for small business
owners when it comes to forming their corporations. One
significant hurdle that is faced by a C corporation that wants
to convert to an S corporation is the LIFO recapture tax. This
is a tax which is computed on the difference for inventories
computed under the LIFO method of taxation and the FIFO method
of taxation. And that recapture tax is paid that the date that
the corporation elects to be taxed as an S corporation.
We believe that this tax could be more than sufficiently
addressed through the built in gains tax, and we believe that
the repeal of this provision, Section 1363(d) of the Internal
Revenue Code, would allow more small businesses such as car
dealerships, jewelry stores and others, to participate in this
popular form of doing business, the S corporation.
A second corporate level tax that is paid by S corporations
is what is known as the passive investment income tax or also
more popularly known as the sting tax. This is paid by many
corporations who have previously accumulated earnings as a C
corporation, and when their gross receipts as an S corporation
exceed more than 25 percent or royalties, rents and interest
and dividends exceed more than 25 percent of their gross
income.
In addition, if this happens for three years in a row, the
S corporation election is automatically terminated. We believe
that the law should be changed to eliminate the termination
provisions because we think that the penalty provision or the
sting tax is enough and that business owners should not be
penalized by having their S corporation status repealed.
I would like to spend a couple minutes also focusing on
partnerships. Many new businesses, small businesses form
partnerships and partnerships or limited liability companies
have become the preferred method for most new businesses that
involve more than one person. Generally Subchapter K of the
Internal Revenue Code, which governs the taxation of
partnerships and partners, can be extremely complex, and yet
there are only a limited number of de minimis rules or other
ways for small businesses that are required to report under
partnership rules to simplify their lives by electing out of
Subchapter K.
One recent enactment created what is called the qualified
joint venture, and this was based on a noble congressional
desire to simplify the tax life of husbands and wives operating
businesses together and to make certain that both spouses
receive credit for purposes of Social Security and Medicare.
This election allows the two partnership participating spouses
to forget about the complexities of Subchapter K and to file as
separate sole proprietors.
Unfortunately, a recent IRS interpretation of this new
statute provides, if this interpretation is allowed to stand,
it is very unclear as to which, if any, of these small
businesses operating as husband and wives would be allowed to
take advantage of this provision. That should be clarified.
We agree, by the way, with Mr. Mackey with respect to the
treating phone and personal PDAs as listed property, and we
think that that should be repealed.
And finally, we would like Congress to change the rules
which currently provide that a taxpayer can take a position
without penalty on the Internal Revenue Code that a tax
preparer could not take without disclosure or being subject to
penalty. We think that makes the playing field unfair, and we
would like to see that changes as well.
Thank you very much.
[The prepared statement of Mr. Hoops may be found in the
Appendix on page 39.]
Chairwoman Velazquez. Thank you, Mr. Hoops.
Our next witness is Dr. Andrew B. Lyon. Dr. Lyon is with
PricewaterhouseCoopers. He is a leader in NEC's legislative and
regulatory economic practice specializing in analyzing the
revenue and economic effects of legislative and regulatory
proposals. He is considered an expert in the tax field and
contributed to the 2005 President's Advisory Panel on Tax
Reform.
Welcome.
STATEMENT OF DR. ANDREW B. LYON, PRINCIPAL, NATIONAL TAX
SERVICES, PRICEWATERHOUSECOOPERS, LLP
Mr. Lyon. Thank you.
I thank the Committee for this opportunity to testify on
the appropriate design of the tax system, especially as it
applies to small business. My testimony is my own, and any
opinions are not necessarily those of PricewaterhouseCoopers.
I understand your interest is both with respect to the
current economic environment and also a forward looking
interest in the promotion of long-term economic growth. While
short-run economic concerns may create deviations from the most
desirable permanent tax structure, I believe the long-term
growth of the U.S. economy and small businesses is best
promoted by providing a simple, transparent tax system with the
lowest possible tax rates.
Small business plays a vital role within the broader
private economy. In 2005, businesses with less than 500
employees represented 99.7 percent of all businesses and
accounted for half of all private employment.
Government data also show that a relatively small number of
large businesses also play an important role in the economy,
and as an example, firms receiving more than $50 million in
receipts represent just a tiny fraction of all firms, yet they
account for about 69 percent of total business receipts.
Given the important role of both small and large businesses
in the economy, there is a general consensus among economists
that the tax system should not try to favor one form of
business over another. The basic rationale is that in the
absence of taxes, the market economy on its own would come up
with the best allocation of small and large businesses that
would maximize output in the economy. So in the presence of
taxes, you would not want to try to change the outcome that
would occur without taxes.
The one complication with this argument is that the very
presence of a tax system can impose inordinate compliance
burdens on small businesses, and while to some this might
justify the use of special incentives to try to offset this
compliance burden, the special incentives themselves may create
new compliance burdens, and the cost of claiming those special
incentives, again, the burdens, may fall disproportionately on
small businesses.
My written testimony touches upon several provisions in the
tax code that create some distinctions between small and large
businesses. Some of those differences are favorable to small
businesses. Some are unfavorable. The point I want to emphasize
is the inordinate compliance cost placed on small businesses
today.
IRS data indicate that there are both significant amounts
of under reporting of income by small businesses and
significant compliance costs placed on small businesses, and
there may be a correlation between the two. While noncompliance
is not to be condoned, it can be understandable how the heavy
compliance burdens may generate the result of noncompliance
with some of the rules of the tax system.
Examining compliance costs, one IRS study found that
businesses with less than $10,000 in annual receipts faced
compliance costs that were twice as large as the total receipts
of the business. Even as you expand to slightly larger small
businesses, for example, those businesses with receipts between
$100,000 and $500,000, compliance costs are estimated to be
about five percent of total receipts. Again, that is measured
relative to receipts, not income.
Income for such firms on average is about seven and a half
percent of total receipts. As a result, compliance costs for
these businesses represent an additional 60 percent tax on
their income.
In summary then, as you think about reforming the tax
system, it is essential to drive down the cost of complying
with the nation's tax laws by reforming them with the goal of
producing a clear, simple, and transparent tax system. As I
mentioned at the beginning, I think this can best be achieved
by creating a tax system with the lowest possible tax rates on
business and with a minimum of special incentives. And in this
way we can best foster entrepreneurship, innovation, and the
long-term investment that will raise this nation's living
standards.
Thank you.
[The prepared statement of Dr. Lyon may be found in the
Appendix on page 49.]
Chairwoman Velazquez. Thank you, Dr. Lyon.
Our next witness is Mr. Frederick Rosenthal, National
Restaurant Association. Mr. Rosenthal is the president of
Jasper's Restaurants. Jasper's has been in operation for over
25 years and has three locations in Maryland. Mr. Rosenthal is
testifying on behalf of the National Restaurant Association,
founded in 1919. The association is the leading advocate for
the restaurant industry. It's 945,000 members employ 13.1
million people.
Welcome, sir.
STATEMENT OF MR. FREDERICK ROSENTHAL, PRESIDENT, JASPER'S
RESTAURANTS, ON BEHALF OF THE NATIONAL RESTAURANT ASSOCIATION
Mr. Rosenthal. Thank you.
I would like to thank the members of the Committee for
giving me this opportunity to offer testimony on behalf of the
National Restaurant Association about ways to update the tax
code and help stimulate the economy.
I have been an entrepreneur in the restaurant business for
over 40 years, building catering halls first in Baltimore, and
restaurants since 1981 in Prince George's, Montgomery, Anne
Arundel, and Calvert Counties in Maryland.
I am proud to be a part of an industry that plays such a
critical role in this nation's economy. The restaurant industry
is the second largest private sector employer outside of the
federal government, with more than 13 million employees,
representing more than nine percent of the job base. The first
is the health care industry, but we are a close second.
The restaurant industry sales for this year are projected
at $558 billion equaling four percent of the U.S. gross
domestic product. Nationwide there are 945,000 restaurant and
food service outlets. More than seven out of ten of these are
small businesses, more than seven out of ten! We are truly a
small business industry becoming an economic powerhouse more
and more so each year.
I am here today to discuss the need for reforms in
depreciation schedules, specifically to shorten the write-off
for restaurant buildings and improvements to 15 years. This
change would create immediate economic activity within the
industry, which in turn would reverberate throughout the
economy.
There is currently legislation pending in the 110th
Congress which addresses the accelerated restaurant
depreciation for new construction and improvements. H.R. 3622
championed by Congressman Kendrick Meek from Florida and
Patrick Tiberi from Ohio would make permanent a 15-year
depreciation schedule for newly constructed restaurants, as
well as restaurant improvements.
The bill currently enjoys bipartisan support with 113
sponsors, including ten members of this Committee. There is no
question that restaurant depreciation schedules are outdated.
According to the tax code, restaurant buildings have a life of
39 and a half years in which they are written off. To suggest
that a restaurant building's actual life is 39 and a half years
is ludicrous. In fact, I wonder how many of you have know a
restaurant that has even been in existence 39 and a half years.
Would any of you eat in a restaurant that had not been
updated 40 years? I cannot even imagine the condition of the
bathrooms and the carpeting in the building.
One hundred and thirty-three million individuals patronize
this industry on a daily basis. Restaurants must constantly
make changes to keep up with the daily assault of traffic in
their buildings. In fact, most restaurants remodel and update
their buildings every six to eight years, a much shorter time
frame than is reflected in the current depreciation schedule.
Over the years Congress has made numerous changes in the
depreciation schedules. They have granted specific benefits to
gas stations and convenience stores, recognizing the need in
those industries, and there have been other changes that create
faster write-offs creating economic advantages.
The tax code should not pick winners and losers in the
restaurant industry. It should allow a level playing field on
which all can play. In today's environment with high commodity
costs, restaurants and small businesses are now yielding bottom
lines of three to four percent, down from ten percent in the
1980s. Most of these small businesses are unable to remodel
their buildings. It is a spiraling effect, downturn of sales,
increasing costs, and in many ways forcing small businesses to
close when the patronage drops below an economic level of
sustainability.
All of these changes are addressed in my written testimony
as well as a detailed explanation of the issue, and in respect
for everyone's time, I will just hit a few points.
The restaurant industry is projected to spend $70 billion
over the next ten years for building construction and
renovation. Finally, there is no question as to whether or not
this provision would immediately spur economic activity. Look
what happened when Congress enacted a provision to provide
restaurants a 15-year schedule for improvements to restaurant
structures in 2004. In 2005, that provision was in effect. The
restaurant industry spent more than $7.5 billion on
improvements, a 42 percent increase over the previous year
before enacted.
We urge the members of this Committee to consider the
information as evidence to keep a strong restaurant industry in
order to help this nation's overall economy.
In conclusion, on behalf of the National Restaurant
Association, thank you for allowing me to testify, and thank
you to those members of the Committee who have co-sponsored and
championed this important legislation.
I will be happy to answer any questions when my turn comes.
[The prepared statement of Mr. Rosenthal may be found in
the Appendix on page 61.]
Chairwoman Velazquez. Thank you, Mr. Rosenthal.
Our next witness is Mr. Drew Greenblatt, National
Association of Manufacturers. He is the president of Marlin
Steel Wire Products, established in 1968 in Baltimore. He is
testifying today on behalf of the National Association of
Manufacturers.
NAM has advocated for small manufacturers since 1895.
Founded in Cincinnati, Ohio, it has 14,000 member companies in
all industry sectors located throughout the nation.
Welcome.
STATEMENT OF MR. DREW GREENBLATT, PRESIDENT, MARLIN STEEL WIRE
PRODUCTS ON BEHALF OF THE NATIONAL ASSOCIATION OF MANUFACTURERS
Mr. Greenblatt. Thank you.
Good morning, Chairwoman Velazquez, Ranking Member Chabot,
and members of the Committee. My name is Drew Greenblatt. I am
the president and owner of Marlin Steel Wire Products in
Baltimore, Maryland.
Marlin was founded in 1968. We manufacture wire baskets,
hooks, and wire forms. We have the capability to produce a wide
range of custom products for our customers. Our products are
used in industrial, aerospace, medical and automotive,
factories and industries. We have clients like Caterpillar,
Toyota, Boeing.
Thank you for the opportunity to let us appear today and on
behalf of the National Association of Manufacturers, we
appreciate it.
The NAM is the nation's largest industrial trade
association, and we represent small and large manufacturers in
every industrial sector in all 50 states. I am pleased that you
have addressed this subject of updating the Internal Revenue
Code. It will help small businesses stimulate the economy.
The NAM's tax policy agenda is designed to promote U.S.
jobs and competitiveness and insure continued economic growth.
I would like to touch on a few of these specific concerns that
we have, and they include making the income tax cuts permanent,
providing a strengthened R&D credit, and repealing the three
percent withholding requirement on all government contracts.
Because Marlin Steel is an S corporation, we pay taxes at
an individual rate. Many manufacturers like us are in the same
boat. In fact, about half of all NAM members are similarly
organized as flow-through companies, meaning they pay
individual rates.
For us, the legislation passed in 2001 and 2003 lowered the
top individual tax rates. This has been very good for us. Lower
tax rates mean more money after taxes to expand our operations
and create new jobs. When enough manufacturers expand, we fuel
economic growth. This translates into more money for the
government to spend and lower deficits.
It is paradoxical but true that lower rates mean higher tax
revenues. Conversely, letting the Bush tax cuts expire
effectively raises taxes in 2011. This will mean that we will
be thinking about cutbacks right in the middle of an economic
downturn.
There has been a lot of talk recently about raising taxes
only on the upper brackets, but many folks in Congress think
this means that they are only raising it on the super wealthy,
but I am here today to remind you that these rates will strike
at the heart of small business. My tax return includes all of
my business income, even though we have never paid a dividend.
We pour every penny of profit back into the company to let it
grow. This so-called profit that the IRS is taxing me on is not
cash in my pocket. It is money that I keep in my company so we
can buy another welding machine to make a basket like this
right here.
If my taxes go up, I will have to have less money to buy
that welding machine or less money to hire a welder in
Baltimore. The toll will not only be paid by manufacturers like
myself, but it is also going to be one less machine that the
welding machine company sells, and it is also going to be
another unemployed person in Baltimore City.
Wouldn't it be better off if I was buying new equipment?
Wouldn't it be better off for me to be hiring new people an the
unemployment rolls to be smaller?
The R&D tax credit is also instrumental in maintaining our
competitive edge. We are the primary innovator in the United
States. Manufacturers understand that R&D drives new
productivity. R&D is how we stay fresh, how we stay
competitive. I cannot compete with other countries when it
comes to wages. So I have to win on innovation.
Chairman Velazquez, let me give you a concrete example.
Travers Tool is one of the excellent companies in your
congressional district. They buy this basket right here from
me. They resell it worldwide. No one is going to get rich from
just this one basket model. Travers needs a steady flow of new,
fresh ideas, new products that are competitive, that are
different.
We use this R&D tax credit to do our Thomas Edison
imitation so that we can be different, innovative, and fresh.
This tax credit helps Marlin stay innovative and contributes to
jobs in our district, in your district. Unfortunately, because
it is a temporary nature, this R&D tax credit, on again, off
again, the fact that we are never certain whether it is going
to be extended, it is very hard for me to decide whether or not
we should continue plowing ahead reinvesting into the company.
As of right now, the tax credit has expired. Because
Congress failed to act, we are going to get hit with a big tax
increase. Making this credit permanent would end the years of
speculation, and it would give the business the certainty we
need to plan ahead.
In conclusion, the tax relief enacted in 2001 for families
and businesses have played an important role in stimulating
economic growth and job creation. Making this tax relief
permanent would be an insurance policy for continued economic
growth. Lowering tax rates, doing the permanent R&D credit are
critical.
Simplifying the tax code by repealing the three percent
withholding, consolidating the AMT and the existing tax
structure, and repealing the estate tax would go a long way
towards helping the small business community.
I want to thank you again, the Committee, for the
opportunity to be here today and talking about the tax code and
its impact on Marlin Steel Wire. I am happy to answer any
questions.
[The prepared statement of Mr. Greenblatt may be found in
the Appendix on page 76.]
Chairwoman Velazquez. Thank you, Mr. Greenblatt.
There is going to be a series of votes. So what I am going
to do is I am going to ask the first question, and then defer
to the minority members. Then when we come back after those
series of votes we will continue the hearing.
I would like to address my first question to Mr. Rosenthal.
In your written testimony, you spoke about the connection
between your industry and the construction trade. Obviously,
because of the housing crisis, construction is one sector of
the economy that is particular struggling. Can you discuss in
greater detail how do you think that tax benefits that help
restaurants will stimulate growth in your industry and in
others?
Mr. Rosenthal. That is a very good point. To give you an
example, right now we have one of our restaurants is overdue
for remodeling and refurbishing. We have plans on the drawing
board to redo our first floor, redo the exterior, redo the roof
and ceiling line at a cost of approximately $175,000.
We are looking as to whether or not we can do this this
year, and part of the problem is our bottom line at that store
has dropped to about three percent. We are facing a perfect
storm right now. Usually when we see economic dips like we are
seeing right now, we find that demand drops and, therefore, our
cost of doing business, supplies and food costs drop.
But with the weak dollar and extremely high commodity
costs, our costs, the food costs and products, have exceeded a
five percent increase over the last year, with high labor costs
dropping our bottom line to under three percent.
Candidly, in an environment where we are only at a three
percent profit line, we do not know if we can take the risk to
make that investment. If we knew that we had the ability to
look at getting accelerated depreciation, which would mean that
approximately double our deduction next year, we would then be
more likely to make that.
As far as the building is concerned, yes, all of the
construction companies are eager to do business. Three years
ago we could not find a company to remodel and today we have 20
biting at the bit to do the job because they are hurting.
Chairwoman Velazquez. Thank you.
Mr. Chabot.
Mr. Chabot. Madam Chair, I am going to reserve my
questions.
Before I yield to my colleagues here, I just want to thank
the panel, and I think their testimony was really excellent. I
certainly agree that we need, rather than more special
incentives complicating the tax code, to simplify it is the
best thing that we could do and make the tax cuts that we
already passed permanent so that businesses know what they are
going to be dealing with down into the future and can plan for
that now. I think that is the best thing that we could do for
the economy, and hiring more people.
But I will yield my time to the gentleman from Tennessee,
Mr. Davis.
Mr. Davis. Thank you so much. I appreciate each of you
being here today. Thank you for what you do in our economy.
You know, as I look around northeast Tennessee where I
represent, I have been a small business owner myself before
coming to Congress about 20 years. So I know what it is to make
a payroll and have to pay taxes and hire accountants to make
sure that I do everything the way I am supposed to.
And I appreciate the opportunity, Madam Chairman, to have
this hearing on taxes because I honestly believe that you
cannot tax and regulate yourself into prosperity, and I think
we are seeing that now especially with energy costs that are
going up. As energy costs go up, commodity costs go up, and you
are starting to see that.
I signed onto a piece of legislation that several members
of the House have signed onto called an economic growth
package. I voted for the economic stimulus package. I think we
actually need a growth package, and the best economic growth
package is a good paying job. It is not higher taxes and more
regulations.
That legislation does basically three things, and I would
like for you to talk to me about how you see this working in
the economy. It would lower the top corporate rate from 35
percent to 25 percent. That would bring us in line with the
European Union nations. That would bring jobs back to America
that have actually left America in my mind.
The second thing it would do is allow for immediate
indexing for new equipment and buildings.
And finally, the third thing it would do is decrease the
top corporate capital gains rates to 15 percent bringing it in
line with individual capital gains rates, putting more money
back into small businesses so that they can go out and create
those jobs, the ultimate best economic stimulus package.
If each of you or some of you could talk about an economic
growth package with those fundamental principles and what it
would do to our economy, I would appreciate hearing your
thoughts.
Thank you.
Mr. Hoops. Thank you.
I think that any package that reduces taxes will improve
the economy. You certainly put more money into the pockets of
small business owners. I think it is a fruitful debate and
discussion to take into account whether those provisions will
simplify the code or make them more complex. I appreciate the
fact that the title of this hearing is modernizing the code,
not simplifying it, and in an economic downturn, I suppose that
modernizing is more important than simplifying.
So I would say in general although your stimulus package
will undoubtedly make the code more complex, it could very well
have the effect of stimulating the economy by putting more
money in the pockets of small business owners.
Mr. Lyon. Let me address the corporate rate reduction. If
you look back prior to 1986, the United States had one of the
highest corporate tax rates in the world. The 1986 Tax Reform
Act reduced the corporate rate from 46 percent to 34 percent,
and at that time did give the U.S. an advantage over most of
our trading partners.
However, what happened since 1986 in the 20-plus years is
that all of our trading partners reduced their rates, and so as
you mentioned, today the average combined federal and local
corporate tax rate in the European Union is less than 25
percent. It is about 24 and a half percent. So the U.S.
corporate rate, by not changing on its own, became out of line
with our trading partners and in many cases creates a
competitive disadvantage for U.S. companies.
And even at a 25 percent federal rate, companies would
still be liable for state and local taxes, which on average
would add close to four or five percentage points on top of
that 25. So many companies might say that that is not even
going far enough.
Mr. Rosenthal. I think it was said here before that most of
us in small business are taking the money from our, quote,
unquote, profits and putting them back into our businesses.
What this does, to lower the tax rate it enables us to invest
and expand at a greater rate when we are burdened with higher
taxes.
Most people do not realize that our industry, the
restaurant industry, today is a highly professional industry.
We are not providing the stereotype of minimum wage jobs. We
are providing major jobs for folks who have growth
opportunities in executive positions, many of whom are in six
figures or more, running restaurants, and in order to expand
that, getting a great job, we need to expand our business. And
at a time when taxes are high and we are unable to use that
money to plow back into our business, then they obviously are
not going to provide those jobs.
Mr. Greenblatt. this is a wonderful idea. We need you to
win. We need more jobs to grow. We need to invest more back
into the company. We need all of our other factories to invest
back in.
We are not competitive. Right now our structure is not
competitive against France. It is not competitive against our
major trading partners. This is crazy. We should be a low tax
environment so that we can fight the French, so that we can
fight the Germans, so that we can fight the Canadians and be
more competitive.
And by you leading the charge on this, we encourage you to
do that because we really need the relief, and now is the time.
Thank you for doing what you are doing.
Chairwoman Velazquez. Your time has expired. Ms. Hirono.
Ms. Hirono. Thank you, Madam Chair.
I know that the tax code has not been revised substantially
since 1986, and so what we have had to add to the complexities
is basically piecemeal legislation. So I commend the testifiers
for focusing on those things that can modernize the tax code,
and thank you for the specific bills that have been introduced.
I do have one question for Mr. Greenblatt. You mentioned in
your testimony that the impact of sunsetting the Bush tax cuts
will have a terrible impact, negative impact, on small
businesses like yours. Do you have any information or data to
support your contention and the extent of that kind of a
negative impact on small businesses?
Mr. Greenblatt. Thank you for the question.
It will be the biggest tax increase in American history,
and that is the wrong thing you want to do when the economy is
on shaky grounds, number one.
Number two, we pay on a flow-through level. So the money
that is coming into us is money that we are reinvesting
everything back into the company. So mean you cream off 35
percent at the top rate, that is a lot of money.
Ms. Hirono. Well, I understand that. What I was asking was
whether you have information from a much more industry-wide
basis what the impact would be. Because these tax cuts are due
to sunset, and if they do not get sunsetted, we are going to
need to apply pay-go rules, and there are going to be massive
cuts in many other programs in order to pay for the extension
of the tax cuts that were supposed to be sunsetted.
So, you know, I am interested in the adverse impact of the
sunsetting on small businesses. So if you can direct me and
this Committee to information that would allow us perhaps to
look at the impact on small businesses as a separate matter,
then I think that would be very helpful.
Mr. Greenblatt. I would be delighted to send you the
information. The bottom line is we are the ones that create
jobs, and our people pay the taxes that make this all work. And
if we are scared because the money is going to go away, then we
are not going to hire as many people, and that is going to
impact how much the tax receipts are in the future.
Ms. Hirono. Dr. Lyon.
Mr. Lyon. I could mention again there are a huge number of
small businesses, I believe something on the order of 21
million businesses, and the income they earn is taxed at
individual rates largely. I believe Treasury has produced data
showing that about 70 percent of the income in the top two
individual tax brackets derive from flow-through businesses. So
most of the income in those top brackets is essentially
business income that would be impacted by a tax increase.
Ms. Hirono. Thank you. Thank you, Madam Chair. I yield
back.
Chairwoman Velazquez. Mr. Buchanan.
Mr. Buchanan. Mr. Rosenthal, I want to mention my
background has been 30 years self-employed. So I share your
experience as an entrepreneur. I was chairman of the state
Chamber last year in Florida a couple of years ago, but let
mention I hear what you are saying. I would like to extend that
to 15 years from 39 for all businesses.
But what about component depreciation and leasehold? We
write off over five years' component over five years. When you
took your position on the improvements for 175,000, how much of
that could go in the one category over the other one? I would
like to get it all to 15, but I would like to see us get 15,
not just in restaurants but other businesses as well.
But I would like to just have your thoughts on that. When I
open a business or something, we put it in two categories, the
land at zero, 39 on the building, and five years. Most of it is
whatever we can component or leasehold. So I would just be
interested in your thoughts.
Mr. Rosenthal. Well, we play that juggling game, you know,
in small business, small business entrepreneurs. We spend as
much time trying to figure out how we are going to categorize
things to maximize our depreciation.
However, as you know, there are restrictions on what we can
use for components. For example, if we put a kitchen in, the
only thing we can accelerate to the five-year level is actual
equipment that is used for cooking. So we have tried to expand
that to say, well, is the duct work over the stove part of
that? And we have been rejected often by the IRS saying, no,
that is not. It is very literally interpreted.
So we wind up with a minimum amount that we are able to put
into a five-year category, and we wind up with most of our
leasehold improvements carrying the full term of full 39 and a
half year depreciation.
If you look at most restaurant expansions today, 15 years
ago a kitchen cost $150,000 to equip a casual dining 7,500
square foot restaurant, and today we are looking at a half a
million dollars for that same kitchen, the majority of which
has to be depreciated over 39 and a half years. so the answer
to your question is there is not enough in that lower category
to offset the 39 and a half year category, and that is why I
think it is important to get the accelerated depreciation.
Mr. Buchanan. Yes, I support you on that.
I wanted to mention, Mr. Greenblatt, on your comment one of
the things I think a lot of people do no understand up here
because they are not in business, a lot of small businesses
pass through income, and what that means, and someone said,
well, that puts more money in the small business person's
pocket. It really do not. I mean, it does, but it does not, I
mean, with net worth.
But the reality of it is if you make 300, you pay 150 in
taxes. You buy some more inventory. By the end of the day I
have seen so many business people say, ``Where is my cash?'' So
not much of it really flows through to the owner, and then you
need that money.
So when they look at raising taxes from 35 to 45 or add
four and a half percent on taxes over 150,000, some of the
surtax up here, that mentality, a lot of that goes right to the
heart of small business. And I know a lot of people that make
500, 700, 800, but it flows back into their businesses to
create jobs, buy equipment, expand. You have got to have it for
the banks if you want to try to grow your business.
Has that been your experience?
Mr. Greenblatt. Absolutely. That is the key. That is the
thing that is critical that we must understand, that we are
reinvesting everything back to stay competitive. We are
righting China. We are fighting Japan. We are fighting Mexico.
And the only way we can be competitive is by reinvesting,
reinvesting.
You know, it is critical that we stay competitive, and that
is only going to happen because we keep the tax rates low and
we plow more money into the company.
Mr. Buchanan. Thank you.
That is it, Madam Chair, for me.
Chairwoman Velazquez. Mr. Fortenberry.
Mr. Fortenberry. Thank you, Madam Chair.
Thank you, gentlemen, for coming today.
Just a side comment regarding Mr. Greenblatt; is that
right? I am sorry. I cannot see your sign. You were talking
about manufacturing. Just an anecdotal story.
A businessman I was speaking to recently was talking about
the cost of manufacturing a particular item in the United
States $13; in Mexico $3; in China 28 cents. And that is the
disparity of what we are facing and the incentives to shift
more and more manufacturing out of this country are very real
because of differences of currency, because of differences of
labor and environmental standards and perhaps tax code
differentials as well that discourage manufacturing investment
here.
And this is a very serious problem. That is not my
question. My question is I like to participate in these
hearings in order to try to discuss big ideas. Now, all of you
have generously given of your time to come today, but we are
still kind of in the framework of discussing on the margins
what already is. You know, tweak this area of the tax code,
simplify this, depreciate that.
I just walked out of the room to talk to a group of people
who have a very legitimate concern that their depreciation
schedule is not consistent with the actual life of the
equipment, very legitimate.
But what are the big ideas that are out there that can
start to fundamentally address the earlier problem that I
talked about, encouraging a new spirit of innovation and
entrepreneurship?
We have a new philosophical direction that is coming in to
work for us. Mr. Rosenthal, you have got employees that are
working for you right now and are looking for learning as to
how to potentially get into business to compete with you one
day, and do you know what? We accept that as a way of doing
business in this country, and that is the spirit of innovation
and entrepreneurship that I think we do need to encourage
because this is where most new jobs that help families come
from in the country.
Let's reframe the question. What are the big ideas out
there that can further draw an entrepreneurial spirit beyond
what we traditionally think about, which is access to capital
and proper education and less regulatory barriers?
One of which, and we have held many hearings in this
Committee, is the problem of health care. We have tethered
health care benefits generally to business because of the way
the 60-year history of this has been, and it is the way it is
written into the tax code. That is a possibility of untethering
that linkage so that people have portability, and yet at the
same time can afford to insure themselves from vulnerable
circumstances.
The other is have we structured the tax code, and Dr. Lyon,
perhaps you can address this, in a way that facilitates the
congregation of people in one place because we depreciate real
estate a particular way or assets a particular way versus
allowing people to be dispersed and entering in new types of
contractual arrangements from home or by telecommuting and
giving incentives to do that, which is much more consistent in
many ways with a lot of the new workplace philosophical
paradigms that we are seeing in terms of this entrepreneurial
spirit.
That may not work in all businesses where you have to have
certain economies of scale, either restaurant or manufacturing,
but in a lot it may, and are we impeding that progress because
of certain structures that we have in the tax code?
These are the kinds of ideas that I want to try to get
under and use you as experts in this field to help think
constructively through, all with the vision toward enlivening
and animating the spirit of entrepreneurship in this country,
which we all agree is for the benefit and well-being of
American families.
So who wants to take that on?
Mr. Lyon. I will start, and the others can be more
creative.
You ask some very challenging questions. If you look at the
compliance costs facing small businesses, you certainly want to
do everything possible to minimize the paper work that they are
required to do in order to claim tax benefits. One of the
virtues of a system like expensing is they do not have to worry
about depreciation schedules.
Mr. Fortenberry. I read your comments on expensing right
before I came.
Mr. Lyon. But short of trying to eliminate burdens in that
way by just allowing complete write-offs, I would say that the
next best thing you can do is strive for the lowest possible
rates on business income, and by doing that, it becomes less
important whether something has a 15-year life or a 20-year
life. The return to the business is being taxed at a lower
rate. Entrepreneurs can spend their time generating income
instead of trying to comply with the tax law.
Mr. Fortenberry. My time is done, but, gentlemen, if you
will ruminate on these broad questions, we are available for
input and ideas. I would appreciate your input because of your
expertise.
Thank you.
Chairwoman Velazquez. Your time has expired.
Ms. Fallin. You do not have questions?
Mr. Akin.
Mr. Akin. Just kind of piggybacking on the last question,
it would appear from even the experience of the last, say, six
years that if you take a look at 2000, we are coming into a
recession. In 2001 and 2002, we did some sort of feel good tax
cuts, and then the first quarter of 2003, we did dividend and
capital gains, and almost instantly you go from a barely over
one percent GDP jump to about four. Unemployment reverses
almost overnight to losing 140,000 jobs a month to gaining
about 160,000 within a period of a couple of months, and you
have got five or six years of a very strong economy.
And most interestingly enough to people in government,
particularly the people that like to spend government money,
the government revenues go up significantly. So here you have a
situation where we have actually cut taxes on businesses or at
least made money available to businesses through the dividends/
capital gains tax cut, and it appears to be paralleling what is
going on in Ireland.
You know, the Irish about 15 years, 20 years ago decided to
cut their taxes on business to be some of the lowest in the
entire European Union, and now everybody in Europe is trying to
copy Ireland because the economy is just going like mad.
It would seem like what we are talking about here is not
that complicated. What we need to do is get capital working in
small businesses. That seems to be the basic principle, and
instead the Fed. keeps cutting interest rates and creating
liquidity. The dollar is just going down like a submarine. It
seems like we have got our hand on the wrong lever and what we
should be doing is, even though it is not very popular, is to
just cut the dividends and capital gains, get the taxes off of
business.
Somebody said it is better to tax the people than to tax
the peach tree. It seems like we are just doing it the wrong
way. Does anybody want to comment?
Mr. Mackey. To comment on your question and the last
gentleman's question together, I mean, I agree we need a lower
compliance cost. We need to lower rates, but more importantly,
I think, when you look at the global economy, we need to do
whatever we can to make sure that dollars are invested in the
United States of America because there are a lot of places for
investors to put dollars right now, and we are truly in a
global economy when it comes to investment.
There are very few barriers to investment flowing to China,
to Europe, to other countries. And so we need to look at
everything we can do to make sure that investment happens here,
the research and development, the things that give us a
competitive advantage.
If that money is not spent here, we are going to lose that
competitive advantage, and unfortunately the industry that I
work with closely, the wireless and telecommunications, we are
saddled with a lot of tax provisions that still date back to
the 1980s when computers depreciated over 30 years, and we have
many, many problems with depreciation schedules with outdated
federal, state and local tax provisions that increase the cost
of investing.
When I look at my business and when I look at the data on
productivity and what is creating wealth in the United States,
it is investments in information technology and communications
that are not just helping those industries, but all of the
other small and large businesses that rely on that innovation,
like in my business, to be able to make money, to be able to
create jobs, to be able to provide the kind of health insurance
and other benefits that we provide for our workers.
So I do not know if that necessarily qualifies as thinking
outside the box in the way that you were doing, sir, and I
appreciate your question, but we have got to get a tax code
that, number one, makes sure that investment is here and stays
here so that our businesses will benefit.
Mr. Akin. That was my only question, Madam Chair. If
somebody else wants to respond, you can.
Mr. Greenblatt. If I may, I think the two idea that you are
trying to create is wonderful. If we could create a one-page
tax code, one page, we would save so much money in compliance
costs and being nervous that the IRS is going to do something
to us and hiring accountants. Right now I could hire a full
person that would make 40-something thousand dollars a year to
weld or to design or to engineer as opposed to paying it to an
accountant. It is insane that I am spending it that way.
In China they do not do that. In France they do not do
that. So we should have a one-page document for our taxes.
Chairwoman Velazquez. The time is expired, but, Mr.
Greenblatt, before we recess, I just would like to comment on
Mr. Mackey's assertion that we should have tax policies that
should be rewarding companies that are creating jobs in
America, not companies that are creating jobs abroad.
What are your comments on that?
Mr. Greenblatt. I make 100 percent of everything in
Baltimore City and we import nothing from China. We import
nothing from the Orient. So we are 100 percent American made.
We believe that if you make the environment so good for
Americans, they will never think about, you know, putting a
factory in Mexico or putting a factory in Canada. So what we
need to do is make it so that we are such a competitive
environment that you would not consider going elsewhere.
Chairwoman Velazquez. Okay. The Committee will stand in
recess until we vote on the floor. We are going to have three
votes. So it will be like 30 minutes.
[Recess.]
Chairwoman Velazquez. Mr. Chabot.
Mr. Chabot. Thank you.
Mr. Mackey, I will begin with you if I can.
Chairwoman Velazquez. It was fixed by a Democrat.
[Laughter.]
Mr. Chabot. Well, since the Democrats broke it, they ought
to fix it.
[Laughter.]
Mr. Chabot. Just kidding. We actually get along very well,
as most people know that follow this Committee.
Mr. Mackey, you mentioned before H.R. 5450, and I happen to
be a co-sponsor of that, which would deal with your problem of
wireless phones and the reporting requirements, personal versus
business and that sort of thing. Could you tell us how much
time is wasted in having to comply with the existing law?
And how often in the final analysis is it really enforced
in any event? So are people just spinning their wheels?
Mr. Mackey. That is a great question. I think not a lot of
time is spent enforcing it or complying with it, quite frankly,
because I do not think most businesses even know they are
supposed to be complying with it, and I think that the entities
that have received audit notices from the IRS have spent a lot
of time trying to figure out, gee, should we just basically do
away with providing our employees with cell phones because the
prospect of having to comply with this is so onerous that it
just not worth it, which of course means that employees then
lose the productivity benefit from having these hand-held
devices and phones that are so critical, you know, to their
ability to do their jobs.
I think if nothing is done about it and information about
the provision and enforcement starts to be more widespread,
then I think you are going to see a huge amount of time and
effort spent by small businesses, first, to figuring out what
to do and what the exposure is and trying to hire folks, you
know, to calculate the back tax liability, and then secondly,
sort of deciding what to do about it.
And then if they do decide to continue to provide it, I can
see, you know, just for myself when I travel around the
country, you know, everybody is going to have to have a policy
about whether you can call your husband or wife and talk to
your family when you are on the road. I mean, there is just an
endless amount of time, so much time I think that companies are
going to really have to rethink whether to provide the benefit
at all.
So it is a very onerous burden, and should it be more
enforced, it is just going to grow exponentially.
Mr. Chabot. Okay. Thank you.
Yes, Mr. Hoops.
Mr. Hoops. You know, when cell phones were first made
listed property, they first of all weren't nearly as common as
they are today, and they were much more expensive on a per unit
basis. So there was probably a good reason for treating them as
listed property, but now the cost of using a cell phone is so
inexpensive. You do not pay by the minute anymore. You buy as
many minutes as you need, and it is one flat rate so that, you
know, the cost benefit of treating this as listed property is
not even close to being a cost benefit in terms of the revenue
generation.
So we really fully support eliminating this as listed
property.
Mr. Chabot. Mr. Hoops, let me follow up with you on a
different question at this time. Yesterday, and, again, to show
the bipartisan cooperation on this Committee, the Chairwoman
and I together met with and addressed the Association of
Equipment Distributors who were here from all over the country
in this room yesterday, and we both gave a little talk, and
then we answered questions.
And one of the first questions that we got was relative to
LIFO that you referred to. Could you go into a little more
depth relative to what the problem is and what you believe that
Congress should do to address that problem?
Mr. Hoops. Well, sure. I would be happy to. You are talking
about the LIFO provision for S corporations?
Mr. Chabot. Yes.
Mr. Hoops. Okay. Many businesses adopt the LIFO method of
computing their inventory and cost of goods sold, and just
briefly the way the LIFO method works is that the costs
associated with a particular sale, you match up the cost of the
last inventory that you purchased with a particular sale. So if
I sell something tomorrow, I would match up my cost with a
product that I purchased today or the day before, not with a
product that I purchased some time ago.
So for a business that has been in existence for a long
period of time, what typically happens is that the inventory on
their balance sheet is reported at something significantly less
than fair market value because that inventory has accumulated
over many years, and as costs rise the cost of replacing that
inventory is much more.
The benefit of that, of course, is lower cost of goods sold
and lower taxes by corporations. When a corporation goes from
being a C corporation to an S corporation, the corporation no
longer pays a corporate tax, but the shareholders pay an
individual tax on the profits, as Mr. Greenblatt alluded to
before.
The provision states that when you elect S status, that
built-in gain in the inventory that had accumulated when you
were C corporation has to be reported in income before you
elect that status. So it's a tax on the C corporation at
conversion.
That is a very expensive tax for a small business, and the
truth of the matter is that if they had remained as a C
corporation, they probably would never have paid that tax or
they would only really pay the tax if they reduced their levels
of inventory significantly.
So our suggestion is that you do not penalize a corporation
that wants to elect S status by making them report that income
immediately. Rather, they would report it at the time a C
corporation would report it, when the inventories were reduced.
Mr. Chabot. Thank you very much.
Dr. Lyon, you had mentioned in your testimony that it is
your belief that what we should have is as clear, simple,
transparent a tax system as we possibly can at the lowest
possible rates and should, if possible, stay away from special
incentives. I assume what you mean basically, one thing you do
with that is you are further complicating the code. We are
trying to help, but we are adjusting things and new forms and
figuring it all out.
Could you again tell us why you believe that that is
important and that is the better route to take?
Mr. Lyon. Well, there are a number of reasons. One is just
to question whether the special incentives themselves really
make our economy more productive on the whole. It is a little
like industrial planning where we think certain activities are
more meritorious than others, and as we observed Japan at one
time engaged in that a great deal, their economy has not done
very well over the past decade. So there is a question of
whether we can really outguess the market in terms of what the
best activities are.
But the other point is that simply to claim these benefits
requires a lot of time spent in understanding how the rules
work, showing that you are in compliance, documenting it, and
especially for small businesses the cost of going through that
paperwork can eat up much, if not all, of the benefit that was
intended from the provision. If instead we had simply channeled
that reduced tax collection through lower rates, businesses
would have incentives simply to go out there and earn income in
the best way that they see to do it.
Chairwoman Velazquez. Would the gentleman yield?
Mr. Chabot. Yes, I would be happy to yield.
Chairwoman Velazquez. Would you say the same is true with
179 expensing and bonus depreciation?
Mr. Lyon. It is a difficult angle. There are some clear
benefits of Section 179 that businesses do not have to keep
paper track of depreciation of the property. They write it off
all at once. That is a big simplification advantage.
However, not all property qualifies for Section 179.
Investment in structures or inventory do not, and so again, we
are doing a bit of industrial planning in rewarding investment
in equipment that does qualify for it over other investments.
Chairwoman Velazquez. Thank you for yielding.
Mr. Chabot. Absolutely, and reclaiming my time, Mr.
Rosenthal, you are next if I can. One of the kind of common
things you hear about the restaurant industry is that when new
restaurants are started there is a fairly good chance that they
are not going to make it, that only so many make it beyond a
certain year, and that sort of thing. How much of the challenge
that a new restaurateur or perhaps even somebody that has been
in business for a number of years, how much of a challenge is
the dealing with the paperwork that is involved, the red tape,
an outside force telling you what wages you have to charge when
we say minimum wage is going to be this, that, or the other
thing?
And various governmental involvement in your business, how
significant is that in the whole success or failure of a
restaurant?
Mr. Rosenthal. Well, we are in a business that the
mortality rate for restaurants unfortunately is very high, and
there are many reasons for that, but over the last decade, and
I have been doing this for over four decades, so over the last
decade, the paperwork, the administrative level of trying to
maintain compliance has gotten so out of hand.
I will give you an example. We have an employee, a very
qualified employee who does nothing but work on I-9s, handles
our I-9 compliance issues because this is a major issue today.
And we pay about $50,000 a year individually in benefits for
someone to do nothing but handle our I-9s. We have about 600
employees, and we like most restaurants are turning about twice
a year. So we have a ton of this coming through, and we have
begged for a better system, a system where we can get on line
and qualify people without us having to do all of these
paperwork faxing, re-faxing. This is the best example.
Additionally, you are right. All of the paperwork utilized
for compliance with tip reporting has become onerous to a point
that we have had to actually invest in a computer system that
will insure that tips are declared properly and spread
properly, and we have a human resources person that handles
basically our tip employee wages, and that is all they do. So
the administrative level of handling not only the paper work
but the people in there and the qualified people to do these
jobs.
Additionally, we are faced with and all of our businesses
are operated as separate corporations for many reasons. They
may have another investor or someone else in there. So they are
set up separately, which means we now operate seven businesses
including the property, which means we have seven federal and
state tax returns, and our accounting bills have gotten to a
point that we do not have a general manager making what our
accountants get paid a year to handle our taxes.
So a long answer to a short question, but the answer is it
has become very onerous and getting worse every day as new regs
come in, health department regs, trans-fat bands, menu
labeling. It goes on and on and on to a point in a narrow
margin business you begin to wonder, as many operators begin to
wonder, is it really worth it. Is it worth expanding?
Mr. Chabot. Thank you very much.
And finally, Mr. Greenblatt, I think one of the main points
that you emphasized was the importance of making the tax cuts
that were already passed, the capital gains tax relief, the
marginal rates across the board, all of the above, make them
permanent. That is one of the main things that we could do.
You also talked about how many business owners are not
really taking a whole lot out of the company. They are plowing
it back in the business. So whereas it may look like they are
rich people, wealthy people who some would argue deserve to be
taxed more, in reality by plowing it back into the business,
they are growing that business and hiring a whole lot of other
folks, giving them a job.
Is that a fairly accurate portrayal that I just made, and
would you like to expound up that?
Mr. Greenblatt. I think you summarized it wonderfully. We
are the job machine. The small business manufacturer, the small
business in general is the job machine, and we are going to get
us out of the recession, and as you give us more impediments,
it is going to take us longer to get out of the recession.
When you tax us, we are less prone to reinvest back into
the company. We are going to be less competitive, and we are
going to lose more jobs to China. We are going to lose more
jobs to some of these other countries.
So the way for us to get motivated and to start hiring
again is to let us reinvest back into the company and grow the
company, and that is our future.
Mr. Chabot. Thank you very much.
Madam Chair, I yield back my time.
Chairwoman Velazquez. Thank you.
Mr. Hoops, we have talked about cell phones as listed
properties. Are there any other listed properties, like
automobiles, that are out of date and need to be updated?
Mr. Hoops. I would eliminate all of the listed property
rules, to be honest. That is one way to simplify the code, make
life easier for small businesses and really eliminate a
disparity that really should not exist.
Chairwoman Velazquez. Okay. And my question is to you. On
the first day of the 110th Congress I introduced H.R. 46, the
Small Business Tax Flexibility Act. One of the provisions in
that bill would give small start-ups the ability to choose the
fiscal year that best fits their business cycle.
This hearing is all about modernizing the tax code to make
it more small business friendly. With that in mind, why is it
important for our tax code to be flexible with regards to small
businesses that are in the start-up stage?
Mr. Hoops. Well, first of all, thank you very much for
introducing that bill. It is something that the AICPA has
supported and believes is necessary and has really thought that
for a long time. So thank you very much.
Mr. Rosenthal mentioned that most of the businesses in his
industry and, in fact, most small businesses, many small
businesses, too many small businesses fail in their first year
of existence. Right now almost all small businesses are
required to adopt a calendar year. There are a couple of
problems with that.
First of all, that may not match up against the
corporation's natural business year.
Second, if a new business starts up in October or November,
after being in business in those first critical months, it has
to stop, close its books and prepare a tax return. This would
give small businesses an opportunity to have a fiscal year that
matched up with their business cycle and for a new business to
have an opportunity to operate for a full 12 months before it
has to close its books.
As an aside, both Mr. Rosenthal and Mr. Greenblatt
mentioned the fees that they are paying to accounting firms. I
would personally like to thank you for that.
[Laughter.]
Mr. Hoops. But because most of our small business clients
are on a calendar year basis, there is an enormous amount of
work that CPA firms have to compress in terms of serving their
clients into a very short period of time.
I think that having fiscal year flexibility would allow
CPAs to devote more time to smaller, new businesses at a time
of year when they are not so incredibly busy. So that is
another important part of this provision.
Chairwoman Velazquez. Thank you.
Mr. Rosenthal, I know that Jasper's has been business for
over 25 years, and I wanted to get your thoughts on the recent
stimulus package that includes tax rebate. In 2001, Congress
passed similar legislation that sent out tax rebate checks to
millions of Americans. At that time, did your industry or
restaurants see a significant boost in revenues?
And do you anticipate higher volumes of business when the
checks start arriving in May?
Mr. Rosenthal. Well, we are all hopeful, but that is a
question which we have been pondering because the last time
that happened, we did not face some of the issues we are facing
today, and that is at the current rate it probably would fill
up someone's tank maybe two or three times, and I do not know
if they are going to have any money left to spend in
restaurants.
So I am not overly optimistic that we are going to see that
trickle down. The real problem--
Chairwoman Velazquez. But in 2001, you did see that?
Mr. Rosenthal. It did help. It did help at that time.
Chairwoman Velazquez. Mr. Mackey, the R&D tax credit
obviously is of great importance to your industry.
Traditionally, that credit has been mainly utilized by larger
companies.
How, in your view, could the credit be modernized or
simplified to make it more attractive for small businesses or
more friendly?
Mr. Mackey. Well, as I mentioned before, I mean, when you
think about the wireless industry, you are thinking about big
businesses, but I do think there are a lot of smaller companies
that are able to use the R&D credit. My firm, for instance, we
do not use it because we end up outsourcing a lot of the
development of software and things like that to other companies
which I assume are using the credit. So we benefit indirectly.
I do think that perhaps more small businesses are able to
take advantage of the credit than some people may generally
realize, and even if they do not take advantage of it directly,
indirectly they are able to benefit from the new products that
are being developed by small businesses that do take advantage
of the credit.
Chairwoman Velazquez. Thank you.
Mr. Hoops, how would the changes that you discuss make
small businesses more competitive? And do you believe that
these reforms could encourage greater small business formation?
Mr. Hoops. Yes, I do believe it would encourage greater
small business formation. I think the changes that we
discussed, most of which are relatively minor and simple to
fix, would go an enormous way, would make enormous strides
towards making it easier for small businesses to comply with
the tax law and to put their time and efforts to earning more
profits.
One of the other members was looking for the big idea. I
have been in this business now for over 30 years, and in those
30 years everyone is always looking for the big idea, but my
experience and judgment tells me that there really is no big
idea and that we would make a lot more progress, especially in
a down economy, by focusing on fixing the hundreds of things
that could be fixed relatively simply in the current tax code
to make it more efficient and easier to comply with for small
businesses.
Chairwoman Velazquez. Thank you.
Dr. Lyon, in light of the budget deficit, the tax gap is a
major concern for the federal government and has received a lot
of increased attention, given the budget deficit. One of the
drivers of the gap is the increasing complexity. How would
updating the tax code potentially reduce the tax gap?
Mr. Lyon. Thank you, Madam Chairwoman.
The actual studies have not been able to determine whether
complexity drives noncompliance. I think there is a lot of
common sense that when it takes more time to compute your
taxes, businesses that have many other valuable things to do
with their scarce time and resources may find it more valuable
to generate income instead of devoting resources to the
compliance costs.
And so I do think as we simplify the tax laws and
especially lower rates, it makes it much easier, less painful
to report income and the tax gap would go down.
Chairwoman Velazquez. Thank you.
Yes, Mr. Hoops.
Mr. Hoops. I think that there is no tax code simplification
that could ever cure the tax gap when it comes to simply not
reporting the income that everyone knows should be reported,
and sadly for the small business owners, sadly the evidence is
irrefutable that when you have increased reporting, you have
increased compliance.
But also I would say based upon my experience and practice
and just dealing with my neighbors is that when there is a
perception that the tax code is extraordinarily complex and
unfairly favors some groups over the other, that people are
even less enthused about paying the taxes that they should pay.
So I think that that tax code in some cases contributes
directly to the tax gap with its complexity and certainly in
other cases indirectly to the tax gap.
Chairwoman Velazquez. Thank you.
Mr. Chabot. Would the gentle lady yield?
Chairwoman Velazquez. Sure.
Mr. Chabot. Yes I thank the gentle lady for yielding.
The term ``the tax gap'' was one that sort of came up a few
years ago, and some--certainly not the Chairwoman because she
does everything right--but some people have used that term--
Chairwoman Velazquez. Make sure that is reflected in the
record.
Mr. Chabot. That is right.
[Laughter.]
Mr. Chabot. But some people, I think, have used that term
because they think that the problem is Congress has been
spending this much and we have been taxing this much. So we are
spending more than we in. So there is sort of this idea out
there that there is a gap between what we spend and what we
bring in in taxes, and some people are not paying their fair
share of their taxes. If we can just get them, we can keep
spending this extraordinary amount of money that we are
spending up here.
And the bottom line is we just spend too much in Congress.
That has been true under Democratic control now and it was true
certainly when Republicans were in control as well.
So it is just a term that sort of has political
implications. Certainly those that are not paying their taxes
are not being fair to those that are, but I think the IRS and
others try as hard as they can to make people comply with the
tax code, and I just would not want to leave that impression
out there that all we have to do is try harder or simplify the
code, which I do think we ought to simplify, but then we will
have more money. Then we can keep spending all of this
exorbitant money, you know.
We need to get control of spending.
Chairwoman Velazquez. Yes, it really grew during this last
eight years.
Anyway, any more questions?
[Laughter.]
Mr. Chabot. Including this eighth year, too. So I have no
other questions.
Chairwoman Velazquez. Okay. So let me take this opportunity
again to thank all of you for your participation and insights,
and we will continue to work.
Today we release this report that I will encourage you to
read and to make any comments that you might want, and I ask
unanimous consent that members will have five days to submit a
statement and supporting materials for the record. Without
objection, so ordered.
This hearing is now adjourned. Thank you.
[Whereupon, at 12:36 p.m., the Committee meeting was
adjourned.]
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